Second Circuit Holds that PBGC Pension Termination Premiums are Non-Dischargeable in Bankruptcy

April 13, 2009

In an important decision published last week, the Second Circuit reversed a decision by the Southern District of New York Bankruptcy Court, which had held that premiums payable to the Pension Benefit Guaranty Corporation following the termination of a pension plan are dischargeable as unsecured pre-petition claims in bankruptcy. The Second Circuit is the first court of appeals to address this issue since a 2005 statute implemented the so-called “termination premiums,” and its decision gives effect to Congress’s apparent intent, which was to make it significantly more expensive for debtors to terminate pension plans.

Pension Benefit Guaranty Corporation v. Oneida Ltd., Docket Number 08-2964-bk (2d Cir. Apr. 8, 2009)

Background

Flatware manufacturer Oneida Ltd. filed for chapter 11 in 2006 in part to address significant pension liabilities.  At the outset of its case, Oneida moved to terminate its three underfunded pension plans, and it eventually reached an agreement with the Pension Benefit Guaranty Corporation (“PBGC”), pursuant to which Oneida agreed to maintain two smaller plans and PBGC agreed to terminate and take over from Oneida a much larger plan (the “Oneida Plan”).  Had the plan not been terminated, Oneida was projected to have liabilities under the Oneida Plan of close to $30 million over the next three years.

When a pension plan covered by Title IV of the Employee Retirement Income Security Act of 1974 (“ERISA”) is terminated, PBGC takes over the plan’s assets and provides for future payments to plan beneficiaries, up to certain statutory limits.  Prior to enactment of the Deficit Reduction Act of 2005, employers often relied on distressed terminations of underfunded legacy pension plans in bankruptcy as a way of facilitating their reorganizations.  Partly as a result, by November 15, 2006, PBGC was obligated to pay benefits to 1.3 million beneficiaries of failed plans, was operating under an $18.88 billion deficit and had projected long-term obligations well in excess of its projected cash flows.[1] 

In an effort to shore up PBGC’s finances, Congress included in the Deficit Reduction Act of 2005 an amendment to Section 4006(a)(7) of ERISA (the “2005 Amendment”).  The 2005 Amendment, enacted approximately one month before Oneida filed for chapter 11, requires employers that terminate qualified pension plans to pay PBGC annual “Termination Premiums” equal to $1,250 per beneficiary.  The Termination Premiums are payable for three years following termination of a plan or, if the employer terminates a plan while in bankruptcy, for three years after the employer’s emergence from bankruptcy.

In their settlement, Oneida and PBGC expressly reserved their rights to dispute whether or not PBGC would be entitled to receive Termination Premiums on account of the termination of the Oneida Plan.

Bankruptcy Court Proceedings

At the completion of its chapter 11 case, Oneida brought an action against PBGC in the Bankruptcy Court for the Southern District of New York seeking a determination that Oneida did not owe Termination Premiums on account of the termination of the Oneida Plan.  With 1,920 workers and retirees covered by the Oneida Plan, the Termination Premiums would have cost Oneida approximately $2.3 million per year for the next three years.

In its complaint, Oneida argued that that the Termination Premiums were unsecured claims that arose prior to confirmation of Oneida’s plan of reorganization and were, therefore, discharged in that plan pursuant to Section 1141(d) of the Bankruptcy Code.  In response, PBGC argued that treating the Termination Premiums in this manner would be contrary to the provisions of the 2005 Amendment and Congress’s expressed intent.  In a brief decision, the Bankruptcy Court sided with Oneida and held that the Termination Premiums had been discharged in Oneida’s plan.

Second Circuit Decision

PBGC appealed the Bankruptcy Court’s ruling, and the Second Circuit granted the parties’ request that it hear the appeal directly, thereby bypassing the district court.  On appeal, Oneida again argued that Termination Premiums arising out of plans terminated during a bankruptcy case are contingent rights to receive payment that arise during the case and are, therefore, “claims” under the Bankruptcy Code and dischargeable as such.  The Second Circuit, however, sided with PBGC and overturned the Bankruptcy Court’s decision.  The court pointed to Congress’s specific provision for payments by post-emergence debtors as evidence that the payment obligations do not arise until post-bankruptcy and, therefore, are not dischargeable.  The court noted that the Bankruptcy Court’s holding, if upheld, would thwart Congress’s clear intent in enacting the 2005 Amendment.

Future Implications

The Second Circuit’s decision is one of first impression among the federal courts of appeal and is likely to be relied upon by other courts faced with this issue.  The appellate court’s treatment of Termination Premiums as non-dischargeable obligations will give effect to Congress’s apparent intent to make it more expensive for debtors to terminate pension plans as part of corporate reorganizations.  This will make it more costly for some employers to terminate underfunded legacy plans, which ultimately will reduce recoveries for other creditors and potentially could inhibit some debtors from successfully reorganizing. 

If you have any questions about the decision discussed in this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact.

Laureen F. Bedell, Partner
212-450-4167 | laureen.bedell@dpw.com

Donald S. Bernstein, Partner
212-450-4092 | donald.bernstein@dpw.com

John Fouhey, Partner
212-450-4358 | john.fouhey@dpw.com

Marshall S. Huebner, Partner
212-450-4099 | marshall.huebner@dpw.com

Benjamin S. Kaminetzky, Partner
212-450-4259 | ben.kaminetzky@dpw.com

Karen E. Wagner, Partner
212-450-4404 | karen.wagner@dpw.com

Michael J. Crames, Counsel
212-450-4744 | michael.crames@dpw.com

Damian S. Schaible, Associate
212-450-4580 | damian.schaible@dpw.com

Davis Polk & Wardwell

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