Distress Terminations of Underfunded Pension Plans

Procedurally, a debtor must comply with the following statutory requirements: 1) serve a 60-day advance notice of intent to terminate on all affected parties (eg, unions, participants and the Pension Benefit Guaranty Corporation (PBGC)); 2) supply the PBGC with actuarial information related to funding; and 3) file a motion with the bankruptcy court to demonstrate that the necessary criteria have been satisfied. The bankruptcy court is charged under ERISA with determining whether the debtor will be unable to pay all of its debts and continue in business outside of the reorganization process unless the plan is terminated.

In addition, ERISA provides that the PBGC will not proceed with a distressed termination if it would violate the terms and conditions of an existing collective bargaining agreement. This requires the debtor to collectively bargain with any unions that represent participants in the affected pension plan. If the debtor and the union are unable to reach an agreement, the debtor will be required to seek to reject or modify the collective bargaining agreement in accordance with the procedures set forth in Section 1113 of the Bankruptcy Code. As a result, a distress termination proceeding will frequently require a simultaneous proceeding under Section 1113.

In analyzing whether a debtor will be able to satisfy the reorganization test for distress termination, counsel will be confronted with a dearth of published case law interpreting the reorganization test. Although the distress termination provisions were added to ERISA in 1986 with the enactment of the Single Employer Pension Plan Amendments Act of 1986, there have been very few published cases in this area.

Recent Cases

As of press time, there are only five published cases on distress terminations. The Bankruptcy Court in In re: Sewell Manufacturing Mfg. Company, Inc., 195 B.R. 180 (Bankr. N.D. Ga. 1996) approved a distress termination based on the following findings. The debtor was operating in a substantially cash negative mode and would be into the foreseeable future. The pension plan was adding approximately $2.3 million in the near term to the debtor's already strained finances. In addition, the debtor established that the only way to meet its impending pension obligations and current debts, aside from finding a willing buyer or lender, was to increase its sales by over 70% in the next 6 months. The court, in light of the industry conditions, determined that this was impossible and ruled that the distress termination provisions had been satisfied and approved the termination.

In In re Wire Rope Corporation of America, Incorporated, 287 B.R. 771 (Bankr. W.D. Mo. 2002) the Bankruptcy Court considered what it thought to be a basic threshold question: '[c]an the Debtor obtain confirmation of any (emphasis in the original) plan of reorganization through the termination of the Retirement Plans?' In this case, the court considered evidence that the debtor would not be able to obtain either debtor or equity financing unless the pension plans were terminated, primarily due to the uncertainty of the future obligations to the plans. Testimony was provided by the debtor's financial expert that approximately $35 million in long-term debt financing was necessary and an additional $10 million in equity investment in order to survive outside of the bankruptcy. However, that lenders and investors would be unlikely to extend this credit or provide an equity infusion in light of the $20.7 million in required funding contributions to the pension plans due over the next 4 years. The court concluded that '[i]f the Debtor cannot obtain confirmation of a plan of reorganization in the first instance, then it clearly cannot pay its debts under a plan of reorganization, and the court's approval of a distress termination of the Retirement Plans would be warranted.' The debtor demonstrated that a condition precedent to any investment would be termination of the retirement plans.

In re: US Airways Group, Inc.

One of the more recent cases involves one of the larger bankruptcies of recent history ' US Airways. In this bankruptcy case, the debtor sought to terminate its retirement plan for its pilots. In re: US Airways Group, Inc., 296 B.R.734 (Bankr. E.D. Va. 2003). In an effort to successfully restructure, US Airways had sought and obtained concessions from its various unions for wage and other benefits. When US Airways missed the budgeted profit for 2003 and was faced with an $800 million loss, pre-tax, it was forced to seek additional concessions from its labor force, aircraft lenders and lessors and its vendors.

