With stock markets plummeting and longterm interest rates continuing to be at historic lows, pension deficits are increasing rapidly. A growing deficit may adversely affect a company’s relationship with its lenders, even if all pension plan contributions required by law are being made. If there is a delay in making required contributions or in remitting employee deductions to the pension fund, there can also be adverse consequences under a company’s credit agreements.  

Specific Pension Funding Provisions

A growing pension deficit can have consequences under a credit agreement directly, where covenants, representations or events of default make specific reference to pension funding.  

For example, a recent revolving credit agreement includes a representation that “No Canadian Pension Plan has any material Unfunded Canadian Pension Liability.” Although neither the covenants nor events of default specifically refer to funding of the Canadian pension plan, this representation poses a problem for the borrower if the liabilities of the plan materially exceed the value of the plan’s assets at any time. As with most revolving facilities, this particular credit agreement provides that the borrower is deemed to make its representations anew upon each drawing under the credit agreement. If falling stock prices have created a material funding deficiency, the borrower’s pension funding representation will not be true at the time of the next draw. Unless a waiver is obtained, such breach will constitute an event of default.  

Indirect Impacts of Pension Deficiencies

There can also be indirect impacts under a credit agreement. For example, if a pension funding deficiency reduces operating income or EBITDA (generally, earnings before income taxes, depreciation and amortization), that may result in a breach of the financial covenants.  

Financial statement accounting for pension plans has been in a state of flux, as Canada moves to International Financial Reporting Standards. Many companies have moved toward mark to market accounting, as well as recognition of pension plan funding in the balance sheet and income statement rather than just in notes. A mature defined benefit pension plan may have large liabilities and assets, such that a sudden drop in market prices can have a material impact on the company’s income statement. Smoothing techniques that were commonly used in the past may no longer be considered appropriate. For a company with an uncertain future, an actuary may be particularly reluctant to apply smoothing techniques (see Tough Times and Pension Funding in Canada: Lessons from Slater Steelregarding a suit involving smoothing techniques used in calculating pension contributions.)  

Delays in Pension Plan Contributions

Failure to make timely contributions to pension plans may breach representations or deemed representations that all required contributions have been made or that the borrower has complied with all applicable legislation.  

Even if there are no deemed representations or no further draws are being made, failure to make timely contributions may breach negative covenants regarding liens. The Pension Benefits Act (Ontario) creates a deemed trust and lien to secure certain required pension plan contributions. While this lien ranks ahead of secured creditors in some circumstances, it does not apply in proceedings governed by the Bankruptcy and Insolvency Act (Canada) (the “BIA”). However, changes to the BIA as of July 8, 2008 create a lien for certain pension plan contributions that ranks ahead of secured lenders on insolvency, which may increase lender sensitivity to delayed contributions (see New Pension Contribution Priorities under the Bankruptcy and Insolvency Act).  

Review Credit Agreements

Therefore, any company with a pension plan should review the covenants, representations and events of default under its credit agreements to locate specific provisions related to pension plans and to determine how pension funding may indirectly impact compliance with the credit agreements.