The Pension Benefit Guaranty Corporation (PBGC) was created by the Employee Retirement Income Security Act of 1974 (ERISA) to help protect the retirement benefits of employees who participate in defined benefit pension plans. To carry out this mandate, ERISA provided the PBGC with certain enforcement mechanisms. One such mechanism is ERISA Section 4062(e). Under certain circumstances referred to as a “Section 4062(e) event,” Section 4062(e) imposes liability on downsizing employers with underfunded defined benefit pension plans.
Although Section 4062(e) has been in effect for decades, little guidance has been issued to assist employers and plan administrators in assessing whether a Section 4062(e) event has, in fact, occurred. In 2006 the PBGC issued a final rule pertaining solely to the computation of an employer’s liability due to the occurrence of a Section 4062(e) event.1 However, it declined to offer guidance on the definitions and meanings of various words and phrases in the provision, often leaving employers uncertain how the PBGC would construe the statute in a given situation.
On August 10, 2010, the PBGC released a proposed rule seeking to clarify the prerequisites required to trigger a Section 4062(e) event that would supersede all of the PBGC’s prior opinion letters and guidance under ERISA Section 4062(e). The preamble to the proposed rule highlights the PBGC’s increased focus on Section 4062(e) by noting that throughout the three and a half years between the issuance of the 2006 final rule and the release of the proposed rule, the PBGC resolved 37 cases under Section 4062(e) and negotiated settlements valued at more than $575 million, providing protection to more than 65,000 plan participants.
The PBGC’s latest proposed rule greatly expands the universe of potential Section 4062(e) event triggers, reiterating the PBGC’s recent aggressive pursuit to monitor underfunded plans. As discussed below, the proposed rule reverses prior PBGC guidance suggesting that asset sales were immune from Section 4062(e)’s reach, and stretches the terminology in Section 4062(e) to provide the PBGC with discretion to impose Section 4062(e) liability on a wide variety of employer business decisions that were once thought exempt from that section.
An Introduction to ERISA Section 4062(e)
ERISA Section 4062(e) states:
If an employer ceases operations at a facility in any location, and as a result of such cessation of operations, more than 20 percent of the total number of his employees who are participants under a plan established and maintained by him are separated from employment, the employer shall be treated with respect to that plan as if he were a substantial employer under a plan under which more than one employer makes contributions and the provisions of sections 4063, 4064, and 4065 shall apply.2
Section 4062(e) requires employers to self-monitor for Section 4062(e) events and report any occurrence to the PBGC. The plan administrator of the affected plan is required to file a notice with the PBGC within 60 days of the later of the cessation date or the date when the number of affected participants is more than 20 percent of the active participant base.3 The filing of the notice by the plan administrator constitutes a request that the PBGC determine the employer’s liability in conjunction with the Section 4062(e) event.
Upon receiving the plan administrator’s notice, the PBGC determines the resulting employer liability by multiplying the liability that would have occurred if the plan had been terminated by the PBGC immediately after the cessation date by the ratio of the number of affected participants to the active participant base.4 In order to satisfy the liability, the PBGC requires that the employer either pay the full amount of the liability to the PBGC to be held in escrow or furnish a bond equal to no more than 150 percent of the liability.5 The PBGC retains full discretion to enter into other arrangements with the employer to satisfy the event, the PBGC must return any escrowed funds or the employer is entitled to cancel the bond.
Goal of the New Proposed Rule
The stated goal of the PBGC’s proposed rule is to provide employers with increased clarity to assess whether certain actions rise to the level of a Section 4062(e) event. The proposed rule’s definitions and interpretations of key terminology in Section 4062(e), including “operation,” “facility,” “cessation,” “separation,” “result” and “active participant base,” grants the PBGC broad powers to assert that Section 4062(e) events have occurred. The proposed rule interprets these terms more broadly than prior PBGC guidance, case law and statutory interpretations. For example the PBGC’s proposed rule purports to close a loophole exempting employers from Section 4062(e) liability when a plan has changed sponsors.7 Constructing the terms of the statute in such fashion may be seen by some to frustrate an intended purpose of Section 4062(e). Additionally, within the preamble the PBGC explicitly states an employer’s risk is irrelevant in determining whether a Section 4062(e) event has occurred.8 While this may be true, the breadth of the proposed rule suggests the PBGC will continue to aggressively assess an employer’s overall financial strength when determining how to satisfy any resulting liability under Section 4062(e).
Defining a Section 4062(e) Event that Triggers an Employer’s Reporting and Liability Obligations Under the PBGC’s New Proposed Rule
As noted above, a Section 4062(e) event occurs when an employer ceases operations at a facility in any location and, as a result of the cessation, more than 20 percent of the employees participating in a plan established and maintained by the employer are separated from service. As described in the following sections, the PBGC’s proposed rule attempts to increase clarity for employers and plan administrators by defining each of the applicable terms in greater detail and in broader terms than any prior guidance.