At the bankruptcy court hearing, US Airways presented evidence that its business plan was the basis for the Airline Transportation Stabilization Board's (ATSB) loan guaranty approval and investment by the retirement system of Alabama were both based on 30-year amortization of the unfunded pension liability provided for in a proposed restoration funding relief bill then pending in Congress. Without the restoration funding relief, required pension plan contributions during 2004 and 2005 would total $862 million or approximately $618 million more than the amount that would be required under the $122 million a year restoration funding. Essentially, US Airway's argument focused on the fact that it would be unable to obtain confirmation of the reorganization plan without the termination of the pilot's pension plan. Although the PBGC did not object to the distress termination, the airline pilot's association and other representatives for retired pilots objected to the motion.

The Bankruptcy Court's analysis focused on the plan of reorganization proposed by the debtor and approved by the ATSB, and noted that it was the only realistic plan to date. In addition, US Airways' financial adviser testified that without resolution of the pension funding issue that will enable the debtor to meet the projections in its business plan, the ATSB was unlikely to issue its guaranty and the retirement system unlikely to make its investment. Further, the only two options to solve for the pension plan issue were restoration funding or termination of the pilot's plan. Failure of Congress to enact legislation providing relief in the form of restoration funding meant that plan termination was the only viable solution.

The court also considered the argument that seeking second-round concessions from other collective bargaining units was not reasonable. In fact, the court noted that asking the mechanics and flight attendants, whose pay and pensions were far below that of the pilots, to agree to a freeze or retroactive reduction in their pension benefits so as to preserve the pilots' benefits verges on fantasy. The court ruled that the debtor did satisfy the burden of proving that unless the pilot's pension plan is terminated, the debtors will not be able to pay their debts under a plan of reorganization and will not be able to continue in business outside of the Chapter 11.

The court noted that none of the reported cases had discussed what showing, if any, is necessary for a debtor to prove beyond meeting the financial requirement set forth in the statute. However, the court did assume that it was within its prerogative to consider other equities in the case. To that end, the court considered the serious financial hardship to the active and retired pilots and their families. This included numerous letters as evidence of the great financial hardship that would result from a distress termination. The court then noted that if the debtors are unable to reorganize and they must liquidate in Chapter 7, the pension plan would be terminated anyways and the retired pilots and their families would be in the same position with regards to their pension as they would be pursuant to a distress termination. Although the court acknowledged the financial distress of individuals, it noted that retention of employment and whatever benefits might accrue under a follow-on plan were preferable to a liquidation. In light of that reality, the court ruled that the financial hardship resulting from a termination of the plan was insufficient to withhold its approval.

In re: Philip Services Corporation, et. al

More recently, the Bankruptcy Court in In re: Philip Services Corporation, et. al, 310 B.R. 802 (Bankr. S.D. Tx. 2004) ruled that the debtors had not proved by a preponderance of the evidence that the plan of reorganization would not be consummated if the pension plans were not terminated. In this case the pension plan funding obligations were small, $1.326 million over 4 years, and represented only .08% of the net cash projected to be provided by operations. The court concluded that the $1.326 pension funding obligation 'was not a straw that would break the camel's back.'

The availability of distress terminations to bankrupt companies remaining the subject of congressional attention. In light of recent bankruptcy filings by Delta and Northwestern, there are several proposed bills in Congress that may amend the current distress requirements of ERISA. The potential impact of Delta and Northwestern's approximately $11 billion in pension underfunding being added to the PBGC's current projected deficit of $87 billion seems likely to result in some legislative changes, although it remains unclear whether such legislative changes will focus on the airline industry along or the law governing distress terminations.

Recent bankruptcies in the airline industry have highlighted the liabilities associated with underfunded defined benefit pension plans. Debtors seeking to restructure and reorganize into viable entities have to make difficult business decisions related to their sponsorship of defined benefit pension plans. The future funding costs and investment risks associated with continued sponsorship of underfunded defined benefit pension plans make pension plans a central issue in large Chapter 11 cases. In some recent Chapter 11 cases, the pension underfunding has exceeded several billion dollars (eg, the underfunding associated with United Airlines various plans alone were approximately $8 billion). In an effort to shed underfunded pension plans in bankruptcy, debtors may elect to seek a 'distress termination' of their plans. Prior to Congress' amendment of the Employee Retirement Security Act of 1974 (ERISA) in 1986, plan sponsors had an unrestricted right to terminate pension plans at any time by providing advance notice to the PBGC. The 1986 amendments to ERISA restricted the ability of debtors to unilaterally terminate pension plans with unfunded benefits. Thereafter, debtors must pursue a distress termination if they wish to terminate an underfunded pension plan in bankruptcy. A distress termination is in contrast to a standard termination where there are sufficient plan assets to fund the promised pension benefits or an involuntary termination instituted by the PBGC.

