Pensions and Benefits Committee

ABI Committee News

Third Circuit Sets Standard for Applying Distress Termination Test to Multiple Plans

A recent decision by the U.S. Court of Appeals for the Third Circuit sets forth a new standard for applying the Employee Retirement Income Security Act of 1974’s (ERISA’s) distress termination test when a bankrupt entity seeks to terminate two or more of its defined benefit plans. In re Kaiser Aluminum Corp., 456 F.3d 328 (3d Cir. 2006). In Kaiser Aluminum, the appeals court held that a bankruptcy court should apply the distress test to all of the debtor’s plans in the aggregate rather than to each plan individually, contrary to the position taken by the Pension Benefit Guaranty Corp. (PBGC). While courts in the past have applied the distress termination test both to plans in the aggregate (when the debtor seeks to terminate more than one plan) and to plans individually (when the debtor seeks to terminate only one of its plans), there are no decisions prior to the Kaiser case expressly considering how to apply the test.

ERISA provides that a plan sponsor that meets certain statutory “distress termination” criteria may terminate its underfunded defined benefit pension plans and turn them over to the PBGC, which then becomes responsible for paying benefits up to statutorily guaranteed amounts. See generally 29 U.S.C. §§1341(c) and 1322. Under the statute, the critical test the bankruptcy court must apply is whether, “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 a chapter 11 reorganization process.” 29 U.S.C. §1341(c)(2)(B)(ii).

In Kaiser Aluminum, the debtor proposed to terminate six of its pension plans.2 PBGC argued that some of the plans, when viewed on an individual basis, failed to meet the distress test and therefore could not be terminated. The bankruptcy court, the district court and the Third Circuit all rejected PBGC’s arguments. The Third Circuit found that PBGC’s position of looking at each of the debtor’s plans individually rather than collectively required a strained statutory interpretation and would lead to unfair results.

The Third Circuit found that in every case it was able to identify where a debtor wanted to terminate multiple plans at once, the courts looked at the plans in the aggregate, although the courts did not explain why they chose the aggregate rather than a plan-by-plan analysis. PBGC had not previously objected to this methodology.

PBGC argued that because the statute used the singular “plan” in the phrase “unless the plan is terminated,” Congress intended that each plan be evaluated separately. The appeals court rejected this argument, finding that such a reading would render the statute unworkable. Were the court to accept PBGC’s argument, then the order in which a court considers the plans would determine in many cases whether a particular plan qualifies for a distress termination. For example, in a case where the levels of underfunding of the debtor’s plans vary, applying the test first to the debtor’s plan with the largest underfunding and finding that it qualifies for a distress termination might mean that the debtor’s remaining plans would then become affordable. On the other hand, if the court were to consider the plan with the greatest underfunding last, the other plans might well be deemed unaffordable and thus satisfy the distress test.

The court also considered §1113 of the Bankruptcy Code, which sets forth the exclusive means by which a debtor-in-possession may seek to reject its collective bargaining agreements. In many cases, the debtor has a pre-existing collective bargaining agreement requiring the maintenance of the debtor’s defined benefit pension plans. In those cases, there can be no distress termination until after the collective bargaining obligation has been eliminated—either through negotiated resolution or court order authorizing rejection of the agreement. Section 1113 requires that before a collective bargaining agreement can be rejected, the debtor first must make a proposal to the union to modify the agreement and that, among other things, the proposal be fair and equitable to all affected parties. The Third Circuit held that a plan-by-plan approach would violate the “fair and equitable” requirement of §1113 and principles of equity embodied generally in the Bankruptcy Code.  The court then held that employing PBGC’s approach under the Kaiser facts would result in an unfair and improper burdening of “certain employees disproportionately as compared to other employees.”

The PBGC also argued that the legislative history, its own administrative interpretation and public policy supported its view. The court rejected each of these contentions and was unpersuaded by PBGC’s argument that the legislative trend was to tighten restrictions on plan terminations, as the court believed a plan-by-plan analysis would likely result in more, not fewer, plan terminations. The court also refused to defer to PBGC’s interpretation, as it found that issues relating to bankruptcy were not within PBGC’s expertise and that, even if they were, PBGC had not articulated a position on the issue sufficient to entitle it to Chevron deference.3 While the Court recognized PBGC’s public policy arguments,4 it held that the legislature, not the courts, was the appropriate entity to decide public policy.

A district court judge in the Eighth Circuit has now followed the Third Circuit’s lead. See PBGC v. Falcon Products, 2006 WL 2711640 (E.D. Mo. 2006). Elsewhere in the country, one should expect the PBGC to continue to fight for its plan-by-plan interpretation.

1 Sara Pikofsky is an associate at Thelen Reid Brown Raysman & Steiner LLP concentrating in pension and benefits litigation, including representations involving the termination of benefits in bankruptcy.

2 Kaiser Aluminum initially moved to terminate seven plans, but later withdrew its motion with respect to one of the plans when it determined it was not underfunded.

3 See Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984).

4 PBGC argued that an aggregate approach would harm workers because it would lead to unnecessary plan terminations and would harm the PBGC economically with increased terminations.