Prudent lenders should monitor their corporate debtors’ pension plan liabilities and pension plan deficits because they may have a significant impact on the priority of the lender’s security and on the amount the lender will recover if the lender enforces its security.

Priority with respect to Lender’s Security

The statutory deemed trust and statutory lien contained in the Pension Benefits Act (Ontario) secure payment of the normal and special contributions which the debtor is required to pay to the pension plan until the plan is wound up. Prior to a debtor’s bankruptcy or receivership, they will likely have priority over the debtor’s inventory and accounts charged by the lender’s general security agreement or assignment of book debts (but likely not over the debtor’s assets assigned to a bank lender under the Bank Act before the pension liabilities arose). If, after July 6, 2008, the debtor becomes bankrupt or a receiver of the debtor's assets is appointed, the arrears of normal pension payments (but not the arrears of special pension payments) would, as a result of the recent amendments to the Bankruptcy and Insolvency Act, have priority over the lender’s security (including its Bank Act security) with respect to all the debtor's assets.

Effect of a Pension Plan Deficit on Lender’s Recovery

The statutory deemed trust and statutory lien do not secure payment of the pension plan deficit prior to the winding up of a defined benefit plan and the recent amendments to the Bankruptcy and Insolvency Act do not give such deficit priority over a lender’s security.

However, if the pension plan was established for the debtor’s unionized employees and the debtor’s pension obligations are included in its collective agreement, a purchaser of the debtor’s business from the lender or others on the debtor’s insolvency, would have to assume the debtor’s pension obligations under the collective agreement. If there is a material deficit in the unionized employees' pension plan, the purchaser will likely reduce the amount of the purchase price it offers for the debtor’s assets to compensate for the deficit. Accordingly, although the priority of the lender’s security is not directly affected by the deficit, the lender would likely recover less from the sale of the debtor’s assets.

This problem should not arise with respect to a deficit in a non-union pension plan because the purchaser would have no legal obligation to assume the debtor’s pension plan. 

Conclusion

Therefore a lender should be aware of the status of its debtor’s pension plan liabilities and deficit and take it into account when establishing margin tests, granting credit and deciding how to realize on its security.