Pensions and the Pecking Order

A probe of Northwest Airlines brings bankrupt companies' retirement-funding duties into sharper focus.

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.

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