Companies that terminate pension plans before filing for bankruptcy may no longer escape paying significant claims to the PBGC.

In Pension Benefit Guaranty Corporation v. Oneida, Ltd. dated April 8, 2009, the U.S. Court of Appeals for the Second Circuit reversed a ruling by the U.S. Bankruptcy Court for the Southern District of New York characterizing certain “termination premiums” owed to the Pension Benefit Guaranty Corporation (PBGC) pursuant to the Deficit Reduction Act of 2005 as contingent, pre-petition claims and thus dischargeable in bankruptcy.

Companies often terminate their pension plans after they file for Chapter 11, creating a large dischargeable, general unsecured claim in favor of the PBGC. If a pension plan is terminated pre-bankruptcy, the PBGC is afforded a secured claim. The Second Circuit’s decision is important because companies of a reasonable size that terminate their pension plans after they file for bankruptcy may no longer completely escape paying significant claims to the PBGC. In some cases, where termination premiums are of sufficient magnitude, treatment as a post-petition administrative claim requiring 100 percent payment may have a meaningful impact on the ultimate distribution to creditors that fall below the PBGC’s priority claim for termination premiums or may even threaten the successful reorganization of a debtor altogether.

Background

On February 28, 2006, the Deficit Reduction Act of 2005 (DRA) was enacted. The DRA amended the Employee Retirement Income Security Act of 1974 and requires payment to the PBGC of a termination premium for pension plans terminated pursuant to a restructuring in or out of bankruptcy.

The termination premiums imposed by the DRA were designed to provide a source of funding to the PBGC, which pays employees certain pension benefits after their pension plans are terminated by their employer. The so-called “General Rule” established by the DRA requires an employer to pay the PBGC a premium “immediately before the termination date” of the pension plan if such plan is terminated outside of a bankruptcy proceeding. If, however, the employer terminates the pension plan during a bankruptcy proceeding, a so-called “Specific Rule” applies, which provides that the termination premiums will be owed on “the date of the discharge or dismissal of [the employer].”

On May 2, 2006, the bankruptcy court presiding over the proceeding of Oneida, Ltd., (the debtor) approved an order granting the debtor’s motion to terminate certain pension plans. Shortly thereafter, the debtor initiated a declaratory action seeking a finding by the bankruptcy court that the termination premiums were pre-petition claims which could be discharged pursuant to a plan of reorganization.

The Bankruptcy Court’s Ruling

The bankruptcy court held that the termination premiums were contingent, pre-petition claims which could be discharged in a bankruptcy proceeding. The bankruptcy court first analyzed the definition of the term “claim” and applied an expansive definition of such term. The bankruptcy court then stated that a “claim” may include rights to payment which are “contingent” and “unmatured,” and concluded that the termination premiums represented a “classic contingent claim” because any obligation to pay the PBGC could not arise unless a pension plan was terminated by a debtor during its bankruptcy.

The bankruptcy court also concluded that the PBGC’s claim arose pre-petition. The bankruptcy court analogized the termination premiums to an indemnification agreement and noted that claims based upon indemnification arise pre-petition because the parties to an indemnification agreement expressly contemplate that the obligation to indemnify may arise in the future. The bankruptcy court reasoned that, since the DRA was enacted before the debtor filed for bankruptcy, both parties had contemplated the possibility of a premium payout. Thus, the termination premiums represented contingent, pre-petition claims which could be discharged by the debtor during its bankruptcy.

The Second Circuit’s Decision

While the Second Circuit agreed that the term “claim” should be read broadly in the bankruptcy context, the court noted that such a broad definition was not without limits. The Second Circuit stated that in order to have a valid bankruptcy claim, a party must have a right to payment that arose pre-petition, which right must be determined according to non-bankruptcy law. The Second Circuit, recognizing the “Specific Rule” as the applicable non-bankruptcy law creating the specific right to payment, found that such rule explicitly stated that any right to payment the PBGC may receive from the termination of a pension plan would not arise until after the employer is discharged from bankruptcy. As such, no right to payment could exist pre-petition because no obligations established pursuant to the “Specific Rule” existed at the time. This conclusion was deemed consistent with the purpose of the DRA, as explained by its legislative history, which is to ensure that the bankruptcy process would not be used to eliminate obligations owed to the PBGC resulting from the termination of an underfunded pension plan.

Conclusion

The Second Circuit clarified that an employer will not be able to characterize termination premiums as contingent, pre-petition claims dischargeable in bankruptcy. In the context of a bankruptcy proceeding, such claims will be deemed to arise post-petition at the time of the debtor’s discharge. The Second Circuit’s decision could impact the ability of companies of size to effectively reorganize. Companies often terminate their pension plans after they file for Chapter 11. By doing so, the PBGC is usually afforded a large (and in fact, sometimes the largest) general unsecured claim, which would receive the same distribution as other general unsecured creditors with the balance of its claim subject to discharge. While this reality is unchanged by the Second Circuit’s decision, what’s new is the ability of the PBGC to receive 100 percent of its claim on account of the termination premium when a plan is terminated post-petition. For companies that range in size from just a few hundred to several thousand, the monetary obligation may be quite steep. This obligation would not only impact distribution to unsecured creditors, but it also could threaten a reorganization of the liability if sufficiently large.

 

Nava Hazan was also a principal author of this On the Subject