The Employee Retirement Income Security Act (ERISA) and Bankruptcies
The bankruptcy of a corporation that sponsors an ERISA governed pension or health plan triggers a series of actions intended to protect the benefits of plan participants if at all possible. This article identifies the different types of bankruptcy filings, the role of the Pension Benefits Guaranty Corporation (PBGC), and options available to participants and beneficiaries.
ERISA and the Bankruptcy Code
Protection generally varies with the type of corporate bankruptcy filing.
In a Chapter 11 bankruptcy, where the plan sponsor attempts to reorganize their liabilities and emerge from the bankruptcy in a stronger financial position, pension and health benefits may be protected by the courts.
In a Chapter 7 bankruptcy, which involves the liquidation of a plan sponsor, plan participants are frequently left with no pension or health benefits, other than their accrued, vested pension. All the corporate assets are generally used to pay off creditors, leaving little if any assets for current and former employees. The assets of a pension or benefit trust are not corporate assets.
Pension Plan Benefits in a Corporate Bankruptcy
ERISA requires that pension benefits be adequately funded and that the pension funds be maintained separately from an employer’s operating assets. Pension assets must be held in a trust. When these ERISA rules are followed, pension funds should be adequate to pay the accrued vested benefits at retirement per the plan provisions. Pension plan assets can only be used to pay plan benefits and expenses and cannot be reached by the creditors in a bankruptcy proceeding. However, plans whose sponsor is in bankruptcy frequently are underfunded for a variety of reasons, the most common being market performance of the assets which the sponsor was unable to offset by additional contributions.
In FY 2010, the PBGC worked closely with the bankruptcy courts and plan sponsors to help more than 30 plans survive Chapter 11 corporate bankruptcies. Despite these PBGC efforts, 147 underfunded single-employer, defined benefit plans did terminate in FY 2010, most often in bankruptcy. The PBGC will take over and administer these plans. However, there is a maximum amount payable by the PBGC. Frequently, existing pensioners will have their benefit reduced and future retirees will receive less than their accrued benefit. For plan participants who commence their benefit after the PBGC assumes control of the plan, it does not pay lump sums, or any optional form of benefit other than the single life annuity, with a 50% survivor benefit for spouses. Complete information on how the PBGC administers plans is available at www.pbgc.gov.
There is no PBGC coverage, however, for “defined contribution” plans such as 401(k), profit sharing and ESOP plans.
If a plan entered bankruptcy on or after September 16, 2006, the following PBGC rule applies:
If your plan sponsor (usually your employer) files a petition for bankruptcy protection before your plan ends, and is still in bankruptcy when the plan ends, PBGC uses the bankruptcy filing date instead of the termination date for your plan to determine the guaranteed pension benefit amount.
While the PBGC has sufficient funds to meet its immediate obligations, the agency notes that as of September 30, 2010 multiemployer plans may require future financial assistance of approximately $20 billion and single-employer plans present a loss exposure to reasonably possible terminations of approximately $170 billion.
Health Benefits in a Corporate Bankruptcy
Any benefits reduction or plan termination must be disclosed by the plan sponsor to all plan participants at least 60 days in advance of any action. In such an event, participants should understand their rights to continue coverage under COBRA or through alternative plans offered by the sponsoring organization. COBRA does not apply, however, if an employer terminates all of its health plans.
Retirees receiving health benefits or members of a collective bargaining agreement may be subject to special bankruptcy rules, and should check with their plan administrator for details.
Recommended Actions for Retirees of Bankrupt Plan Sponsors
Employees, retirees, and other beneficiaries of a corporate plan sponsor that files for bankruptcy should contact their plan administrator to determine the likely impact on their benefits. Questions to ask include whether benefits plans will be terminated, if benefits will be reduced, and if so by how much.
In the event of a health plan termination, beneficiaries will want to ask how long coverage will remain in effect and for both future and past health care procedures. Also, a beneficiary may wish to file a claim documenting any unpaid medical expenses with the bankruptcy court.
Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances. ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.