WHAT CONSTITUTES AN “OPERATION AT A FACILITY IN ANY LOCATION” WHEN ASSESSING WHETHER A SECTION 4062(E) EVENT OCCURS?
The proposed rule defines an operation as “a set of activities that constitutes an organizationally, operationally, or functionally distinct unit of the employer.”9 Determining whether a set of activities is an operation depends, in part, upon whether the activity is considered or treated as operation within the relevant industry, the employer’s organizational structure or accounts, or any relevant collective bargaining agreement. Additionally, the PBGC will look to how the employer’s employees and customers and the general public perceive the activities to determine whether they constitute an organizationally, operationally or functionally distinct unit of the employer.10
Notably, the PBGC changed the term operations from plural in the act to singular in the proposed rule. Although the PBGC maintains this interpretation of the term “operation” remains consistent with its prior interpretations, it could serve to greatly expand Section 4062(e)’s scope. Specifically, prior to the proposed rule, the assumption was that all or substantially all operations at a facility must cease in order for Section 4062(e) to apply. By changing the term “operations” from plural to singular, the proposed rule would allow the PBGC to assert that a Section 4062(e) event occurs when less than all operations at a facility cease—which appears to be a novel interpretation of the term and of Section 4062(e)’s reach.
The proposed rule’s definition of the phrase “facility in any location” also appears to expand the possibilities for a Section 4062(e) event. The proposed rule defines a facility in any location to mean the place or places where an operation is performed.11 Typically a “facility” is a building, series of buildings or similar structures, though the term also encompasses any one or more enclosed or open areas or structures.12 Most important, as discussed above, a single facility can now house multiple discrete and/or interrelated operations. The preamble to the proposed rule provides a specific example on this point:
For example, an employer might conduct a manufacturing operation under the same roof with shipping and administrative functions – or with another, distinct manufacturing operation. If the employer ceases the manufacturing operation (or one of the two manufacturing operations) at the facility, the cessation may fall within the ambit of a Section 4062(e) event even though the shipping and administrative operations continue in earnest.13
If the PBGC adopts this interpretation in its final regulations, potential Section 4062(e) liability could be greatly expanded.
The proposed rule appears to apply to an employer’s cessation of an operation at a facility in any location even when the employer continues or resumes the operation at another location. Accordingly, when an employer ceases operations at Facility A and relocates the operations to Facility B, a possible Section 4062(e) event occurs. Note, however, the proposed rule somewhat tempers the effect of relocations by exempting certain transferred employees within the definition of “separation” as discussed in more detail below.
WHEN DOES AN EMPLOYER’S DECISION OR AN EVENT RISE TO THE LEVEL NECESSARY TO BE DEEMED A “CESSATION” TO ASSESS WHETHER A SECTION 4062(E) EVENT HAS OCCURRED?
When determining whether an employer’s discontinuance of an operation at a facility rises to the level of a cessation, as defined in the proposed rule, the PBGC requires the employer to determine whether the event represents a mere cutback or contraction, or is so thorough that the employer’s conduct of the operation at the facility can no longer be considered ongoing. In making the assessment, the proposed rule provides analytically distinct guidelines for voluntary and involuntary discontinuances.14
A voluntary cessation occurs when an employer discontinues all significant activity at a facility in furtherance of the purpose of the operation.15 In contrast, an involuntary cessation can result from employees’ voluntary conduct or the occurrence of a sudden, unanticipated event such as a natural disaster.16 The proposed rule clarifies that an employee cessation may occur due to a sickout or a strike, though it leaves open the interpretation of what other events constitute “employee action” which may rise to level of an involuntary cessation.
When an involuntary cessation occurs due to employee action, the cessation date (important for fixing the moment in determining the active participant base) is the day on which the employee action ends unless, within seven days after such date, the employer has resumed significant activity at the facility in furtherance of the operation, or the date on which the employer chooses not to resume significant activity in furtherance of the operation.17 If an involuntary discontinuance of activity occurs for any reason apart from the employees’ own actions, the proposed rule provides a 30-day window within which the employer may resume significant activity at the location in furtherance of the purpose of the operation and avoid a cessation.18 If the employer fails to resume significant activity after occurrence of the event, the cessation date is deemed to be the 30th day after the event’s occurrence or, if earlier, the date the employer affirmatively decides not to resume activity. Though not specifically addressed by the proposed rule, an involuntary cessation may be deemed to have occurred in the context of a labor lockout. If an employer decides to lockout its employees when engaging in collective bargaining and the lockout extends beyond 30 days, the proposed rule appears to state that a cessation of an operation has occurred. If this interpretation is correct, then the scope of Section 4062(e) will be further expanded because, under labor laws, lockouts do not cease an operation so long as bargaining with a union continues in good faith.
