Despite indicators that the economy may be improving, the sting from the last few years will continue to encourage prudent employers to consolidate operations and shut down outdated manufacturing facilities. An important lesson learned from recent plant shutdowns involves the need for advance planning for defined benefit pension plans that cover employees who will be laid off when a plant closes. The recent assumption of multimillion-dollar pension obligations by the Pension Benefit Guaranty Corporation (“PBGC”) from underfunded automotive-related pension plans has taken a major toll on the PBGC’s coffers. This is prompting immediate attention from the Department of Labor and PBGC upon notice of a plant shutdown. Interestingly, the PBGC frequently receives “notice” of a plant shutdown in the form of newspaper articles that are released prior to an actual notice to the PBGC by the plan sponsor.
ERISA’s Plant Shutdown Pension Liability
There are very few defined benefit pension plans that are fully funded on a plan termination basis. Under Section 4062(e) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), following an employer’s cessation of operations at a facility in any location (usually referred to as a plant shutdown), if the pension plan covering the facility’s employees is not fully funded, and 20 percent of the active plan participants are terminated in connection with the shutdown, the employer sponsoring the plan is required to provide security to the PBGC to cover all or part of the unfunded pension liability. However, for purposes of calculating the liability, Section 4062 cites Section 4063 of ERISA, used to calculate multiple employer plan withdrawal liability, which for all practical purposes is not useful in the plant shutdown context unless all active participants are terminated in connection with the plant shutdown. Without a method for calculating the pension liability, PBGC very rarely enforced the security requirement. Fast forward to the 2006 release of PBGC regulations that provide a plant shutdown calculation method, followed by the drastic economic downturn starting in 2008 that foisted a multitude of underfunded pension plans on the PBGC, and suddenly the PBGC developed a keen interest in enforcing the plant shutdown security requirements (and enforcing them in a hurry while the employer still had valuable security to tender).
Depending on the liquidity of the employer, the security is usually provided through a combination of monetary forms that can include cash, a line of credit, mortgages (even mortgages on overseas properties), other security interests and any other unencumbered (and sometimes even encumbered) available assets. The security is then held by the PBGC and returned to the plan sponsor if the plan has not terminated within five years after the shutdown (no earnings accrue during the applicable five-year period). If the plan terminates on an underfunded basis during the five-year period, the security is applied to offset the underfunding. In the alternative, an employer may satisfy the security requirement by posting a bond equal to 150 percent of the plant shutdown pension liability. In our experience, this is rarely the preferred alternative. The form and amount of security to be tendered is negotiated between the PBGC and the plan sponsor following the PBGC’s review of a detailed information request on the employer’s assets. (As a caveat, all employers should enter into a confidentiality agreement with the PBGC before tendering sensitive financial information.)
PBGC Plant Shutdown and Reportable Event Notices
Within 60 days of the plant shutdown (or date on which the plan’s 20 percent reduction in active participants occurs), the plan administrator is required to submit written notice of the shutdown to the PBGC and request that the PBGC calculate the employer’s resulting pension liability. In addition, under Section 4043(c) of ERISA, within 30 days following a reduction in the number of active participants to 80 percent of those at the beginning of the plan year, or 75 percent of those at the beginning of the previous plan year, the plan administrator is required to file a Notice of Reportable Event with the PBGC. For ease of administration, the two Notices can be combined and reported to the PBGC in one document.
IRS Partial Plan Termination Considerations
Frequently, a reduction in active participants of 20 percent or more results in a partial plan termination requiring 100 percent vesting of affected participants to the extent their accrued benefits are funded. The 20 percent figure may be calculated, for IRS purposes, by aggregating employer-initiated turnover over several years. Advance Planning In many instances, advance planning can avoid or lessen the imposition of the plant shutdown security provisions. In particular, prior to the plant shutdown, a merger of the pension plan covering the plant employees into another pension plan, sponsored by the same employer or controlled group of employers, may create a participant population sufficiently large to avoid the 20 percent reduction in active participants. However, plan mergers require disclosure to the impacted plan participants, as well as IRS filings, both of which require advance planning. If a plan merger is not an option, the employer may still be able to transfer employees to another location, or plan the timing of the shutdown to help alleviate the security burden. For instance, under certain circumstances, the cessation of operations in several stages could be beneficial. Further, the determination of the 20 percent reduction may be extended, for PBGC purposes, if the shutdown occurs in stages. When a plant shutdown is under consideration, a significant amount of heartburn and expense can be avoided by including the pension plan’s actuary and employee benefits counsel in discussions as early as possible.
To comply with U.S. Treasury regulations, we must advise you that any discussion of Federal tax issues in this communication was not intended or written to be used, and cannot be used, by any person (i) for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service or (ii) to promote, market or recommend to another party any matter addressed herein.