Shareholder Assets May Also Be at Risk

Before the current market crisis, many defined benefit plans lacked sufficient assets to pay guaranteed retirement benefits. With the events of the past several weeks, losses in those plans have grown deeper, and still more plans have fallen into distress. It may be quite some time before conditions grow better, and they may get worse yet.

Generally, a contributing employer need not fund a benefit plan shortfall immediately. However, a corporate asset sale, layoff, operation shutdown or other action that a corporation is likely to take in response to depressed economics may unwittingly trigger a "plan withdrawal." In the event of a withdrawal, the contributing employer and all members of a "controlled group" are immediately liable for the full amount of any benefit shortfall. The controlled group assets may include the assets of shareholders and their family members.

With proper planning, such liability may be avoided, mitigated or otherwise addressed appropriately. Corporations, affiliates and shareholders of corporations that contribute to defined benefit plans are urged to consider whether a "withdrawal" event will occur and, if so, what assets will be deemed "controlled group" assets for benefits' liability purposes.

What Is Withdrawal Liability?

A defined pension benefit plan guarantees a specific retirement benefit regardless of sufficiency of contributions or asset performance. Plan actuaries constantly project whether plan contributions and projected asset performance are sufficient to meet retirement obligations as they become due. Generally, an employer is not required to make up any projected underfunding unless and until the employer "withdraws" from the plan.

When an employer "withdraws," the fund actuary calculates the amount of the unfunded vested benefit and demands payment from the employer in periodic installments for up to 20 years. In the event of default in payment, the full amount becomes immediately due in a lump sum. Liability amounts are often staggering, leaving retirement plans desperately searching for assets to attach to satisfy benefit obligations.

What Events Trigger Withdrawal Liability?

A complete withdrawal occurs when an employer ceases making contributions. If an employer ceases operations and liquidates, then withdrawal liability is triggered unless the seller meets certain "safe harbor" provisions, which include requiring the buyer to assume the contribution obligation and to post a bond securing contributions for future years.

In certain industries, such as construction, if a corporation permanently ceases operations, then no withdrawal occurs and no liability is imposed. However, plans often successfully argue that an affiliated entity's continued or subsequently commenced operations constitute an alter ego continuation such that the noncontributing alter ego is responsible for the contributing employer's withdrawal liability.

A partial withdrawal occurs when the rate of contribution rapidly falls below a certain percentage as a result of a staff reduction or work hour decline. Downsizing must be examined for its potential partial withdrawal effects.

Commonly Owned and Controlled Affiliates Are Jointly and Severally Liable

Liability extends to trades or businesses under common control at the time of the withdrawal. A parent-subsidiary controlled group exists when a parent directly or indirectly owns at least an 80 percent equity interest in its subsidiary. A brother/sister controlled group exists where the same five or fewer individuals own at least 80 percent of two or more businesses. Under certain conditions, ownership interests of spouses, parents, children or grandchildren may be combined to determine whether a controlled group exists. Each member of the controlled group is treated as a single entity so that all trades or businesses within the controlled group are joint and severally liable. Proper planning in corporate transactions will allocate interests so that controlled group liability is not created.

A Shareholder's "Personal" Assets May Be at Risk

The law provides that an unincorporated "trade" may constitute a member of a controlled group for liability purposes. The term "trade" is given broad interpretation and is fact dependent. If a controlled group shareholder's assets are used to derive income, they may be considered part of the controlled group assets subject to attachment. For example, vacation properties rented out for income, a residence used for business

activities, art holdings or collector automobiles bought and sold as a hobby can all be considered controlled group assets subject to liability.

Transactions Designed to Evade or Avoid Liability Will Be Disregarded

If the principal purpose of a transaction is to evade or avoid liability, liability will be applied under the controlled group analysis without regard to the transaction. However, if no liability existed at the time of the structuring, it cannot be said to have been designed to evade or avoid liability. Ownership interests should be structured to avoid creating controlled group liability where none exists. Future transactions must be planned with withdrawal liability considerations in mind.

Conclusion

Individuals and corporations should examine their affiliation with any organization participating in a defined benefit plan. Layoffs, asset sales or other restructuring must be examined for the withdrawal liability consequences to affiliates and other controlled group assets. Employers may choose to withdraw now and address plan losses before they grow deeper, delay triggering withdrawal to a more advantageous time, sell assets under a safe harbor provision, or restructure to mitigate, avoid or otherwise address liability.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.