by: Joel W. Ruderman
Pension Benefit Guaranty Corp.; Washington, D.C.
When the sponsor of a pension plan fails to make required contributions to the plan, and the aggregate unpaid balance of all current and past-due contributions exceeds $1 million, a lien arises under the Internal Revenue Code (IRC) 1 and the Employee Retirement Income Security Act of 1974 (ERISA) in favor of the plan against all of the assets of the plan’s sponsor and the members of the sponsor’s controlled group.2 IRC §412(n)(1); ERISA §302(f)(1), 29 U.S.C. §1082(f)(1). The lien may be perfected and enforced only by the Pension Benefit Guaranty Corp. (PBGC) or at the direction of the PBGC. See IRC §412(n)(5); ERISA §302(f)(5), 29 U.S.C. §1082(f)(5).
This article focuses on how to calculate the amounts owed to a pension plan to determine when this statutory lien arises, how to calculate the amount of the lien, how PBGC perfects this lien against assets of the plan sponsor and its controlled group, and the extent to which the lien is valid against previously filed security interests.
Liens under IRC §412(n) were created pursuant to the Pension Protection Act of 1987 to provide an early warning to PBGC, the IRS and the plan’s participants of possible employer difficulty in meeting its funding obligations, and to ensure that contributions are actually paid to the pension plan. See H. Con. Res. 93, Rep. No. 100-76, at p. 222 (1987). The lien arises as a matter of law when the aggregate unpaid balance of contributions owed exceeds $1 million as of a due date for a required installment or payment. The plan sponsor is required to inform PBGC within 10 days of the due date of its failure to make a required installment or payment that causes a lien to arise. See IRC §412(n)(4); ERISA §302(f)(4), 29 U.S.C. §1082(f)(4). If the plan sponsor fails to inform the PBGC, a penalty may be assessed against the plan sponsor in an amount up to $1,100 per day. See ERISA §4071, 29 U.S.C. §1371; 29 C.F.R. 4071.3.
The amount of the lien is not the pension plan’s accumulated funding deficiency at the time of the missed payment. Instead, the amount of the lien represents the aggregate amount of all missed contributions, including interest. See IRC §412(n)(3); ERISA §302(f)(3), 29 U.S.C. §1082(f)(3). The lien will accrue interest from the payment due date at the funding standard rate established by the pension plan’s enrolled actuary. Unlike PBGC’s lien for termination liability under ERISA §4068, no statutory limit exists on the amount of the pension plan’s lien under IRC §412. Compare IRC §412(n)(3); ERISA §302(f)(3), 29 U.S.C. §1082(f)(3) with ERISA §4068(a); 29 U.S.C. §1368(a).
After the lien arises, if a subsequent quarterly payment is missed, a second lien will arise (assuming the sum of the new missed contribution and the previous missed contributions, plus interest still exceeds $1 million). This subsequent lien will arise in the amount of the subsequent missed payment. For example, if a lien arose on April 15 in the amount of $1.5 million and a subsequent contribution in the amount of $750,000 is missed on July 15, the pension plan would now possess an initial lien in the amount of $1.5 million, plus interest that accrues after April 15, and a second lien in the amount of $750,000 plus interest that accrues on that amount after July 15.
If the aggregate amount of missed payments, with interest, is reduced to less than $1 million as of the end of the plan year, the pension plan’s lien will expire as a matter of law at the end of the plan year. See IRC §412(n)(4)(B); ERISA §3022(f)(4)(B), 29 U.S.C. §1082(f)(4)(B). Because the statute provides for expiration of the lien only at the conclusion of the plan year when the missed contributions, plus interest, are less than $1 million, PBGC does not have the authority to extinguish the lien prior to the end of the plan year. Id. However, PBGC may withdraw the notice and/or subordinate the lien as part of a workout or forbearance agreement.
Although the pension plan’s lien under IRC §412(n) arises as of a specific date, the lien is not effective against other interests until a notice of the lien has been filed in the appropriate recording office. Notice of the lien is required to be filed in a manner similar to the way the Internal Revenue Service files federal tax liens pursuant to IRC §6323. See IRC §412(n)(4)(C); ERISA §302(f)(4)(B), 29 U.S.C. §1082(f)(4)(B) and ERISA §4068(c), 29 U.S.C. §1368(c).