The determination of whether an operation ceases or remains ongoing depends entirely upon the degree to which the purpose of the operation continues to be fulfilled by the employer’s activity at the facility. Accordingly, the proposed rule requires that the employer discontinue all significant activity at the facility in order for a cessation to occur. If an employer ceases an activity and continues to engage in insignificant activity in furtherance of the operation, a Section 4062(e) cessation has likely occurred. For example, if an employer discontinues significant manufacturing operations at a facility (apart from manufacturing activities related to materials on hand) and continues to employ an active maintenance and security staff, a cessation has likely occurred because the maintenance and security activities do not further the intended purpose of the now discontinued manufacturing operation.
DO ASSET SALES TRIGGER SECTION 4062(E) LIABILITY?
The proposed rule’s definition of “cessation” also extends the reach of Section 4062(e) to asset sale transactions for the first time, specifically to situations in which the employer ceases operations at a facility even though the operation is continued or resumed by another employer at the same or different facility (which is also important when determining whether an employee separates from employment, covered below). For example, if Employer A sells the assets of its manufacturing facility to Employer B, and Employer B continues or resumes the operation with all of Employer A’s former employees, Employer A’s decision to sell the assets is a voluntary cessation of the operations under Section 4062(e) and could result in Section 4062(e) liability.
The inclusion of asset sales and possibly some types of stock sales within the list of possible Section 4062(e) events reverses prior PBGC opinion letters that expressly held such sales would not create liability under Section 4062(e).19 Within this context, the PBGC clarifies that it is irrelevant whether an employer begins a new operation contemporaneously with the discontinuance of the existing operation either at the same or existing facility.20 Though the new operation is irrelevant for purposes of whether a cessation has occurred, if enough participants affected by the operation’s cessation are retained by the employer with respect to a new operation, as described below the employer could potentially avoid the 20-percent reduction in the active participant base required to trigger a Section 4062(e) event.
WHAT CONSTITUTES AN EMPLOYEE’S “SEPARATION” AND WHEN DOES THE SEPARATION “RESULT” FROM VOLUNTARY/INVOLUNTARY CESSATION?
A Section 4062(e) event occurs when a cessation results in more than 20 percent of the total number of employees who are participants under the plan incurring a separation from employment. The proposed rule clarifies the context of the term “separation” by applying it within the more commonly held interpretation of employer-employee relationship, as opposed to separation from the affected operation. Thus, the PBGC states that a separation does not occur when an employee transfers within the employer’s organization. The proposed rule’s interpretation of the term separation aligns with the rule’s proposed approach that an employee separates from their relationship with their original employer when the employer sells the business’ assets to another party who continues or resumes the operation using the same employees (i.e., the old employment relationship is severed as of the date of sale).21
The proposed rule requires that plan administrators fix and determine two dates: the date the cessation occurred and the date of the 20-percent reduction in the active participant base. Though a cessation may occur, it does not trigger a Section 4062(e) event until the active participant base shrinks by more than 20 percent. When an employer discharges an employee or an employee quits, the plan administrator should have little difficulty in fixing the separation date. Fixing the separation date becomes increasingly difficult in the case of employer layoffs. To assist in determining the separation date, the proposed rule provides that an employee separates from employment when the employee discontinues active performance pursuant to the employee’s employment relationship with the employer of activities in furtherance of any of the employer’s operations, unless when the discontinuance occurs it is reasonably certain the employee will resume active work within 30 days.22 The proposed rule permits plan administrators the authority to determine whether a separation has occurred by applying this 30 day continuance window. After the passage of 30 days, the employee is considered to have separated from employment on the date on which the active work stopped.
The proposed rule requires that a separation from employment must be the result of the cessation of the operation.23 When determining if the employee’s separation occurred as a result of the cessation, the timing of the separation (i.e., whether the separation occurs before, on or after the cessation date) is not determinative of whether the separation occurred as a result of the cessation.24 The proposed rule notes that an operation often does not cease instantaneously. Thus, employees may leave prior to the cessation date, when significant activity in furtherance of the operation is ongoing, because the operation in which they are working has begun the winding-down process. Conversely, some maintenance employees may work well past the cessation date in assisting with the disassembly of machines that were once used in the operation’s day-to-day activities.
