Do some companies file for Chapter 11 protection to avoid pension payments?
The question springs from recent reports concerning the shedding of defined-benefit pension liabilities by United, Northwest, and other bankrupt airlines — and from worries that other struggling companies might follow suit. After going into bankruptcy in 2002, United Airlines, for example, was able to shed $8.3 billion of its pension burden by terminating its plans. Bradley Belt, the director of the Pension Benefit Guaranty Fund (PBGC), which assumed $6.4 billion worth of the bill, excoriated the company for failing to contribute to its pension funds for years before its filing. Lately, United emerged from Chapter 11, shorn of its defined-benefit plans and their obligations.
A March New York Times story concerning Northwest Airlines brought the issue into focus yet again. The newspaper reported that the Labor Department was investigating whether Northwest Airlines “systematically shortchanged its employee pension fund over three years,” then avoided having to make a $65 million payment due to the fund on September 15, 2005 by going into bankruptcy on September 14 of that year.
The report has potentially wide-ranging consequences for the sponsors of pension plans, healthy as well as ailing. The investigation “suggests that the Labor Department is looking for a way to break an entrenched pattern, in which distressed companies quietly deplete their pension funds over a number of years, then declare bankruptcy and transfer huge obligations to the federal government,” according to the newspaper.
The alleged pattern could hurt healthier companies in at least two ways: by hiking the premiums they must pay to PBGC and by putting them at a competitive disadvantage. In a recent survey, 84 percent of 122 senior finance executives polled by Grant Thornton said that the rules enabling bankrupt companies to turn over their pension obligations to the PBGC should be tightened, making it less easy to do so. “When you have any company go into bankruptcy and go to the PBGC, that puts competitors in a difficult spot — they almost need to follow suit,” explains John Hepp, a senior manager at Grant Thornton. “The alternative to tightening rules could be a race to the bottom.”
For its part, Northwest contends that it has done nothing wrong
— in fact, that it has acted virtuously. True, the company’s timing enabled it to avoid an unquestionably negative effect: if the airline hadn’t declared bankruptcy before the pension payment was due, its pension fund would be socked automatically with a lien against its assets. Presumably, the bankruptcy filing might also help Northwest to hash out a lighter pension burden with its unions.
But the company issued a statement contesting the claim in the Times article that it had “systematically shortchanged” its workers’ pension fund for more than three years. Until its bankruptcy filing, the airline “paid in full and on time all amounts due and owing to its pension plans,” it said in statement. When it went into bankruptcy, the company’s pension fund had $5.8 billion in assets against $11.5 billion in liabilities — meaning that it was $5.7 billion underfunded.
Referring to amounts the company spent after the Chapter 11 filing, a Northwest spokesperson said that “we paid the normal post-petition service contribution” but that the company would not comment on the $65 million due before the filing. The Labor Department did not respond to a request for comment on the case.
Unlike other bankrupt airlines, Northwest says, it prefers not to terminate its plans and wants to continue funding them. That, however, depends upon whether Congress and President Bush enact legislation giving the airline industry pension-funding relief, according to the company. To date, the House and Senate are still ironing out their differences on a pension bill that may or may not include such relief.
To be sure, the findings of DOL’s Northwest probe may be a long time coming — and they might never include revelations of the airline’s motivations. It’s unlikely, however, that a big company in a troubled industry would slip into bankruptcy just to avoid a pension payment, bankruptcy professionals contend.
Such a company has, for instance, lots of other creditors, employee claims, and debt to consider. “The notion that [pending pension bills are] a primary motivator for a company is just silly,” asserts a bankruptcy attorney who spoke on condition of anonymity. “No company that I’m aware of has pension as the problem and bankruptcy as the solution.”
Still, struggling companies might well take looming pension-fund payouts into account in deciding when to seek Chapter 11 shelter. What’s more, it would be the right thing to do, some contend. The lawyer puts it this way: “at the margins, if a company is going to file anyway — if the choice is between before or after [a certain date] — it would be irresponsible to prefer the claims of pension plan beneficiaries over other creditors.” Further, doling out a large pension payment isn’t likely to solve the pension problems of a hugely underfunded company, he adds.
Shelling out whopping amounts of cash to a pension plan when other claims are looming could also have legal consequences. If a company has crossed into the muddily defined “zone of insolvency,” directors and officers could find themselves the targets a lawsuit from other creditors if they plotted out such payments, notes William Lenhart, National Director of BDO Seidman’s Financial Recovery Services Group.
When companies enter into the zone, says Lenhart, the duties of directors and officers shift partly from shareholders to creditors. “Just not pulling the plug soon enough” on payments to retirees, bondholders, or other unsecured creditors could land managers in court, Lenhart suggests.