Termination Premiums Under ERISA Held to Be Dischargeable Prepetition Claims

Background

Oneida is one of the world's largest marketers of stainless steel silverware and flatware products. Following an unsuccessful out-of-court financial restructuring in late 2004, Oneida and its domestic affiliates filed for Chapter 11 bankruptcy protection in March 2006, shortly after the enactment of the DRA on Feb. 8, 2006. Concurrently with the filing of its bankruptcy petition, Oneida filed a motion before the bankruptcy court seeking to terminate all of its pension plans pursuant to the distress termination procedures contained in ' 4041(c)(2)(B)(ii) of ERISA. The PBGC, a governmental corporation that guarantees benefits offered under defined benefit pension plans (up to a statutory limit), stood to become the trustee of Oneida's pension plans if the bankruptcy court were to approve Oneida's motion.

In the course of the Chapter 11 case, Oneida and the PBGC arrived at a settlement whereby, among other things, Oneida agreed to retain and continue funding two of its three underfunded pension plans, the PBGC consented to the termination of the pension plan with the largest underfunding liability (the 'Oneida Pension Plan') of nearly $35 million, and the parties agreed to reserve all of their rights with respect to the enforceability of the termination premiums. In May 2006, the bankruptcy court approved the distress termination of the Oneida Pension Plan on the basis of this settlement. In September 2006, Oneida emerged from Chapter 11 pursuant to a confirmed plan of reorganization that, among other things, provided for zero recovery on, and complete discharge of, all claims resulting from the distress termination of the Oneida Pension Plan.

Following Oneida's emergence from bankruptcy, the PBGC demanded approximately $7 million in termination premiums from Oneida, an amount the PBGC argued was payable as a result of the distress termination of the Oneida Pension Plan in Chapter 11. In November 2006, Oneida commenced an adversary proceeding before the bankruptcy court seeking a declaratory judgment that the termination premiums owed to the PBGC were prepetition claims against Oneida's bankruptcy estate that were discharged pursuant to its confirmed Chapter 11 plan.

In December 2006, the PBGC filed a motion with the United States District Court for the Southern District of New York to 'withdraw the reference' to the bankruptcy court of the adversary proceeding. The PBGC's motion cited to 28 U.S.C. ' 157(d), which, among other things, requires district courts to withdraw the automatic reference to the bankruptcy court in the event that the resolution of the issues presented requires 'significant interpretation, as opposed to simple application[,] of federal non-bankruptcy statutes.' Keene Corp. v. Williams Bailey & Wesner L.L.P. (In re Keene Corp.), 182 B.R. 379, 381-382 (S.D.N.Y. 1995). The PBGC argued that the adversary proceeding must be heard before the district court because the bankruptcy court would need to engage in a 'significant interpretation' of ERISA in order to resolve the issues underlying the termination premium dispute, an act that is prohibited under 28 U.S.C. ' 157(d). The district court disagreed with the PBGC and declined to withdraw the reference to the adversary proceeding, finding that in order to resolve the dispute in connection with the termination premiums, 'the [bankruptcy court] will be required to do what it does on a routine basis: determine whether the [termination premiums] are post-petition obligations that must be paid by Oneida upon reorganization, or pre-petition 'claims' that may be discharged pursuant to [Oneida's plan of reorganization].' See Oneida Ltd. v. Pension Ben. Guar. Corp., 372 B.R. 107, 111 (S.D.N.Y. 2007).

With the procedural dispute as to where to conduct the adversary proceeding having been resolved, in October 2007, Oneida filed a motion for summary judgment in its favor on all counts asserted in its complaint. The PBGC countered with a summary judgment motion opposed to the requested relief.

Decision

On Feb. 27, 2008, the bankruptcy court issued the Memorandum Opinion granting Oneida's summary judgment motion and denying the PBGC's summary judgment motion. In the Memorandum Opinion, the bankruptcy court expressly held that the termination premiums assessed against reorganized Oneida were prepetition claims that were discharged under Oneida's confirmed Chapter 11 plan of reorganization. Oneida Ltd. v. Pension Ben. Guar. Corp. (In re Oneida Ltd.), Case No. 06-01920 (ALG), 2008 WL 516493, at *13 (Bankr. S.D.N.Y. Feb. 27, 2008).