Perhaps most important, an employee’s separation may be the result of a cessation of an operation at a facility even if the employee was employed in another operation or at another facility.25 For example, an employer may have one operation that assembles widgets from pre-fabricated parts and a second operation that fabricates widget parts for use in the employer’s own widgets or for sale to third parties. If the employer elects to voluntarily cease the assembly operation, the reduced demand for parts will affect the fabrication operation, resulting in a plant shutdown or layoffs within the fabrication operation. Accordingly, the proposed rule broadly interprets whether a separation occurs as the result of a cessation of an operation by viewing operations as interrelated.
The PBGC proposes four rebuttable presumptions based upon the relationship between the timing of a separation and the events involved in a cessation for use in determining whether the separation results from the cessation of the operation. A separation results from the cessation when:
- An employee is employed in an operation at a facility and involuntarily separates from employment on or after the date when the employer decides to cease the operation at the facility26
- An employee in an operation at a facility voluntarily separates from employment after the employer decision to cease the operation at the facility becomes known to the employee, employees generally or the public27
- A cessation is involuntary, and an employee in the operation voluntarily or involuntarily separates from employment on or after the date of the event that caused the cessation28
- An employee employed in an operation becomes employed by a new employer that continues or resumes the operation29
WHEN AND HOW DOES A PLAN ADMINISTRATOR COMPUTE THE “ACTIVE PARTICIPANT BASE” IN ORDER TO ASSESS WHETHER A SECTION 4062(E) OCCURS?
In order for a Section 4062(e) event to occur, a cessation of operations must result in more than 20 percent of the total number of the employer’s employees who are participants under the affected plan separating from employment. Though Section 4062(e) is helpful in determining what the base number is for purposes of the measurement, it does little to clarify when the measurement should occur. The proposed rule harmonizes the definition of the base number for purposes of determining whether a Section 4062(e) event occurs with the final 2006 rule used in determining termination liability. Accordingly, the applicable denominator when testing for a Section 4062(e) event is “the total number of employer’s current employees, as determined immediately before the cessation of operations, who are participants under the plan.”30
Despite the congruency of the definitions, the PBGC believed the phrase “immediately before the cessation” required additional clarification. The proposed rule prescribes more specific rules for counting active participants for purposes of fixing the single base number for both the 20-percent test and any resulting liability. When determining the active participant base, the plan administrator must identify the point in time when employment is adversely affected by the cessation. Immediately prior to the cessation, the plan administrator applies the same formulation for counting active participants as they would in determining separations from employment. Accordingly, immediately before the employer’s decision that marks the beginning of the cessation or the event that caused the cessation, the plan administrator tallies the persons engaged in active performance of activities in furtherance of the employer’s operations (or reasonably certain of resuming active work for the employer within 30 days of the event’s occurrence).31 The PBGC believes applying the same definition to determining the active participant base and the number of separated employees ensures consistency.
Enforcement of Section 4062(e)
Concerned with its ability to monitor and enforce Section 4062(e), the PBGC utilizes two avenues to keep abreast of potential events. First, the PBGC requires plan administrators to report any Section 4062(e) events within 60 days of their occurrence. Second, ERISA Section 4003(a) provides the PBGC with the authority to conduct investigations it deems necessary to enforce Title IV and the regulations thereunder. The preamble to the proposed rule notes that the PBGC’s enforcement actions have been significantly supported by such investigations and that the PBGC expects to continue relying on investigations as a key element in its enforcement of Section 4062(e). In the course of its investigation, the PBGC may request additional information. Any failure to respond to the request can result in the assessment of penalties under ERISA Section 4071.
Section 4071 authorizes the PBGC to assess a penalty against anyone who fails to timely provide any notice or other material information required under Section 4062(e) or the applicable rule. The maximum statutory penalty for failure to comply with the request is $1,100 per day. The PBGC’s general policy is to assess penalties lower than the maximum permitted by the statute. In most circumstances, the PBGC would assess a penalty equal to $25 per day for the first 90 days of delinquency and $50 per day thereafter, with limitations based on plan size. The PBGC notes that it retains the right to increase the penalty if the circumstances warrant. Based upon the preamble to the proposed rule, it appears likely that the PBGC is willing to assert the maximum penalty for any delinquency due to the potential of harm to plan participants and the PBGC.
The PBGC’s proposed rule reflects a concerted effort by the agency to expand the scope of Section 4062(e) in an effort to bolster underfunded single-employer defined benefit plans. If the proposed rule becomes effective as written, employers will be forced to address Section 4062(e) issues in a wide variety of business decisions in which liability may not have been contemplated previously, including asset sales, collective bargaining and reductions in force over different geographical locations. Advanced and careful planning will be required to ensure potential Section 4062(e) liabilities are included in the analyses of such business decisions.
The PBGC extended the comment period by 30 days (from October 12 to Friday, November 12, 2010) to provide sufficient time to review and comment on the proposed rule.