Second Circuit Ruling Makes Pension Plan Termination in Bankruptcy More Expensive

The perceived ease with which financially strapped companies have been able to jettison billions of dollars in pension liabilities has figured prominently in headlines for many years. Assumption of these obligations by the Pension Benefit Guaranty Corporation (“PBGC”) contributed to a PBGC deficit that aggregated nearly $33.5 billion for the first half of fiscal year 2009—the largest in the agency’s 35-year history—representing an increase over fiscal year 2008’s $11 billion shortfall. Despite airline relief provisions contained in pension reforms enacted in 2006 designed to staunch the flow of PBGC assets, the agency’s overall financial outlook is bleak, given a nationwide underfunding of defined-benefit pension plans that, according to PBGC’s estimates, may be as high as a half-trillion dollars, and the looming (or already filed) bankruptcies of a slew of U.S. automakers, parts suppliers, retailers, and other companies with significant underfunded pension liabilities. 

Termination of one or more defined-benefit pension plans has increasingly become a significant aspect of a debtor employer’s reorganization strategy under chapter 11 of the Bankruptcy Code, providing a way to contain spiraling labor costs and facilitate the transition from defined-benefit- based programs to defined-contribution programs such as 401(k) plans. However, when the Employee Retirement Income Security Act of 1974 (“ERISA”) was amended in 2006 to impose a “termination premium” payable upon the “distress termination” of a pension plan, it was unclear to what extent chapter 11 would continue to be beneficial to employers intent upon using bankruptcy to contain spiraling labor costs. That issue has now been tested in the courts. A ruling recently handed down as a matter of first impression by the Second Circuit Court of Appeals indicates that, if followed by other courts, terminating a pension plan in a bankruptcy reorganization will be a more expensive exercise. In Pension Benefit Guar. Corp. v. Oneida Ltd., the court of appeals held that the termination premium payable upon a distress or involuntary termination of a pension plan in bankruptcy becomes payable only upon the terminating employer’s receipt of a discharge, such that any claim based upon the premiums cannot be treated as a pre-petition unsecured claim.



The respective rights and obligations of employers and retirees vis-à-vis pension benefits are generally governed not by the Bankruptcy Code, but by ERISA, which provides the primary regulatory framework and protection for pension benefits. Enacted in 1974, ERISA is a comprehensive regulatory scheme intended to protect the interests of employee benefit plan participants and beneficiaries and to preserve the integrity of trust assets. On a basic level, it establishes minimum participation, vesting, and funding standards and contains detailed reporting and disclosure requirements. ERISA also created PBGC to act as both the regulatory watchdog and the guarantor, at least to a certain extent, for the pension and related rights of the U.S. workforce. PBGC today is responsible for pension programs covering 1.3 million people. It pays about 640,000 people actual benefits worth about $4.3 billion a year. 

Companies pay insurance premiums to PBGC, and if an employer can no longer support its pension plan, PBGC takes over the assets and liabilities and pays promised benefits to retirees up to certain limits. The maximum annual guaranteed benefit for plans assumed by the agency in 2009 is $54,000 for a straight life annuity at age 65. If PBGC recovers assets in excess of the guarantee, it allocates those assets to participants in accordance with a statutory scheme. PBGC finances payments to employees under terminated plans through five sources of income: (i) insurance premiums paid by current sponsors of active plans (for plans sponsored in 2009, $34 per year per single-employer plan participant, although companies posing high risks of underfunding must pay an additional variable-rate premium equal to $9 for every $1,000 of unfunded vested benefits); (ii) assets from terminated plans taken over by PBGC; (iii) recoveries from former sponsors of terminated plans; (iv) PBGC’s own investments; and (v) in connection with certain distress and involuntary plan terminations occurring on or after January 1, 2006, an annual “termination premium” of $1,250 per participant payable in each of the three years after the termination.

PBGC insures only “defined-benefit” plans. These are plans under which benefits are defined by a formula, where the employer contributes the statutorily determined amounts to a pension fund. The amount of retirement income an employee will receive generally depends on the employee’s length of service and salary. Actuaries perform complex calculations regulated by ERISA and the Internal Revenue Code to determine the amount of the required minimum periodic funding contributions the employer must make. Not all plans are defined-benefit plans. Many employers have “defined-contribution” plans instead. In these plans, the employer may contribute a certain amount for each participant (who typically contributes most of the funds to the plan), but the employer makes no promise regarding the ultimate benefit or amount that each participant will receive. Defined-contribution plans, such as 401(k) plans, are not guaranteed by PBGC.