In holding that 'the [termination premium] in a Chapter 11 case is a classic contingent claim,' Id. at *6, the bankruptcy court reaffirmed the well-established principle that the term 'claim,' as defined in the Bankruptcy Code, is to be interpreted broadly to ensure 'that all legal obligations of the debtor, no matter how remote or contingent, will be ' dealt with in the bankruptcy case.' Id. at *5 (emphasis added) (quoting United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1003 (2d Cir. 1991)). Rejecting the PBGC's argument that the termination premiums cannot be 'claims' because the obligation to pay such amounts does not arise until after the date of the debtor's discharge, the bankruptcy court held that, although non-bankruptcy law (here, ERISA) governs the liquidated value of, the enforceability of, and defenses to, a right of payment, bankruptcy law determines whether a claim exists and whether such claim arose pre- or post-petition. Id. at *6.

The bankruptcy court noted that in order for it to adopt the PBGC's position that the termination premiums had survived Oneida's Chapter 11 discharge, the court would have to find that the DRA had impliedly amended the Bankruptcy Code to provide for the non-dischargeability of the termination premium obligations. The bankruptcy court was unable to make such a finding because of the strong presumption that a later law does not impliedly amend an established one, such as the Bankruptcy Code. Id. at *8. Indeed, the PBGC had made no effort to overcome this presumption on the basis that an irreconcilable conflict exists between the amended ERISA statute and the Bankruptcy Code. Id. To the contrary, the bankruptcy court found that a proper reconciliation of the DRA with the Bankruptcy Code's discharge provision produces a contingent unsecured claim in the amount of the termination premiums that is subject to compromise through the bankruptcy process. Id., n. 11. (The court noted, however, that pursuant to Oneida's confirmed Chapter 11 plan of reorganization, the PBGC's prepetition claims for the termination premiums had received zero recovery and been discharged. Id.)

Although the PBGC made no attempt to rebut the presumption against implied repeal and amendment by demonstrating a 'clear and manifest' intent of Congress to amend the Bankruptcy Code through the DRA, the bankruptcy court nevertheless found that no such showing could have been made. Id. In fact, the bankruptcy court found evidence to the contrary, noting, for example, that only a few months prior to the adoption of the DRA, Congress had amended the Bankruptcy Code to create several new non-dischargeable claims, but it had not included the termination premiums in that amendment. Id. The court, therefore, found that the DRA had not impliedly amended the Bankruptcy Code to provide for the non-dischargeability of the termination premiums.

Having established that they qualified as 'claims' under the Bankruptcy Code, the bankruptcy court also found that the termination premiums were prepetition claims that are subject to compromise in Chapter 11 (and thus can be paid cents on the dollar), as opposed to postpetition administrative expenses that must be paid in full before a debtor can emerge from Chapter 11. Id. at *13. The bankruptcy court's decision was based on the fact that the termination of the Oneida Pension Plan was well within the realm of possibilities contemplated by Oneida and the PBGC prior to Oneida's Chapter 11 filing. The DRA was enacted prior to Oneida's petition date, and, as the bankruptcy court noted, the parties had met on at least two separate occasions prior to the bankruptcy filing to negotiate the terms of the pension plan termination. Id. at *10. In other words, the termination premiums were prepetition unsecured claims for many of the same reasons that they qualified as contingent claims in the first instance. Moreover, the bankruptcy court reasoned that the termination premiums could not qualify as administrative expense claims because the imposition of such amounts had not benefited Oneida in the operation of its business during the pendency of the Chapter 11 case. Id. at *11.

On March 28, 2008, the PBGC filed a notice of appeal in connection with the bankruptcy court's decision.

