Vol 4 (2007) - Issue 4

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Distress Termination of Pension Plans Under ERISA: Managing the Risks Associated With Non-Debtor Foreign Affiliates

Introduction
As US companies strive to adapt to an increasingly com-petitive marketplace, a new focus has been placed on defined benefit pension plans.1 For years, these pension plans were commonly offered to US workers, particu-larly in the manufacturing industry, and, due in large part to the clout of labor unions, often provided gener-ous benefit payments. Today, however, pension plans have become too costly to maintain for many employ-ers. The retiree base for many existing plans continues to expand due to both the increased life expectancy of participants and the ‘baby boom’ generation reaching retirement age. As a result, companies that are saddled with ballooning pension obligations have had difficulty competing against the increasing number of businesses that do not offer pension plans, and, therefore, are not burdened with the attendant costs and expenses. To illustrate the extent of this problem, General Motors Corporation revealed in 2004 that its pension expenses added $675 to the price of each vehicle sold, in contrast to its Japanese rivals who had no such costs. For those reasons, among others, many employers in the United States have sought to terminate their pension plans in recent years.

Under US law, a company seeking to terminate its pen-sion plan without fully funding the often enormous cost of that obligation is required to satisfy a stringent test in which it must demonstrate, among other things, that it is unable to remain in business without terminating its pension obligations. This standard, generally referred to as the ‘financial distress’ requirement, must be met by all members of the ‘controlled group’ – composed of the legal entity that officially sponsors the pension plan and the sponsor’s corporate affiliates that are jointly and severally liable for the pension obligations (which is any affiliate, whether foreign or domestic, with at least 80% common ownership). When a company seeks to terminate its pension obligations in the course of a chapter 11 bankruptcy proceeding, as is often the case, the bankruptcy court has the authority to determine whether the financial distress requirement has been met by the debtor-entities. The bankruptcy court, however, lacks the jurisdiction to make any such finding regarding any non-debtor member of the controlled group. Instead, whether a non-debtor satisfies the financial distress requirement is a determination that must be made by the Pension Benefit Guaranty Corporation (the ‘PBGC’), a US government agency that has a vested interest in the pension system, as discussed below.

This statutory framework incentivizes companies to cause chapter 11 cases to be commenced with respect to each controlled group member so that the decision relating to the satisfaction of the financial distress requirement can be made entirely by the bankruptcy court – a body that regularly oversees the rehabilitation of troubled companies. By contrast, if any controlled group member is left out of chapter 11, the PBGC could potentially stall the debtor’s pension termination process by making an adverse determination regarding a non-debtor. An additional issue arises when members of the controlled group are foreign affiliates of the US-based debtor, because a chapter 11 filing often is not a viable option for such affiliates. As a result, US companies seeking pension termination have struggled to devise an effective strategy for dealing with foreign affiliates.