While proposed legislation has 'laudable goal,' could it also hasten the demise of these plans?
A federal private member’s bill prioritizing defined pension plan members during a company’s insolvency is making its way through Parliament. However, restructuring and pension lawyers at Blake, Cassels & Graydon LLPs say unintended consequences could lead to a dramatic decrease in DB plans, considered by many the gold standard for funding retirement.
“Protecting pensions that employees have accrued is a very laudable goal,” says pension lawyer Jeff Sommers, noting the ripple effect it will have on other creditors. “The issue is whether this bill is really the right way of doing that.”
In November, 318 federal Members of Parliament voted unanimously in support of Bill C-228, a private member’s bill sponsored by Conservative MP Marilyn Gladu, sending it to the Senate for review and third reading. It is expected to pass into law by the time Parliament adjourns for the summer. However, there will be a four-year transition period before fully implemented.
If given royal assent, the law would change bankruptcy and insolvency law to give pensioners “superpriority” for unfunded liabilities in private sector defined benefit pension plans. That would put the pension liability ahead of secured and unsecured creditors, improving the chances that plan members would be made whole in insolvency.
But the bill has sparked debate about whether superpriority for pensioners is a policy that could unintentionally hasten the demise of the very pension plans whose value it seeks to protect.
Employers who have DB plans for their employees may also face consequences such as the restriction of credit or increased cost of credit.
Restructuring and insolvency lawyer Kelly Bourassa agrees that the goal of protecting employee pensions when a company is facing bankruptcy is important and adds that the law, as now written, includes a four-year transition period for employers. But the concern is that it “could have the effect of restricting access to capital for those companies with defined benefit plans for their employees,” as lenders and other creditors look for more certainty.
These restrictions could trigger insolvency during transition or prompt employers to wind up their DB plans.
Sommers explains that DB plans promise employees they will get a future stream of payments for life, usually based on the amount of service they have had with the employer and their earnings. The money comes from the pension fund that the employer and employee have contributed to.
“So, you do a calculation, and then the employer has to put enough money aside to provide those pensions,” he says. “But because the actual value of those pensions is based on so many different assumptions - how long people are going to live, what interest rates are going to be – it’s never completely accurate.” When pensions are valued, it’s only a snapshot in time, and whether it is underfunded or overfunded usually works out over time for pensions.
But the problem, says Sommers, is what happens if a company goes through insolvency or restructuring. It might happen when the pension plan is considered underfunded, “leading to a situation where retirees take a haircut in their pensions.”
The new bill would change how pensions are addressed during insolvency proceedings, impacting all registered pension plans, including those registered provincially. Specifically, Bill C-228 would increase the unfunded pension amounts protected by priority in insolvency.
Currently, priority is given to amounts such as those deducted from an employee’s pay for payment to the pension fund, unpaid “normal costs,” and defined contributions required to be paid by the employer to the pension fund.
The proposed legislation would expand the priority to include both “special payments … that would have been required to be paid by the employer … to liquidate an unfunded liability or a solvency deficiency” and any amount required to liquidate any other unfunded liability or solvency deficiency as determined on the day on which the insolvency proceedings commenced.
This superpriority would fully fund the DB plan on both a “going concern” basis and a solvency basis, even if the employer had until then been funding the plan under legislative requirements.
As a result of the expanded priority proposed by Bill C-228, Bourassa says lenders to companies with DB pension plans may find themselves at more risk if they must stand in line behind significant unfunded pension liabilities that may only be determined when an employer files for insolvency.
This alters the risk profile for lenders to companies with DB plans, who may respond by making credit less available, more difficult to obtain, and more expensive. There could even be covenants to restrict DB plans or consider any solvency deficiency regarding a DB pension plan a default in the credit agreement.
Bourassa says that the limited priorities currently given to defined benefit plans in an insolvency focus on aspects of the plan that can be relatively easy to quantify. But because the new bill prioritizes any solvency deficiency, something that isn’t quantifiable until a company declares insolvency, “it inserts risk into secured lending and investment in businesses that have defined benefit plans.”
The impact on employers with DB plans would be the increased cost of capital or inability to borrow, and this could lead to winding up the DB plan or switching to another form of retirement savings, such as a Defined Contribution plan or group RRSP plan, generally seen as inferior to an employer-sponsored DB plan.
Sommers and Bourassa say some have suggested ways to better protect defined benefit plans without posing as much potential risk to other secured creditors. One idea is a form of insurance that would kick in to protect accrued pensions when an employer becomes insolvent. Ontario has a version of this with its Pension Benefit Guarantee Fund, but such insurance plans could also involve the private sector.
Other possible suggestions include requiring employers to put money into plans so it never goes into a deficit. However, that could be expensive for employers to provide. Keeping a more vigilant eye on a DB plan to ensure it is as small as possible at any given time could also be a solution.
Another suggestion is not forcing a defined benefit plan to wind up immediately when an employer declares insolvency. “If we just allowed it to continue even with no more new money going in, time could still right the ship, based on changes in interest rates, for example,” says Bourassa. Others have suggested merging these affected plans with larger ones earning good investment returns. “So there are some creative ideas out there,” Bourassa says, to protect DB plans.
“The four years of the transition period are going to be very telling because that’s when lenders to these DB employers are going to have to start assessing their risks because their whole risk profile could change significantly once this law comes into force.”
Sommers says that in his role as a pension lawyer, he has been keeping his clients up to date on the bill and advising them that during the transition period, those who have DB plans will have to understand how the new law may affect their access to capital and the cost of borrowing, and if they will need to provide more frequent actuarial valuations of the plan. A lending contract could even have “triggers” that would call in a loan if the pension deficit was too large.
“We don’t know exactly what will happen, but we are telling our DB sponsor clients that there’s likely going to be a reaction from lenders, and we’ll have to see how it plays out.”