Ramifications

The Memorandum Opinion allows a debtor that effectuates a distress termination of a pension plan in Chapter 11 to exit bankruptcy without the potentially crippling post-emergence costs associated with the termination premiums. Under the bankruptcy court's ruling, the PBGC's claim for termination premiums owed by a debtor would be subject to compromise (as a prepetition unsecured claim) through the plan of reorganization confirmed in the debtor's Chapter 11 case, and it would be discharged upon its emergence from bankruptcy. Given the formula for calculating the termination premiums, the claim amount likely would constitute a substantial portion of the debtor's claims pool, which could materially diminish the recovery of competing creditors. It therefore is possible that going forward, the debtor, or the official committee of unsecured creditors appointed in the debtor's Chapter 11 case, will seek to characterize the termination premiums as 'penalties' and move to equitably subordinate such claims under section 510(c) of the Bankruptcy Code. See, e.g., In re Justin Colin, 44 B.R. 806, 810 (Bankr. S.D.N.Y. 1984) (in subordinating a penalty claim pursuant to ' 510(c) of the Bankruptcy Code, bankruptcy court considers impact on competing creditors).

Moreover, a debtor that effectuates a distress termination of a pension plan in Chapter 11 may be able to avoid incurring the termination premiums in the first instance by appropriately structuring its bankruptcy case. As the bankruptcy court discussed in the Memorandum Opinion, based on the plain reading of the DRA ' under which bankruptcy discharge is one of the conditions to the incurrence of the termination premiums ' the termination premiums are not assessed against a debtor that liquidates in Chapter 11. Oneida, 2008 WL 516493, at *6, n. 8 ('If a corporate debtor liquidates in Chapter 11, it does not obtain a discharge [citation omitted].'). As a result, it is possible that a debtor could avoid the imposition of termination premiums by conducting a sale of its assets in Chapter 11 under section 363 of the Bankruptcy Code, and then distributing the proceeds under a liquidating Chapter 11 plan.

In addition to the importance for companies needing to terminate their pension plans in Chapter 11, the Memorandum Opinion also is significant because it reaffirms the truly expansive scope of the term 'claim' under the Bankruptcy Code and enhances the ability of debtors to emerge from bankruptcy with a 'fresh start.' The bankruptcy court also made clear in its decision that
in order to render an obligation that otherwise qualifies as a 'claim' non-dischargeable in bankruptcy, Congress must express its clear and unambiguous intent to that effect, which the court found to be lacking with respect to the termination premiums.

It remains to be seen whether Congress will further legislate an amendment to the Bankruptcy Code to clarify its original intent. In the meantime, at least until the termination premium dispute is finally resolved through appellate review, debtors and the PBGC would be well-served to negotiate up-front how the termination premiums should be treated in the bankruptcy case. For a debtor, raising this issue in its prepetition negotiations with the PBGC would allow it to argue that the termination premiums are prepetition claims because the parties had contemplated, prior to the filing of the Chapter 11 case, the possibility that such premiums may be incurred. The PBGC also has incentives to negotiate how the termination premiums are treated in the debtor's plan of reorganization, because alternatively, it runs the risk of having its claim for the termination premiums discharged without having received any recovery on that claim. In other words, at least in the short term, the bankruptcy court's decision in Oneida v. PBGC is likely to incentivize debtors and the PBGC to arrive at a consensual resolution regarding the treatment of the termination premiums arising under the newly amended ERISA.

William J.F. Roll, III and Michael H. Torkin are partners at Shearman & Sterling LLP, New York, in the Litigation Group and the Bankruptcy & Reorganization Group, respectively. Solomon J. Noh is an associate in the firm's Bankruptcy & Reorganization Group.

In a matter of first impression, the United States Bankruptcy Court for the Southern District of New York held that the termination premiums assessed against Oneida Ltd. ('Oneida') as a result of the termination of one of Oneida's pension plans during its Chapter 11 case were prepetition 'claims' (as defined in
' 101(5) of title 11 of the United States Code (the 'Bankruptcy Code')) that were discharged under Oneida's confirmed plan of reorganization. Oneida Ltd. v. Pension Ben. Guar. Corp. (In re Oneida Ltd.), Case No. 06-01920 (ALG), 2008 WL 516493 (Bankr. S.D.N.Y. Feb. 27, 2008) (the 'Memorandum Opinion').

