Pensions and Benefits Committee

ABI Committee News

Regulators' Perspective: Handling Distress Terminations in Bankruptcy

Title IV of ERISA sets forth the exclusive means for terminating a PBGC-insured pension plan: (I) an employer-initiated (voluntary) standard termination of a fully-funded plan or distress termination of an underfunded plan, and (II) a PBGC-initiated (involuntary) termination of an underfunded or abandoned plan.  29 U.S.C. §§1341(a)(1), 1342(a); see Hughes Aircraft v. Jacobson, 525 U.S. 432, 446 (1999).2 

This article focuses on distress terminations of underfunded plans maintained by chapter 11 debtors. After discussing the basic statutory framework, recurring issues, and key court decisions, the article will provide some practical guidance for bankruptcy generalists.
Under ERISA’s reorganization distress test, the bankruptcy court must determine that “unless the plan is terminated, [the debtor] will be unable to pay all its debts pursuant to a plan of reorganization and will be unable to continue in business outside [bankruptcy],” and “approve the termination.” §1341(c)(2)(B)(ii)(IV). Under ERISA’s business-continuation distress test, typically applied to nondebtors, PBGC must determine that “unless a distress termination occurs, [the entity] will be unable to pay [its] debts when due and will be unable to continue in business.” §1341(c)(2)(B)(iii)(I). 

ERISA provides that the plan sponsor and its controlled group members are jointly and severally liable for minimum funding contributions. §1082(c)(11)(B)(i).3 Likewise, the sponsor and each controlled group member must meet a distress test. §1341(c)(2)(B). In practice, under the reorganization and business continuation tests, projected cash flow generally must be inadequate to support projected minimum funding contributions. As discussed below, the feasibility of a reorganization plan and the debtor’s ability to attract necessary capital may be relevant.

A distress termination cannot proceed if it would violate a collective bargaining agreement. §341(a)(3). Therefore, a termination motion may be preceded by a motion to modify or reject the CBA under 11 U.S.C. §1113. The plan itself cannot be rejected as an executory contract. In re Philip Services Corp., 310 B.R. 802, 808-09 (Bankr. S.D. Texas 2004).

The reorganization distress test has generally been construed as a “but for” test-that is, after all constituencies have made meaningful sacrifices and the debtor has explored all reasonable alternatives, the debtor would be able to reorganize “but for” pension-funding requirements. In re Resol Mfg. Co., Inc., 110 B.R. 858, 861-62 (Bankr. N.D. Ill. 1990). In some reported cases, this has been a close question. Compare In re U.S. Airways Group, Inc., 296 B.R. 734 (Bankr. E.D. Va. 2003), with In re Wire Rope Corp. of America, Inc., 287 B.R. 771 (Bankr. W.D. Mo. 2002).  

The statute speaks of a reorganization plan. Courts have therefore held that the question is whether the pension plan is unaffordable under any feasible reorganization plan. As one court put it, this is a matter of existential financial reality, not the reorganization plan that certain constituencies may prefer. Philip Services, 310 B.R. at 808. Among the factors considered are whether the debtor has considered funding waivers, benefit freezes and other measures to reduce pension costs, trimmed other fixed costs and properly identified discretionary spending. U.S. Airways, 734 B.R. at 745; Philip Services, 310 B.R. at 805, 808.  

In some cases, the debtor argues that no plan is feasible because the exit lender or equity investor will not fund unless the pension plan is terminated.  There, the debtor must show that the transaction has been market-tested.  The lender’s or investor’s ipse dixit does not suffice. Philip Services, 310 B.R. at 808; accord, In re Aloha Air Group, No. 1:05cv00777 (D. Haw. 12/15/05) (Tr. 73-79). In other cases, the debtor argues that all pension plans must terminate even though some are affordable, based on equality of sacrifice among workers, particularly where the distress termination motion follows rejection of one or more CBAs under §1113. PBGC argues that ERISA calls for a plan-by-plan determination, and that ERISA does not embody a fair and equitable standard like §1113. This issue is on appeal in two cases, In re Kaiser Aluminum, 2005 U.S. Dist. LEXIS 5106 (D. Del. 2005), appeal docketed, No. 05-2695 (3d Cir.), and Falcon Products, Inc. v. PBGC, No. 4:05cv2247 (E.D. Mo.).4