Under IRC §6323(f), notice of federal liens against real property and personal property must be filed in the one office within the state designated for the filing of federal tax liens by the laws of the state in which the property subject to the lien is situated. IRC §6323(f)(1)(A). If a state fails to designate one office as the appropriate place, the notice must be filed in the U.S. District Court where the property subject to the lien is situated. IRC §6323(f)(1)(B). In some cases, federal tax liens and PBGC notices of a pension plan’s lien are filed in offices different from other liens, such as those under the Uniform Commercial Code (UCC). Therefore, a party conducting a public records search for notice of a pension plan’s lien must be sure to search the proper index at the proper recording office. For example, a plan sponsor incorporated in Delaware but with its principal executive office in New York will have UCC financing statements recorded with the Secretary of State of Delaware but federal tax liens filed with the New York Department of State.
Once notice of the pension plan’s lien is filed, the lien will have priority over any credit extended, and any collateral acquired by the borrower after the filing of the notice of the pension plan’s lien (subject to certain exceptions noted below). See IRC §6323.
The pension plan’s lien is not superior to a prior perfected security interest. Under the IRC, a security interest is recognized as perfected if it meets the following three conditions: (1) the property must exist; (2) the security interest is protected under state law against a subsequent judgment lien; and (3) the holder must part with money or money’s worth. IRC §6323(h)(1). Thus, if one of these conditions is not met, a lender’s security interest will not have priority over a pension plan’s lien.
Often a security interest will be perfected simultaneously with the pension plan’s lien. For example, a lender will have on file a security interest against future inventory and accounts receivable and PBGC will have filed a subsequent notice of the pension plan’s lien against the debtor’s personal property. Both the lender’s security interest and the pension plan’s lien will be perfected upon the debtor’s receipt of the inventory and accounts receivable. Under a decision of the U.S. Supreme Court, the federal lien will be superior. See U.S. v. McDermott, 507 U.S. 447, 449-450 (1993) (holding that the filing of notice renders the federal lien “first in time” for priority purposes). Thus, as a debtor’s inventory turns over, subject to certain exceptions, the pension plan’s lien will prime a secured creditor’s first priority position against such inventory and any accounts receivable arising from the sale of the inventory.
Section 6323(c) protects the priority of certain security interests for future extensions of credit and after-acquired property. These protections apply to a previously filed security interest against qualified property covered by either a commercial transaction financing agreement, a real property construction financing agreement or an obligatory disbursement agreement, as those terms are defined in the statute. However, these exceptions are limited. For example, the commercial financing exception is limited to credit extended at any time before the earlier of the 46th day after the filing of the pension plan’s lien and the time that the creditor received actual notice of the pension plan’s lien. See IRC §6323(c)(2). This exception is significantly less generous than the protections afforded a secured creditor as to future advances and after-acquired property under the UCC. See UCC §9-323(b) (protecting all advances made by a lender without knowledge of the lien of a judgment creditor). A more detailed description of the exceptions set forth in IRC §6323(c) is beyond the scope of this article.
IRC §6323(d) also contains a catch-all provision to protect prior perfected security interests. This subsection grants priority to a previously perfected security interest for any disbursements made by a lender within 45 days after the filing of notice of the PBGC lien, if the holder of the security interest did not have actual knowledge of the federal lien. Any disbursements made to a debtor after the 45-day period or after the lender learns of the federal lien, whichever comes first, will be primed by the federal lien. Thus, all disbursements made to a debtor 45 days after the filing of the notice, unless with respect to qualified property protected under IRC §6323(c), will be primed by the pension plan’s lien, regardless of whether the lender had actual knowledge of the lien.
A good example of a lien enforced by PBGC priming the lien of a prior perfected security interest occurred recently in In re Plymouth Rubber Company, Inc., Case No. 05-16088 (D. Mass). There, the lender continued to loan money to the debtor under a revolving line of credit based on its claim that it was unaware that PBGC had filed notice of a federal lien against the debtor’s personal property eight months earlier. During this eight-month period, the revolving credit line and the debtor’s inventory turned over several times. When the lender finally learned of the pension plan’s lien, the lender refused to continue to loan money to the debtor and the debtor filed bankruptcy. The lender raised numerous arguments contesting the pension plan’s first-priority position against the debtor’s personal property, including lack of actual notice. Ultimately, the lender and PBGC resolved the matter by granting PBGC a first-priority position against the debtor’s personal property in the amount of $5.2 million. As a result, the lender’s position against the debtor’s collateral was undersecured by $3.5 million.
Thus, a revolving lender would be well advised to conduct due diligence with regard to a debtor that has a defined benefit pension plan every 45 days to ensure that notice of a lien has not been filed by PBGC. This practice is even more imperative when the debtor’s financial statements and regulatory filings indicate that the pension plan is underfunded.