The controversy at issue in the court's decision originated from The Deficit Reduction Act of 2005 ('DRA'), which amended the Employee Retirement Income Security Act of 1974 ('ERISA') to require a debtor that effectuates a 'distress' termination of an underfunded pension plan in Chapter 11 to pay termination premiums to the Pension Benefit Guaranty Corporation (the 'PBGC') following its discharge in bankruptcy. (The termination premiums are not applicable to a debtor that does not receive a bankruptcy discharge, including a debtor that liquidates after terminating its pension plan obligations.) Those premiums, set at $1,250 per employee covered by the terminated plan, per year for three years, could amount to hundreds of millions of dollars in post-bankruptcy liabilities for reorganized debtors, and could limit significantly the benefits of terminating an underfunded pension plan in Chapter 11. In certain cases, the cost of the termination premiums could even exceed the amount of the terminated pension funding liability.

The bankruptcy court's decision establishing the dischargeability of these post-bankruptcy emergence obligations has broad-ranging implications, not just for troubled industries that are burdened with unsustainable 'legacy' liabilities (such as the automotive sector, for example), but for all Chapter 11 debtors.

Background

Oneida is one of the world's largest marketers of stainless steel silverware and flatware products. Following an unsuccessful out-of-court financial restructuring in late 2004, Oneida and its domestic affiliates filed for Chapter 11 bankruptcy protection in March 2006, shortly after the enactment of the DRA on Feb. 8, 2006. Concurrently with the filing of its bankruptcy petition, Oneida filed a motion before the bankruptcy court seeking to terminate all of its pension plans pursuant to the distress termination procedures contained in ' 4041(c)(2)(B)(ii) of ERISA. The PBGC, a governmental corporation that guarantees benefits offered under defined benefit pension plans (up to a statutory limit), stood to become the trustee of Oneida's pension plans if the bankruptcy court were to approve Oneida's motion.

In the course of the Chapter 11 case, Oneida and the PBGC arrived at a settlement whereby, among other things, Oneida agreed to retain and continue funding two of its three underfunded pension plans, the PBGC consented to the termination of the pension plan with the largest underfunding liability (the 'Oneida Pension Plan') of nearly $35 million, and the parties agreed to reserve all of their rights with respect to the enforceability of the termination premiums. In May 2006, the bankruptcy court approved the distress termination of the Oneida Pension Plan on the basis of this settlement. In September 2006, Oneida emerged from Chapter 11 pursuant to a confirmed plan of reorganization that, among other things, provided for zero recovery on, and complete discharge of, all claims resulting from the distress termination of the Oneida Pension Plan.

Following Oneida's emergence from bankruptcy, the PBGC demanded approximately $7 million in termination premiums from Oneida, an amount the PBGC argued was payable as a result of the distress termination of the Oneida Pension Plan in Chapter 11. In November 2006, Oneida commenced an adversary proceeding before the bankruptcy court seeking a declaratory judgment that the termination premiums owed to the PBGC were prepetition claims against Oneida's bankruptcy estate that were discharged pursuant to its confirmed Chapter 11 plan.

In December 2006, the PBGC filed a motion with the United States District Court for the Southern District of New York to 'withdraw the reference' to the bankruptcy court of the adversary proceeding. The PBGC's motion cited to 28 U.S.C. ' 157(d), which, among other things, requires district courts to withdraw the automatic reference to the bankruptcy court in the event that the resolution of the issues presented requires 'significant interpretation, as opposed to simple application[,] of federal non-bankruptcy statutes.' Keene Corp. v. Williams Bailey & Wesner L.L.P. (In re Keene Corp.), 182 B.R. 379, 381-382 (S.D.N.Y. 1995). The PBGC argued that the adversary proceeding must be heard before the district court because the bankruptcy court would need to engage in a 'significant interpretation' of ERISA in order to resolve the issues underlying the termination premium dispute, an act that is prohibited under 28 U.S.C. ' 157(d). The district court disagreed with the PBGC and declined to withdraw the reference to the adversary proceeding, finding that in order to resolve the dispute in connection with the termination premiums, 'the [bankruptcy court] will be required to do what it does on a routine basis: determine whether the [termination premiums] are post-petition obligations that must be paid by Oneida upon reorganization, or pre-petition 'claims' that may be discharged pursuant to [Oneida's plan of reorganization].' See Oneida Ltd. v. Pension Ben. Guar. Corp. , 372 B.R. 107, 111 (S.D.N.Y. 2007).