Under ERISA Section 4041(c)(2)(B), if one of four tests are met by the contributing sponsor and each member of the contributing sponsor's controlled group as of the proposed termination date, then a distress termination of the pension plan will be permitted. For purposes of this article, I focus on distress terminations sought in a Chapter 11 case, referred to as the reorganization test, rather than Chapter 7 liquidation. In a Chapter 11 case, the debtor must prove that unless the pension plan is terminated, it will be unable to: 1) pay all of its debts pursuant to a plan of reorganization; and 2) continue in business outside Chapter 11 reorganization.

Statutory Requirements

Procedurally, a debtor must comply with the following statutory requirements: 1) serve a 60-day advance notice of intent to terminate on all affected parties (eg, unions, participants and the Pension Benefit Guaranty Corporation (PBGC)); 2) supply the PBGC with actuarial information related to funding; and 3) file a motion with the bankruptcy court to demonstrate that the necessary criteria have been satisfied. The bankruptcy court is charged under ERISA with determining whether the debtor will be unable to pay all of its debts and continue in business outside of the reorganization process unless the plan is terminated.

In addition, ERISA provides that the PBGC will not proceed with a distressed termination if it would violate the terms and conditions of an existing collective bargaining agreement. This requires the debtor to collectively bargain with any unions that represent participants in the affected pension plan. If the debtor and the union are unable to reach an agreement, the debtor will be required to seek to reject or modify the collective bargaining agreement in accordance with the procedures set forth in Section 1113 of the Bankruptcy Code. As a result, a distress termination proceeding will frequently require a simultaneous proceeding under Section 1113.

In analyzing whether a debtor will be able to satisfy the reorganization test for distress termination, counsel will be confronted with a dearth of published case law interpreting the reorganization test. Although the distress termination provisions were added to ERISA in 1986 with the enactment of the Single Employer Pension Plan Amendments Act of 1986, there have been very few published cases in this area.

Recent Cases

As of press time, there are only five published cases on distress terminations. The Bankruptcy Court in In re: Sewell Manufacturing Mfg. Company, Inc., 195 B.R. 180 (Bankr. N.D. Ga. 1996) approved a distress termination based on the following findings. The debtor was operating in a substantially cash negative mode and would be into the foreseeable future. The pension plan was adding approximately $2.3 million in the near term to the debtor's already strained finances. In addition, the debtor established that the only way to meet its impending pension obligations and current debts, aside from finding a willing buyer or lender, was to increase its sales by over 70% in the next 6 months. The court, in light of the industry conditions, determined that this was impossible and ruled that the distress termination provisions had been satisfied and approved the termination.

In In re Wire Rope Corporation of America, Incorporated, 287 B.R. 771 (Bankr. W.D. Mo. 2002) the Bankruptcy Court considered what it thought to be a basic threshold question: '[c]an the Debtor obtain confirmation of any (emphasis in the original) plan of reorganization through the termination of the Retirement Plans?' In this case, the court considered evidence that the debtor would not be able to obtain either debtor or equity financing unless the pension plans were terminated, primarily due to the uncertainty of the future obligations to the plans. Testimony was provided by the debtor's financial expert that approximately $35 million in long-term debt financing was necessary and an additional $10 million in equity investment in order to survive outside of the bankruptcy. However, that lenders and investors would be unlikely to extend this credit or provide an equity infusion in light of the $20.7 million in required funding contributions to the pension plans due over the next 4 years. The court concluded that '[i]f the Debtor cannot obtain confirmation of a plan of reorganization in the first instance, then it clearly cannot pay its debts under a plan of reorganization, and the court's approval of a distress termination of the Retirement Plans would be warranted.' The debtor demonstrated that a condition precedent to any investment would be termination of the retirement plans.

In re: US Airways Group, Inc.

