Regulatory Update: Bankruptcy Filing Date Treated as Plan Termination Date For Certain Purposes
by: Nichole Brunk*
Pension Benefit Guaranty Corporation; Washington, D.C.
When an underfunded, single-employer defined-benefit pension plan terminates, it must go through plan termination procedures set forth in title IV of the Employee Retirement Income Security Act of 1974 (ERISA).[1] Invariably, the Pension Benefit Guaranty Corporation (PBGC)[2] becomes the statutory trustee of the terminated plan and pays benefits to participants, even if the plan would otherwise be unable to meet those obligations. The benefits that PBGC pays depend on each participant's benefits earned under the provisions of the plan, the statutory and regulatory limits on PBGC's guarantee, the statutory scheme for allocating the assets of the terminated plan and the amount of those plan assets.
Until recently, the application of all of the above factors depended heavily on the plan's "termination date." As of the termination date, established under §4048 of ERISA, no additional benefits can be earned. Therefore, a participant's benefit can be no more than the amount he or she has earned as of the termination date, and PBGC guarantees are fixed as of that date.
The Pension Protection Act of 2006 (PPA 2006) changed this feature of title IV for many plans. Section 404 of PPA 2006 amended title IV to provide that, where an underfunded pension plan terminates during the bankruptcy of the plan sponsor,[3] many of the factors used in benefit determinations will be measured from the date the sponsor entered bankruptcy (bankruptcy filing date) rather than the plan's termination date. Applying the new provisions will generally reduce the benefits that PBGC pays. It may also change somewhat the dynamics of a bankruptcy case in which pension liabilities play a major role. The amendment applies to any plan that terminates during a bankruptcy proceeding initiated on or after Sept. 16, 2006 (a "PPA 2006 Bankruptcy Termination").
PBGC published proposed rules implementing the new provisions created by PPA 2006 on July 1, 2008. The following article summarizes many of the resulting changes related to the calculation of guaranteed benefits as well as the allocation of benefits to "priority category 3." Priority categories, part of the statutory method under which PBGC must allocate plan assets, dictate the order in which benefits under a plan are paid.[4] To read the proposed rule and the preamble in their entirety, go to www.pbgc.gov/docs/E8-14813.pdf.
The preamble to the proposed regulation notes that a persistent challenge to PBGC's insurance scheme is that a plan's funded status often deteriorates during a plan sponsor's bankruptcy. A substantial period can elapse between the filing of a bankruptcy petition and the termination of the sponsor's plans, resulting in significantly increased liabilities for PBGC. To better protect PBGC, Congress determined that PBGC's guarantees in a PPA 2006 Bankruptcy Termination should be based on the earlier bankruptcy filing date in lieu of the actual termination date.
There are several consequences attendant to this substitution of dates. For purposes of PBGC's guarantee, the following service components freeze on the bankruptcy filing date: accruals, vesting and eligibility for benefits (such as early retirement benefits). If the plan continues operating after the bankruptcy filing date, the participants will continue to accrue service under the plan, but the benefits associated with those postpetition accruals will not be guaranteed.
In a PPA 2006 Bankruptcy Termination, all of PBGC's guarantee limits will be determined as of the bankruptcy filing date. This means that the maximum guaranteeable benefit (MGB) that a participant can be paid,[5] the five-year phase-in of benefit increases[6] and the accrued-at-normal-limit[7] will be set as of the bankruptcy filing date, even though the actual termination date may be a year or more later. For participants with benefits affected by these limits, application of the PPA 2006 changes can result in a substantially lower monthly benefit.
The modification to guaranteed benefits will also affect participants who become eligible for certain benefit types, such as disability benefits or early retirement subsidies,[8] after the bankruptcy filing date but before the plan's termination date. For example, in a plan that offers an unreduced early retirement benefit after 30 years of service, a participant who has 29 years of service with the employer as of the bankruptcy filing date and later completes 30 years of service before the plan's termination date, will not have that subsidized benefit guaranteed.
Participants in a terminated plan sometimes receive more from PBGC than their guaranteed benefit. This happens if all or part of a participant's benefit is entitled to priority in the six-tier allocation scheme in §4044 of ERISA and if the plan had enough assets to pay those benefits. Under §4044, benefits are assigned to a "priority category" of one through six, with higher priority going to the lower-numbered category.[9] The value of the plan assets is then "poured through" the categories, beginning with priority category one, until the assets are exhausted or all priority categories are covered.
Priority category three is usually the most important category, for it is typically when benefits are in this category that a participant may receive more than his or her guaranteed benefit. Prior to PPA 2006, it included benefits that were in pay status (i.e., were being paid to a retiree) as of the beginning of the three-year period ending on the termination date, or that would have been in pay status had the participant retired by that date.[10] However, any benefit increases that became effective during the five-year period before the termination date are not included.[11] This category was substantially altered as a result of PPA 2006. Like the change to the guarantee amounts, the change to priority category three requires use of the bankruptcy filing date, rather than the termination date, for measuring the three-year and five-year periods described above.
