Thursday, February 7, 2013

Insolvency and Underfunded Defined Benefit Pension Plans

The Supreme Court of Canada recently released a decision that many see as a victory for creditors of companies with underfunded defined benefit pension plans.  Indalex Limited ("Indalex") was the sponsor and administrator of two employee pension plans, one for salaried employees and the other for executive employees. It then became insolvent. Indalex sought protection from its creditors under the Companies' Creditors Arrangement Act ("CCAA") . Both plans had "wind-up deficiencies".

In a series of court-sanctioned steps, the company was authorized to enter into debtor in possession ("DIP") financing in order to allow it to continue to operate. The CCAA court granted the DIP lenders priority over the claims of all other creditors.

Ultimately, with the approval of the CCAA court, Indalex sold its business but the purchaser did not assume its pension liabilities. The proceeds of sale were not sufficient to pay back the DIP lenders so Indalex's parent company, the guarantor of the debt, paid the shortfall and stepped into the shoes of the DIP lenders in terms of priority. The CCAA court authorized payment in accordance with the priority but ordered that an amount be held in reserve so that the members of the pension plans could argue their rights to share in the proceeds of sale.

The plan members challenged the priority granted to the parent company and claimed that the pension plans had priority in the amount of the wind up deficiency by virtue of a statutory deemed trust under section 57(4) of the Pension Benefits Act (PBA), Ontario and also by reason of a constructive trust arising from Indalex's alleged breaches of fiduciary duty as an administrator of pension funds.

The motions judge dismissed the motions and held that the plan members were unsecured creditors. The Ontario Court of Appeal reversed the ruling and held that the wind up deficiencies were subject to deemed and constructive trusts which had priority over the DIP financing and other secured creditors.

The Supreme Court of Canada allowed the parent's appeals. A narrow 4 - 3 majority of the seven member court upheld the Court of Appeal's finding that the statutory deemed trust in section 57(4) of the PBA applies to the entire unfunded deficiency on the wind up a pension plan. However, all the judges agreed that under the doctrine of federal paramountcy, the CCAA court ordered priority had the same effect as a legislative provision and superseded the statutory deemed trust.

All member of the seven judge panel also agreed that where an employer is also the plan administrator, there is a conflict between the roles of the employer as an employer and its role as plan administrator in insolvency proceedings. The fiduciary duty of the administrator to the plan members requires at the very least notice of the insolvency proceedings so that the plan members can take steps to protect their interests.

Justice Deschamps wrote - In an insolvency, often large claims of ordinary creditors are left unpaid and the promise of defined benefits made to employees during their employment is put at risk. Although the employer in this case breached a fiduciary duty, the harm suffered by the members of the pension plan resulted from the employer's insolvency and not from the breach of the fiduciary duty.

To improve the prospect of pensioners receiving their full benefits after a pension plan is wound up, the Ontario Legislature has protected contributions to the pension fund that have accrued but are not yet due at the time of the wind up while providing for a deemed trust that supersedes all other provincial priorities over certain assets of the plan sponsor. The court held that the deemed trust extends to contributions the employer must make to ensure that the pension fund is sufficient to cover liabilities upon wind up. In this case however, the deemed trust was superseded by the security granted to the DIP creditors.

There are good reasons for giving special protection to members of a pension plan in insolvency proceedings. Parliament considered doing so before enacting the most recent amendments to the CCAA but chose not to. In an insolvency process a CCAA court must consider the employer's fiduciary obligations to plan members as their plan administrator. It must grant a remedy where appropriate. However, courts should not use equity to do what they wish parliament had done through legislation.

Justice Cromwell wrote - In an insolvency, pension plans and creditors may find themselves in a zero-sum game with not enough money to go around. Although all current contributions are up-to-date, the company's pension plan did not have sufficient assets to fulfill the pension promises made to its members. In this case, the deemed trust provisions of the Pension Benefits Act did not apply and even if it did, the superpriority would override it.  Justice Cromwell concluded that Indalex had failed in its duty to the plan beneficiaries as their administrator and that the beneficiaries ought to have been afforded more procedural protections in the CCAA proceedings. However, the Court of Appeal erred in using the equitable jurisdiction of a constructive trust to defeat the super-priority ordered by the CCAA judge.



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