Good news for lenders and bondholders out of the Pension Benefit Guaranty Corp. on Tuesday, June 14, 2011. The PBGC has issued final rules providing that it will not guarantee benefits that are earned in the window between when an employer files for bankruptcy and the PBGC takes over a pension plan. The new rules also provide that only benefits that are nonforfeitable (i.e. vested) as of the petition date will be guaranteed. This could free up more cash for lenders and bondholders on the plan effective date.

Effect on Lenders and bondholders:

These new rules are intended to reduce the PBGC’s exposure to losses as the PBGC runs near-record deficits. However, they also benefit lenders and bondholders dealing with debtors in bankruptcy. Essentially, to the extent that PBGC incurs liability based on unfunded postpetition benefits, the PBGC is arguably entitled to an administrative claim against the debtor for such liability.  See 11 U.S.C. § 503(b)(1)(A)(i). In chapter 11, administrative claims must be paid in full upon the effective date of a plan of reorganization. See 11 U.S.C. 1129(a)(9)(A). With the new rules issued on June 14, 2011, the liabilities incurred by the PBGC will decrease, which means any administrative claim asserted by the PBGC will decrease as well. Less administrative claims mean more funds available for lenders and bondholders. 

The Nitty Gritty:

The new rules implement Section 404 of the Pension Protection Act of 2006. Section 404 amended Title IV of ERISA such that, when an underfunded, PBGC guaranteed, single employer pension plan terminates in bankruptcy, sections 4022 and 4044(a)(3) of ERISA are applied by treating the petition date as the plan termination date. This means that the amount of benefits guaranteed by the PBGC, as well as those benefits that are in “priority category 3″ of the PBGC asset allocation hierarchy (it is rare for assets in priority categories 1 and 2 to run out) will be determined as of the petition date. The PBGC believes that in most cases this change will lead to a reduction in PBGC guaranteed benefits.

The final rule was published in the Federal Register on June 14, 2011 and becomes effective 30 days thereafter.