With the procedural dispute as to where to conduct the adversary proceeding having been resolved, in October 2007, Oneida filed a motion for summary judgment in its favor on all counts asserted in its complaint. The PBGC countered with a summary judgment motion opposed to the requested relief.

Decision

On Feb. 27, 2008, the bankruptcy court issued the Memorandum Opinion granting Oneida's summary judgment motion and denying the PBGC's summary judgment motion. In the Memorandum Opinion, the bankruptcy court expressly held that the termination premiums assessed against reorganized Oneida were prepetition claims that were discharged under Oneida's confirmed Chapter 11 plan of reorganization. Oneida Ltd. v. Pension Ben. Guar. Corp. (In re Oneida Ltd.), Case No. 06-01920 (ALG), 2008 WL 516493, at *13 (Bankr. S.D.N.Y. Feb. 27, 2008).

In holding that 'the [termination premium] in a Chapter 11 case is a classic contingent claim,' Id. at *6, the bankruptcy court reaffirmed the well-established principle that the term 'claim,' as defined in the Bankruptcy Code, is to be interpreted broadly to ensure 'that all legal obligations of the debtor, no matter how remote or contingent, will be ' dealt with in the bankruptcy case.' Id. at *5 (emphasis added) (quoting United States v. LTV Corp. (In re Chateaugay Corp.), 944 F.2d 997, 1003 (2d Cir. 1991)). Rejecting the PBGC's argument that the termination premiums cannot be 'claims' because the obligation to pay such amounts does not arise until after the date of the debtor's discharge, the bankruptcy court held that, although non-bankruptcy law (here, ERISA) governs the liquidated value of, the enforceability of, and defenses to, a right of payment, bankruptcy law determines whether a claim exists and whether such claim arose pre- or post-petition. Id. at *6.

The bankruptcy court noted that in order for it to adopt the PBGC's position that the termination premiums had survived Oneida's Chapter 11 discharge, the court would have to find that the DRA had impliedly amended the Bankruptcy Code to provide for the non-dischargeability of the termination premium obligations. The bankruptcy court was unable to make such a finding because of the strong presumption that a later law does not impliedly amend an established one, such as the Bankruptcy Code. Id. at *8. Indeed, the PBGC had made no effort to overcome this presumption on the basis that an irreconcilable conflict exists between the amended ERISA statute and the Bankruptcy Code. Id. To the contrary, the bankruptcy court found that a proper reconciliation of the DRA with the Bankruptcy Code's discharge provision produces a contingent unsecured claim in the amount of the termination premiums that is subject to compromise through the bankruptcy process. Id., n. 11. (The court noted, however, that pursuant to Oneida's confirmed Chapter 11 plan of reorganization, the PBGC's prepetition claims for the termination premiums had received zero recovery and been discharged. Id.)

Although the PBGC made no attempt to rebut the presumption against implied repeal and amendment by demonstrating a 'clear and manifest' intent of Congress to amend the Bankruptcy Code through the DRA, the bankruptcy court nevertheless found that no such showing could have been made. Id. In fact, the bankruptcy court found evidence to the contrary, noting, for example, that only a few months prior to the adoption of the DRA, Congress had amended the Bankruptcy Code to create several new non-dischargeable claims, but it had not included the termination premiums in that amendment. Id. The court, therefore, found that the DRA had not impliedly amended the Bankruptcy Code to provide for the non-dischargeability of the termination premiums.

Having established that they qualified as 'claims' under the Bankruptcy Code, the bankruptcy court also found that the termination premiums were prepetition claims that are subject to compromise in Chapter 11 (and thus can be paid cents on the dollar), as opposed to postpetition administrative expenses that must be paid in full before a debtor can emerge from Chapter 11. Id. at *13. The bankruptcy court's decision was based on the fact that the termination of the Oneida Pension Plan was well within the realm of possibilities contemplated by Oneida and the PBGC prior to Oneida's Chapter 11 filing. The DRA was enacted prior to Oneida's petition date, and, as the bankruptcy court noted, the parties had met on at least two separate occasions prior to the bankruptcy filing to negotiate the terms of the pension plan termination. Id. at *10. In other words, the termination premiums were prepetition unsecured claims for many of the same reasons that they qualified as contingent claims in the first instance. Moreover, the bankruptcy court reasoned that the termination premiums could not qualify as administrative expense claims because the imposition of such amounts had not benefited Oneida in the operation of its business during the pendency of the Chapter 11 case. Id. at *11.

