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The Effects of Terminating a Pension Plan in Bankruptcy

By Claudia Z. Springer and Daniel A. Zazove
November 29, 2004

Oftentimes, one of the largest commitments of a company is its ongoing funding obligations under its pension plan. Contribution obligations to a company-sponsored pension plan will often influence the timing of a financially troubled company's bankruptcy filing. An example of this is the Chapter 11 case of United Air Lines (United) and its affiliates. United viewed its obligations to make significant contributions to its pension plans as somewhat incompatible with its need to create a fiscally strong enterprise so as to effectively compete with low- cost carriers that do not have the same economic burdens.

United is not alone in having to grapple with its significant pension liabilities. Declining stock prices, low interest rates, and fierce corporate competition (both domestic and foreign) are causing other large financially distressed companies to consider bankruptcy as a means to terminate or modify existing pension obligations.

Although the Bankruptcy Code permits the debtor to modify or reject certain ongoing obligations that burden its rehabilitation, the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code limit the bankruptcy court's authority to terminate certain defined benefit pension plans. Under ERISA, the Pension Benefit Guaranty Corporation (PBGC), was created to, among other things, oversee private defined benefit pension plans and to compensate plan beneficiaries in the event that a pension plan is underfunded. As increasing numbers of financially distressed corporations use bankruptcy as a tool to rid themselves of long-standing pension obligations, the PBGC is forced to pick up the tab resulting from the termination of underfunded plans. The PBGC, therefore, is oftentimes a major creditor in large corporate bankruptcies when the debtor has a significant underfunded pension liability. The timing of the termination of a defined benefit plan can have an enormous impact on the administration of the estate and the debtor's ability to effectively reorganize.

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