Remarks at The University of Texas School of Law VALCON Conference
by Bradley D. Belt
Executive Director, Pension Benefit Guaranty Corporation
"The Role of the PBGC in Corporate Restructurings and Bankruptcies"
Thank you for the invitation to speak to you today about the PBGC's role in corporate restructurings and bankruptcies. Unfortunately, it is an increasingly visible and important role, for two main reasons: the growing number of companies struggling to meet the costs of the promises they have made to their workers and retirees, and the growing incidence of companies seeking to renege on such promises.
As you are aware, PBGC has been a key player in some of the largest and most complex bankruptcy reorganizations in the nation's history. United Airlines is the biggest and most visible. Ultimately, we had an allowed claim against the estate for the full amount of underfunding in the pension plans-more than $10 billion. Given the extraordinary strain that case put on the Corporation's resources, particularly our corporate finance and legal staff, I had hoped we would be able to take a brief respite.
Alas, we are now actively involved in some other bankruptcies you might have heard of-Northwest Airlines, Delphi Automotive and Delta Airlines, to name just a few. All told, the PBGC is currently dealing with more than 300 open bankruptcy cases of all sizes and types. In addition to bankruptcies, we must also monitor the status of on-going plans where the underfunding or default risk has risen.
In past years, the role of the federal pension insurance program was more limited. However, pension plans have grown dramatically in size. With more than $2 trillion in obligations, defined benefit pension plans represent one of the largest liabilities underwritten by corporate America-off-balance sheet, but a liability nonetheless. If there were sufficient assets set aside to cover these liabilities, there wouldn't be much of an issue for the pension insurance program-and, more important, for beneficiaries.
Unfortunately, that is not the case. As a result of falling assets value in the earlier part of the decade, sustained low interest rates, new benefit promises, and inadequate cash contributions, the number of pension plans that are underfunded and the amount of underfunding has skyrocketed over the past five years. Estimates vary, but there is well north of $200 billion in underfunding measured on an "on-going" or GAAP basis, and more than $400 billion on a settlement cost basis. As the cash flows necessary to support these funding gaps have risen, so-called legacy costs have become a front and center issue in some companies' economic survival.
All too many of them have sought to terminate their pension plans, most of them through the "distress" termination process. In 2005 alone, there were 120 corporate pension defaults affecting almost 270,000 participants. As I will discuss in more detail in a moment, there is a rigorous legal process that must be followed before a plan can be terminated. Based on the public comments of some company executives, however, one might conclude that terminating pension plans and shifting those costs to the federal insurance program is a perfectly acceptable business stratagem to enable them to become more competitive. I want to disabuse them of that notion. Let me be clear: As long as a company maintains a pension plan, there is a legal obligation to fund the plan, comply with ERISA, and fulfill the fiduciary obligation to act in the best interests of plan participants.
Bear in mind that the PBGC wears two hats when dealing with companies in bankruptcy-one as a contingent creditor, and the other as a regulator. It is our regulatory status that is often overlooked. As the agency responsible for administering and enforcing Title IV of ERISA, PBGC has a statutory responsibility to protect the interests of the federal pension insurance program and its stakeholders, which include participants in pension plans at risk of termination, all insured participants, premium payers and, ultimately, taxpayers. As such, the PBGC strives to prevent avoidable losses, mitigate risks, maximize recoveries, and enforce compliance with Title IV.
As a creditor, we use our status as appropriate. While the PBGC has some priority claims, we typically are a general unsecured creditor with respect to the full amount of the unfunded benefit liability. Even so, that unsecured claim in many cases makes us the largest creditor of the company, by far. In addition, we will occasionally have a security interest as a result of a settlement agreement or a funding waiver, and we typically (but not always) serve on creditors' committees.
As a regulator, our authorities are more limited than those of other financial regulators and federal insurers. The FDIC, for example, has several enforcement arrows in its regulatory quiver that better enable it to protect against bank failures, including the authority to issue cease and desist orders. While PBGC's tools are more limited in scope, the agency uses them as proactively and aggressively as appropriate to protect the insurance program. Among other things, we have the authority to:
- conduct examinations, audits, and investigations
- issue subpoenas
- act to prevent long-run losses and evasion of liability
- bring actions in federal court for legal or equitable relief
- bring actions for breach of fiduciary duties (if we have become plan trustee).
PBGC also coordinates with other regulators on pension funding and related matters, including the SEC and ERISA agencies, and will make enforcement referrals in appropriate circumstances.
It is important to understand PBGC's interest and role in out-of-court restructuring as well as in the bankruptcy context. As a guarantor of financial and credit risk, PBGC closely monitors developments in on-going plans as part of its Early Warning Program. As an insurer, PBGC is concerned with both the potential incidence of claims as well as the potential magnitude of claims. We will take action as necessary and appropriate to reduce the risk of a claim or lessen the magnitude of the loss if a claim is ultimately presented. PBGC is particularly interested in actions or transactions that pose a risk of loss to the insurance program, such as a material increase in the amount of underfunding or decrease in the ability of the plan sponsor to support one or more pension plans. The types of transactions that PBGC has identified in previously issued guidance as relevant in this regard include:
- the breakup of a controlled group
- the transfer of significantly underfunded pension liabilities
- the payment of extraordinary dividends
- the substitution of secured debt for unsecured debt.