On March 28, 2008, the PBGC filed a notice of appeal in connection with the bankruptcy court's decision.

Ramifications

The Memorandum Opinion allows a debtor that effectuates a distress termination of a pension plan in Chapter 11 to exit bankruptcy without the potentially crippling post-emergence costs associated with the termination premiums. Under the bankruptcy court's ruling, the PBGC's claim for termination premiums owed by a debtor would be subject to compromise (as a prepetition unsecured claim) through the plan of reorganization confirmed in the debtor's Chapter 11 case, and it would be discharged upon its emergence from bankruptcy. Given the formula for calculating the termination premiums, the claim amount likely would constitute a substantial portion of the debtor's claims pool, which could materially diminish the recovery of competing creditors. It therefore is possible that going forward, the debtor, or the official committee of unsecured creditors appointed in the debtor's Chapter 11 case, will seek to characterize the termination premiums as 'penalties' and move to equitably subordinate such claims under section 510(c) of the Bankruptcy Code. See, e.g., In re Justin Colin, 44 B.R. 806, 810 (Bankr. S.D.N.Y. 1984) (in subordinating a penalty claim pursuant to ' 510(c) of the Bankruptcy Code, bankruptcy court considers impact on competing creditors).

Moreover, a debtor that effectuates a distress termination of a pension plan in Chapter 11 may be able to avoid incurring the termination premiums in the first instance by appropriately structuring its bankruptcy case. As the bankruptcy court discussed in the Memorandum Opinion, based on the plain reading of the DRA ' under which bankruptcy discharge is one of the conditions to the incurrence of the termination premiums ' the termination premiums are not assessed against a debtor that liquidates in Chapter 11. Oneida, 2008 WL 516493, at *6, n. 8 ('If a corporate debtor liquidates in Chapter 11, it does not obtain a discharge [citation omitted].'). As a result, it is possible that a debtor could avoid the imposition of termination premiums by conducting a sale of its assets in Chapter 11 under section 363 of the Bankruptcy Code, and then distributing the proceeds under a liquidating Chapter 11 plan.

In addition to the importance for companies needing to terminate their pension plans in Chapter 11, the Memorandum Opinion also is significant because it reaffirms the truly expansive scope of the term 'claim' under the Bankruptcy Code and enhances the ability of debtors to emerge from bankruptcy with a 'fresh start.' The bankruptcy court also made clear in its decision that
in order to render an obligation that otherwise qualifies as a 'claim' non-dischargeable in bankruptcy, Congress must express its clear and unambiguous intent to that effect, which the court found to be lacking with respect to the termination premiums.

It remains to be seen whether Congress will further legislate an amendment to the Bankruptcy Code to clarify its original intent. In the meantime, at least until the termination premium dispute is finally resolved through appellate review, debtors and the PBGC would be well-served to negotiate up-front how the termination premiums should be treated in the bankruptcy case. For a debtor, raising this issue in its prepetition negotiations with the PBGC would allow it to argue that the termination premiums are prepetition claims because the parties had contemplated, prior to the filing of the Chapter 11 case, the possibility that such premiums may be incurred. The PBGC also has incentives to negotiate how the termination premiums are treated in the debtor's plan of reorganization, because alternatively, it runs the risk of having its claim for the termination premiums discharged without having received any recovery on that claim. In other words, at least in the short term, the bankruptcy court's decision in Oneida v. PBGC is likely to incentivize debtors and the PBGC to arrive at a consensual resolution regarding the treatment of the termination premiums arising under the newly amended ERISA.

William J.F. Roll, III and Michael H. Torkin are partners at Shearman & Sterling LLP, New York, in the Litigation Group and the Bankruptcy & Reorganization Group, respectively. Solomon J. Noh is an associate in the firm's Bankruptcy & Reorganization Group.