Because of the importance of the bankruptcy filing date in a PPA 2006 Bankruptcy Termination, the determination of the filing date becomes quite significant. In some cases, the determination will be straightforward as the date that the bankruptcy petition was filed will be obvious. But there are situations where the date could be considered ambiguous. One such situation would occur if a plan has more than one sponsor and multiple sponsors have filed bankruptcy petitions on different dates. In this case, PBGC proposes to determine the dates for purposes of calculating guaranteed benefits based on the facts and circumstances involved. In addition, where a sponsor has filed for reorganization under chapter 11, but the case is later converted to a liquidation case under chapter 7, the initial filing date, not the conversion date, will be used as the bankruptcy filing date.[12]
Another issue relating to determination of the bankruptcy filing date involves involuntary bankruptcy petitions. The proposed rule does not distinguish between voluntary and involuntary filings, but comments on the topic were received during the regulatory comment period.[13] The comments have urged PBGC to define the bankruptcy filing date as when a court issues an order of relief in the case of an involuntary bankruptcy proceeding, as opposed to the date that the petition is filed against the debtor. As of this writing, PBGC has not yet issued a final rule.
Finally, although benefits payable in a PPA 2006 Bankruptcy Termination will be typically calculated as of the date of the bankruptcy filing, the plan's actual termination date will continue to control for other purposes. [14] Of particular interest to many participants, PBGC will continue to use the plan termination date for calculating benefit overpayments subject to recoupment. Overpayments often occur because PBGC must estimate benefits while it processes the termination of the plan. If it is later determined that the participant received more than he or she was entitled to under title IV of ERISA, the net amount of overpayments is recouped by PBGC by reducing future benefits. The net overpayment is calculated from the latest of several dates-one of which is the plan termination date.[15] PBGC proposes to make no change to this rule, meaning that benefits paid to participants between the bankruptcy filing date and the plan termination date will not be treated as overpayments and subject to recoupment by PBGC.
The PPA 2006 amendments to §§4022 and 4044 are among the most significant changes to PBGC's benefit guarantee in many years. The substitution of the bankruptcy filing date for the plan termination date will certainly affect the level of benefits payable to many participants in PPA 2006 Bankruptcy Terminations and may change the way that pension plans are handled during a plan sponsor's bankruptcy.
* Nichole Brunk is an attorney in the Office of Chief Counsel of the Pension Benefit Guaranty Corporation. The views expressed in this article do not necessarily represent the PBGC's views.
1.29 U.S.C. §1301, et seq.
2. PBGC is a wholly owned U.S. government corporation created by ERISA. One of PBGC's functions is to insure certain benefit payments to participants when a covered, single-employer pension plan terminates with insufficient assets to pay liabilities under the plan.
3. The plan sponsor is usually the employer.
4. Priority categories are discussed in more detail below.
5. 29 U.S.C. §1322(b)(3). This is a statutory limit, which increases annually. The MGB for 2008 for a straight life annuity commencing at age 65 is $4,312.50 per month, and in 2007 it was $4,125. This limit is actuarially reduced if a participant receives benefits from PBGC before he or she reaches age 65. Therefore, both the MGB and the participant's age at the bankruptcy filing date, not at the plan's termination date, will be used to calculate the maximum monthly benefit payable to that participant.
6. 29 U.S.C. §1322(b)(1). Under the "phase-in" rules, new or increased benefits are guaranteed in 20 percent increments. For example: If the bankruptcy filing date for a PPA 2006 is in 2007, and an amendment increasing benefits had been in effect for two years, only 40 percent of that increase would be guaranteed.
7. 29 C.F.R. §4022.21(a)(1).
8. Generally, an early retirement subsidy refers to a benefit payable to a participant before the attainment of the plan's normal retirement date that has not been actuarially reduced to reflect the early receipt of benefits.
9. 29 U.S.C. §1344(a)(1)-(6).
10. 29 U.S.C. §1344(a)(3); 29 C.F.R. §4044.13(a).
11. Id.
12. "Bankruptcy Filing Date Treated as Plan Termination Date," 73 Fed. Reg. 37,390, 37,397 (July 1, 2008) (to be codified at 29 C.F.R. pts. 4001, 4022, and 4044) (noting that this interpretation is consistent with the Bankruptcy Code provisions that state that such a conversion does not alter the date of filing the petition).
13. The comments are available on the PBGC Web site at www.pbgc.gov/practitioners/law-regulations-informal-guidance/content/page13748.html.
14. Some other instances where PBGC will still use the actual plan termination date are valuing plan assets, calculating unfunded liabilities under the plan, determining parties liable for the liabilities. Bankruptcy Filing Date Treated as Plan Termination Date, 73 Fed. Reg. at 37,392.
15. 29 C.F.R. §4022.81(c)(1).