There are several ways for a defined-benefit plan to terminate under ERISA. In a “standard termination,” an employer can voluntarily terminate its plan so long as the plan has sufficient assets to pay all future benefits. The employer remains liable to PBGC for all plan benefit liabilities. An employer can also voluntarily act to terminate its plan in a “distress termination” if each member of its controlled group experiences one of the following circumstances: (i) liquidation in bankruptcy; (ii) a reorganization in bankruptcy in which the court approves the termination after determining “that, unless the plan is terminated, [the employer] will be unable to pay all its debts pursuant to a plan of reorganization and will be unable to continue in business outside the chapter 11 reorganization process”; and (iii) a nonbankruptcy situation where a distress termination is necessary because without it, the employer would be unable to pay its debts when they matured and would be unable to continue in business, or because the costs of providing pension coverage have become unreasonably burdensome solely as a result of a decline in the employer’s workforce. The standard set forth in (ii) above is commonly referred to as the “reorganization test.”

Upon termination of a plan, PBGC assumes responsibility for guaranteed benefits and attempts to collect funds from the employer. An employer cannot effectuate either a standard or distress termination if terminating the plan would violate the terms and conditions of an existing collective bargaining agreement. However, a plan sponsor seeking a distress termination while in bankruptcy may nullify a contractual bar to plan termination by obtaining court authority to reject or modify the bargaining agreement under section 1113 of the Bankruptcy Code. Finally, PBGC itself can move to terminate a company’s pension plan if certain statutory criteria are met (e.g., the company defaults on its minimum funding requirements or PBGC determines that it will be exposed to unreasonable risk in the long run if the plan continues). PBGC need not consult with union representatives before terminating a plan on its own initiative, although PBGC is reluctant to terminate a plan in violation of a collective bargaining agreement. 

2006 Pension Reforms

In early 2006, President George W. Bush signed the Deficit Reduction Act of 2005 (“DRA”), which amended ERISA to add a new premium of $1,250 per participant per year for three years after a plan is terminated, whether through a distress termination or an involuntary termination initiated by PBGC, and whether inside or outside bankruptcy. The provision was originally enacted as a temporary measure but was subsequently made permanent in the Pension Protection Act of 2006 (“PPA”). Under the amendment, if a plan is terminated during a chapter 11 case, the termination premium does not become due until after the debtor emerges from bankruptcy, while a company that liquidates in bankruptcy incurs no premium. However, PBGC regulations provide that if any member of a controlled group is not liquidating, the termination premium applies to the nonliquidating member(s). ERISA now contains a “General Rule” and a “Special Rule” governing single-employer plan terminations.


The “General Rule” provides that:


[i]f there is a termination of a single-employer plan [under the circumstances specified], there shall be payable to [PBGC], with respect to each applicable 12-month period, a premium at a rate equal to $1,250 multiplied by the number of individuals who were participants in the plan immediately before the termination date.


However, the “Special Rule” provides that if a plan is terminated during a chapter 11 reorganization case, “[the General Rule] shall not apply to such plan until the date of the discharge or dismissal of [the debtor] in such case.” 

Under the General Rule, the “applicable 12-month period” runs from the “first month following the month in which the termination date occurs” and requires payment for a total of three years. By contrast, under the Special Rule, the applicable 12-month period does not commence until “the first month following the month which includes the earliest date as of which each [debtor] is discharged or dismissed” from the bankruptcy case.

These changes were enacted against the backdrop of successive pension plan terminations in the chapter 11 cases of high-profile steelmakers, automobile parts suppliers, and airlines and reflected lawmakers’ perceptions that it had become too easy to shed liabilities from pension plan obligations. As articulated by the House Committee on Education and the Workforce, “The bankruptcy courts should not be used as a mechanism for eliminating the burden of an underfunded pension plan,” justifying “an additional premium paid to the PBGC to recognize [that] the agency’s assumption of unfunded plan liabilities is reasonable.”


Oneida Limited—First Test in the Courts of the New Premium


Flatware maker Oneida Ltd. (“Oneida”) filed a “pre-negotiated” chapter 11 case on March 19, 2006, in New York. During its reorganization proceedings, Oneida terminated one, but not all, of its pension plans and entered into a settlement agreement with PBGC fixing the agency’s secured claims for past-due minimum funding contributions, as well as employer liability under ERISA and “traditional” premium claims. Under the agreement, Oneida reserved the right to challenge PBGC’s claim for the new termination premium. 

Oneida’s confirmed chapter 11 plan became effective on September 15, 2006, making Oneida the first reorganized company subject to the new termination premium assessment. Oneida immediately sought a declaratory judgment from the bankruptcy court that the termination premium claims were pre-petition claims covered by the PBGC settlement agreement and therefore discharged by confirmation of Oneida’s chapter 11 plan. PBGC, arguing that the dispute’s resolution required substantial and material consideration of ERISA as well as bankruptcy law, responded by moving to withdraw the reference of the matter so that the litigation could be adjudicated by a federal district court. The district court denied the motion, ruling that the determination of what is a “claim” and whether it has been discharged is something that bankruptcy courts routinely do and that the determination was merely a “simple application” rather than a “significant interpretation” of ERISA’s new termination premium provision.