One of the more recent cases involves one of the larger bankruptcies of recent history ' US Airways. In this bankruptcy case, the debtor sought to terminate its retirement plan for its pilots. In re: US Airways Group, Inc., 296 B.R.734 (Bankr. E.D. Va. 2003). In an effort to successfully restructure, US Airways had sought and obtained concessions from its various unions for wage and other benefits. When US Airways missed the budgeted profit for 2003 and was faced with an $800 million loss, pre-tax, it was forced to seek additional concessions from its labor force, aircraft lenders and lessors and its vendors.

At the bankruptcy court hearing, US Airways presented evidence that its business plan was the basis for the Airline Transportation Stabilization Board's (ATSB) loan guaranty approval and investment by the retirement system of Alabama were both based on 30-year amortization of the unfunded pension liability provided for in a proposed restoration funding relief bill then pending in Congress. Without the restoration funding relief, required pension plan contributions during 2004 and 2005 would total $862 million or approximately $618 million more than the amount that would be required under the $122 million a year restoration funding. Essentially, US Airway's argument focused on the fact that it would be unable to obtain confirmation of the reorganization plan without the termination of the pilot's pension plan. Although the PBGC did not object to the distress termination, the airline pilot's association and other representatives for retired pilots objected to the motion.

The Bankruptcy Court's analysis focused on the plan of reorganization proposed by the debtor and approved by the ATSB, and noted that it was the only realistic plan to date. In addition, US Airways' financial adviser testified that without resolution of the pension funding issue that will enable the debtor to meet the projections in its business plan, the ATSB was unlikely to issue its guaranty and the retirement system unlikely to make its investment. Further, the only two options to solve for the pension plan issue were restoration funding or termination of the pilot's plan. Failure of Congress to enact legislation providing relief in the form of restoration funding meant that plan termination was the only viable solution.

The court also considered the argument that seeking second-round concessions from other collective bargaining units was not reasonable. In fact, the court noted that asking the mechanics and flight attendants, whose pay and pensions were far below that of the pilots, to agree to a freeze or retroactive reduction in their pension benefits so as to preserve the pilots' benefits verges on fantasy. The court ruled that the debtor did satisfy the burden of proving that unless the pilot's pension plan is terminated, the debtors will not be able to pay their debts under a plan of reorganization and will not be able to continue in business outside of the Chapter 11.

The court noted that none of the reported cases had discussed what showing, if any, is necessary for a debtor to prove beyond meeting the financial requirement set forth in the statute. However, the court did assume that it was within its prerogative to consider other equities in the case. To that end, the court considered the serious financial hardship to the active and retired pilots and their families. This included numerous letters as evidence of the great financial hardship that would result from a distress termination. The court then noted that if the debtors are unable to reorganize and they must liquidate in Chapter 7, the pension plan would be terminated anyways and the retired pilots and their families would be in the same position with regards to their pension as they would be pursuant to a distress termination. Although the court acknowledged the financial distress of individuals, it noted that retention of employment and whatever benefits might accrue under a follow-on plan were preferable to a liquidation. In light of that reality, the court ruled that the financial hardship resulting from a termination of the plan was insufficient to withhold its approval.

In re: Philip Services Corporation, et. al

More recently, the Bankruptcy Court in In re: Philip Services Corporation, et. al, 310 B.R. 802 (Bankr. S.D. Tx. 2004) ruled that the debtors had not proved by a preponderance of the evidence that the plan of reorganization would not be consummated if the pension plans were not terminated. In this case the pension plan funding obligations were small, $1.326 million over 4 years, and represented only .08% of the net cash projected to be provided by operations. The court concluded that the $1.326 pension funding obligation 'was not a straw that would break the camel's back.'

The availability of distress terminations to bankrupt companies remaining the subject of congressional attention. In light of recent bankruptcy filings by Delta and Northwestern, there are several proposed bills in Congress that may amend the current distress requirements of ERISA. The potential impact of Delta and Northwestern's approximately $11 billion in pension underfunding being added to the PBGC's current projected deficit of $87 billion seems likely to result in some legislative changes, although it remains unclear whether such legislative changes will focus on the airline industry along or the law governing distress terminations.