In addition to giving 60-day notice of a proposed termination to plan participants and beneficiaries, any union and the PBGC (§§1301(a)(21), 1341(a)(2)), the debtor must give PBGC timely notice of the distress motion. §1341(c)(2)(b)(ii)(III). PBGC may object, and at the least will advise the court of the legal standards and how they may apply.5 If the court makes the necessary findings, PBGC will be bound by a final and nonappealable order. 29 CFR §4041.41(d)(iv). Of course, if the order is entered over PBGC’s objection, PBGC may appeal. In any case, since the ultimate determination involves other ERISA requirements and may involve nondebtors, that determination is for PBGC. In re Sewell Mfg. Co. Inc., 195 B.R. 180, 185 (Bankr. N.D. Ga. 1996); accord In re Diversified Industries Inc., 166 B.R. 141, 144-45 (E.D. Mo. 1993).

For bankruptcy practitioners, I would emphasize several points. First, the debtor should establish that it has considered alternatives to plan termination, such as a benefit freeze or a funding waiver. The debtor should also establish that it has taken appropriate cost-cutting measures, and that affected constituencies, including executives and managers, rank-and-file workers and trade creditors have made reasonable sacrifices. The debtor should also establish that exit financing, whether an exit loan, an equity infusion, or favorable trade terms, has been appropriately market-tested. 

Second, the debtor should consider the timing of distress proceedings in light of ERISA’s notice requirements, any §1113 proceedings and the timetable for the reorganization plan process. If distress proceedings are set for the eve of confirmation and plan termination is a condition precedent to confirmation or closing, the reorganization plan would carry significant execution risk. If §1113 proceedings are also set for the same timeframe and the CBA arguably prohibits voluntary plan termination, the problem is magnified.  

Third, the debtor should discuss plan-termination issues with PBGC early so PBGC can perform necessary due diligence. Exchange of information and views may avoid a contested proceeding, and in such cases may allow for streamlined proof (e.g., by affidavit or proffer). A trial on short notice, on the other hand, may well lead to a contest, which may be followed by two rounds of appeal. So attempting to resolve the issue consensually may be in the interest of all constituencies. Like most issues in bankruptcy, the majority of plan terminations are resolved consensually, without the cost of a full briefing and an evidentiary hearing and the attendant litigation risks. It may also be possible to resolve other issues with PBGC, such as allowance of claims and confirmation objections, which may facilitate a consensual reorganization plan.

A good example in my recent experience was In re Huffy, No 04-39148 (Bankr. S.D. Ohio). There, PBGC and the debtor cooperated in discovery and informal information exchange, with the encouragement of the creditors’ committee. A key issue was whether the exit financing had been appropriately market-tested. Ultimately, the distress motion was uncontested, and a claims settlement and a consensual reorganization plan followed.

1Mr. Goldowitz is deputy chief counsel of the PBGC. The views expressed do not necessarily represent the PBGC’s views.

2 Unless otherwise noted, all statutory citations reference Title 29 of the U.S. Code. 

3A controlled group consists of all 80 percent or more commonly owned entities.  §§1082(c)(11)(B)(ii), 1301(a)(14); IRC §414(b), (c); 26 CFR §1.414(b)-1, (c)-1 et seq.

4The court agreed with PBGC on this issue in In re Special Metals Corp., No. 02-10335 (Bankr. E.D. Ky. 12/12/03) (Tr. 65).  See, also, U.S. Airways, 296 B.R. at 744.

5For a recent example, see Response of PBGC to Debtors’ Motion for approval of Distress Termination of Pension Plan, In re Hexacon Electric Co.,  No. 05-18846 (Bankr. D. N.J. Dec. 30, 2005).