On cross-motions for summary judgment later filed in the bankruptcy court, the court held that the termination premium was a pre-petition claim within the meaning of the Bankruptcy Code because it was a “classic contingent claim.” Interpreting the term “claim” broadly, and relying on rulings in other cases that pension liabilities are contingent pre-petition claims, the bankruptcy court found telling the fact that, although the Bankruptcy Code was significantly overhauled just a few months prior to enactment of the DRA as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the amendments did not include a provision making the yet-to-be-enacted termination premiums priority or nondischargeable claims.


The Second Circuit’s Ruling


On direct appeal to the Second Circuit Court of Appeals rather than the district court because the question involved “a question of law as to which there is no controlling decision of the court of appeals for the circuit or of the Supreme Court of the United States, or involves a matter of public importance,” a three-judge panel of the court of appeals unanimously reversed.

Analyzing the plain language of the General Rule and the Special Rule as well as the legislative history of the termination premium, the panel concluded that Congress unequivocally intended that the termination liability would not arise until after a reorganized employer emerges from bankruptcy. The Second Circuit examined the substantive nonbankruptcy law that gave rise to the obligation to determine the nature of the claim:


Here, the substantive, non-bankruptcy law giving rise to Oneida’s obligation to pay a Termination Premium is the Special Rule, which unambiguously states that where a pension plan is terminated in connection with an employer’s bankruptcy reorganization, the General Rule—which creates PBGC’s right to a Termination Premium—“shall not apply to such plan until the date of the discharge or dismissal of [the employer].” . . . The obvious purpose of this rule is to prevent employers from evading the Termination Premium while seeking reorganization in bankruptcy. Although in the context of a private contract, this language might not control the question of whether a “claim” existed, Congress may prescribe when a claim will be legally effective for the purposes of the Bankruptcy Code, at least where, as here, the non-bankruptcy statute explicitly discusses how the obligation should be treated in bankruptcy.


According to the court of appeals, what happened in the Oneida case is not a situation, as the bankruptcy court erroneously perceived, where an obligation had already been created prior to bankruptcy but is subject to a contingency. Rather, the Second Circuit explained, “an employer’s obligation to pay a Termination Premium on a pension plan that is terminated during the course of the bankruptcy does not even arise until the bankruptcy itself is terminated.” “No matter how broadly the term ‘claim’ is construed,” the court of appeals emphasized, “it cannot extend to a right to payment that does not yet exist under federal law.” Thus, the court found no ambiguity in the statutory language. Even so, it analyzed the legislative history of the DRA and the PPA, concluding that “[t]reating the Special Rule as a pre-petition claim would directly thwart Congress’s aim in establishing the Special Rule.”




Oneida Limited is unquestionably a positive development for PBGC, especially because the ruling is the only decision at the circuit level to address the issue to date. Unless and until a competing view emerges in subsequent decisions, terminating a pension plan in a bankruptcy reorganization has become a significantly more expensive proposition. For example, if the termination premium had been part of ERISA when United Air Lines was authorized to terminate its four pension plans in what was then and still is the largest PBGC assumption in history, the termination premium would have aggregated almost $460 million. 

At this juncture, the impact Oneida Limited will have on a potential debtor employer’s strategic planning in anticipation of a possible chapter 11 filing remains to be seen. The venue selected for a filing will unquestionably be a key consideration. In addition, plan feasibility in any chapter 11 case pending in the Second Circuit must include an examination of a reorganized company’s ability to satisfy any anticipated termination premium payment obligations. Whether such obligations must or even could be treated as administrative expenses of the chapter 11 estate is an open question. It is not clear in the Second Circuit’s ruling whether the termination premium is an obligation of the bankruptcy estate or the reorganized company. It is also unclear whether PBGC will take the premium into account when negotiating settlements of plan termination liabilities.

Finally, the Second Circuit’s ruling in Oneida Limited may have thrown a wrench into traditional bankruptcy jurisprudence regarding the issue of when a claim arises. The prevailing view in bankruptcy is that a claim under a pre-petition contract arises at the time the contract is executed, even though the claim may be contingent or unliquidated until sometime after one party to the contract files for bankruptcy protection. Oneida Limited suggests that a different rule applies to pre-petition pension plans terminated during a bankruptcy case. 



Pension Benefit Guar. Corp. v. Oneida Ltd., 562 F.3d 154 (2d Cir. 2009).