These or similar actions or transactions may not have an adverse impact on a pension plan. To the extent that the impact may be adverse, however, PBGC will discuss with the sponsor ways in which the adverse impact can be eliminated or the interests of plan participants and the federal insurance program can otherwise be protected. Typical protections that PBGC will seek from plan sponsors include:
- making additional contributions to the plan
- posting collateral or another security interest
- providing letters of credit or guarantees
- escrowing funds that would be available to the plan upon certain triggering events.
PBGC routinely will retain a financial advisor to assist in the analysis of a transaction and the structuring of appropriate protections for the insurance program.
The key message I want to deliver is that companies with large pension liabilities, significantly underfunded pension plans, or sub-investment grade credit ratings should contact PBGC in advance of taking any action or engaging in any transaction that may impact the pension liability. It would be best for all concerned to resolve issues in advance than get into the position of trying to unscramble eggs.
Let me now turn to bankruptcy context, and more specifically, the process for "distress" terminations under Title IV of ERISA. PBGC has a statutory responsibility to ensure that companies seeking to terminate underfunded pension plans strictly adhere to the legal and regulatory requirements before they may shift their liabilities onto the pension insurance program. Time does not permit me to go into great detail about the distress procedures and requirements, but suffice it to say that a desire to be more competitive is not a relevant consideration under the statute. Rather, the plan sponsor has the burden to prove it meets the distress criteria. This is true for all members of the sponsor's controlled group as well. In addition, mere assertions that a plan is not affordable or that the company can't otherwise continue in business while maintaining a plan are insufficient. I emphasize the singular because the showing must be made on a plan-by-plan basis.
Moreover, a distress termination is intended to be used only after other remedies or less drastic measures have been exhausted. This includes reducing non-pension costs or freezing existing plans to reduce future liability growth. Sponsors also should have exhausted other statutory remedies intended to deal with business hardships or cash flow problems, such as funding waivers under section 412(d) of the Internal Revenue Code, amortization extensions under 412(e), or Prohibited Transaction Exemptions from DOL under Title I of ERISA. Distress is a last resort, not the path of least resistance.
I would also note that while a bankruptcy court determines whether a company would be able to emerge from bankruptcy while maintaining a plan, PBGC will not process a termination if it determines that the statutory procedures have not been fully satisfied. In addition, PBGC has the authority and discretion under ERISA to restore plans during the process or after plans have been terminated and trusteed-for example, if business conditions have changed or there has been an abuse of the insurance program.
In this latter regard, we will closely scrutinize transactions or arrangements that are, or appear to be, related to plan terminations. Financial arrangements or transactions that are structured to inappropriately shift liabilities onto the pension insurance program, or to use the federal guarantee as a subsidy in conjunction with new benefits or other financial consideration, frustrate the purposes of ERISA and are prohibited. PBGC will assess whether the purpose or effect of transactions or financial arrangements is to avoid the strict criteria and procedures for a distress termination; to avoid or evade the maximum guarantee limits established by Congress; to avoid the termination liability of a sponsor or controlled group member; to induce employees to agree to termination of a plan; to transfer or allocate assets in a manner inconsistent with the provisions of Title IV; to threaten the integrity of the pension insurance program in any other manner.
The factors that PBGC will consider in determining whether a transaction or arrangement is abusive include the timing of the arrangement or transaction (i.e., is it temporally related to plan termination); the structural relationship of the arrangement or transaction to plan termination (e.g., is there a linkage with benefits promised under the terminated plan); and financial considerations (e.g., whether follow-on pension benefits or other financial considerations provided could otherwise support one or more of the existing plans).
A couple of examples may be illustrative. This audience is undoubtedly familiar with the agency's authority to address abusive "follow-on" plans, which was upheld by the Supreme Court in the LTV case. That case dealt with a fairly flagrant example of evading the maximum guarantee limits and inducing employees to agree to a plan termination. We have subsequently seen instances of more creative approaches that nonetheless have the same purpose or effect. This includes providing cash or other securities to employees to compensate for the loss of non-guaranteed benefits, whether or not they are provided in a deferred compensation structure. Other transactions that may constitute an impermissible abuse of the insurance program include control group breakups or asset sales that result in the sponsor being unable to support a plan.
The key point is that the substance and effect of the arrangement or transaction will dictate whether it is abusive, not the form. If an arrangement or transaction is determined to be abusive, PBGC will take action to protect the interests of the pension insurance program. In addition to declining to process a proposed termination or restoring a plan to its pre-termination status as noted above, PBGC may also pursue claims against former contributing sponsors or controlled group members or seek to obtain injunctive or other equitable relief in federal court.
The bottom line is that the federal pension insurance program is not intended to subsidize a company's on-going labor costs. This adversely impacts plan participants, industry competitors, other plan sponsors that have responsibly funded their pension promises, and it puts American taxpayers at risk of having to bailout the insurance program. The company that makes promises to its employees should keep them and not shift its obligations to third-parties.