Wednesday, November 18, 2009

Pension priority in backruptcy

An article in the November 11, 2009 issue of Macleans included the following comment on why bankruptcy protection could not be extended to pension plan members:

"Despite the calls from Nortel employees, Ottawa stopped well short of suggesting legislative changes to protect pensioners in the event of a corporate bankruptcy. While Liberal Leader Michael Ignatieff has said employees deserve to be near the front of the line as an insolvent company’s assets are being carved up, experts argue such a move could displace other creditors and, in turn, make it difficult for frail companies to raise badly needed financing, potentially forcing more bankruptcy proceedings. In short, pensioners may never be guaranteed a soft landing when their employer goes belly up."

Do CEO's and business leaders agree with the Macleans' experts? A recent Compas poll found that its panelists, CEOs and business leaders, are especially supportive of the idea of legal priorizing of pension rights in the event of corporate bankruptcy. In fact, this idea had more support other ideas such as expanding the CPP or giving tax incentives to build pension surplus. So, the question is: is prioritizing pension rights in a corporate bankruptcy really a bad idea?

There are at least a couple of ways of looking at this question. There is no question that pension plan deficits are a real headache for corporations and their CFOs, but let's assume that deficits are given priority in bankruptcy proceedings - what would happen? For a start, CFOs would have a strong incentive to improve plan funding, or at least put in place a letter of credit, to ensure that creditors are not concerned with the pension plan and its new priority status. A plan that is fully funded, or backed by a letter of credit, would not add to the list of unsecured creditors in the event of bankruptcy. There would be more inclination to match asset duration to liability duration, which would mean reduced equity investments. This would reduce the likelihood of surprise deficiencies in the future. Funding flexibility and the opportunity to take contribution holidays may be reduced, but true costs would be better known and pensions would be substantially more secure.

From another perspective, a creditor today must assess the risk of any loan. As the new accounting rules (IFRS) come into play, pension plan deficits will show up on the balance sheet. Even if the pension plan members are not given bankruptcy priority, the creditor and rating agency will know the risks. A big one is that it would only take a change in government to flip the situation. In other words, pragmatically, the creditor should be operating as if the bankruptcy protection was now in place. Not having bankruptcy priority for the pension plan will not do much to improve the chances of getting a business loan.

How should a CFO respond? Clean up the pension plan financing as quickly as possible. A plan deficit is like the proverbial albatross. A corporation's finances will not be helped by ignoring the security needs of pension plan members and retirees. The government could help by adopting the Canadian Institute of Actuaries proposal to allow a Pension Security Trust. This Trust would be attached to the pension plan, but allow for reimbursement to the corporations of funds no longer needed once a suitable solvency margin is reached.

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