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Will this proposal capture unfunded liabilities under defined benefit pension plans?
As we summarized in a recent Financial Services & Insolvency Communiqué, Saskatchewan has introduced Bill 151 (the Bill) which amends The Personal Property Security Act, 1993 (Saskatchewan) (the PPSA or the Act). Over the coming weeks our Saskatchewan Financial Services team will bring you a number of posts to inform you about the coming changes and how they may impact you.
This post will focus on an amendment in Bill 151 that could have a huge impact on both secured lenders and employers with defined benefit plans.
In brief, the potential exists for unfunded liabilities and solvency deficiencies under defined benefit pension plans to be given an enhanced priority under the PPSA, putting claims for such unfunded liabilities ahead of all secured claims other than purchase-money security interests (“PMSIs”). This amendment, which may be easy to overlook in Bill 151, could have a serious impact on the risks borne by secured lenders of employers with defined benefit plans, and thus on the availability of credit for such employers.
Legislation across a number of Canadian provinces, including Saskatchewan, provides for a deemed trust in respect of certain contributions owed to a pension plan’s fund by an employee and employer. Section 43 of The Pension Benefits Act, 1992 (Saskatchewan) (the “PBA”) creates several deemed trusts as follows:
- A deemed trust in respect of amounts contributed by employees to be paid into the plan, including by way of payroll deductions; and
- A deemed trust in respect of any amount required to be paid into a plan by an employer as the employer’s contribution to the plan.
Bill 151 contains amendments to the PPSA that would create an enhanced priority for such pension deemed trusts:
“35 (12) A security interest, other than a purchase-money security interest, is subordinate to the interest of a person who is a beneficiary of a sum deemed to be held in trust pursuant to section 43 of The Pension Benefits Act, 1992”.
“35 (13) Sums deemed to be held in trust pursuant to section 43 of The Pension Benefits Act, 1992 are an obligation of the employer secured by a security interest, other than a purchase-money security interest, in the personal property of the employer that is perfected without registration”.
The real source of concern, which may rise to the level of alarm, would be if this enhanced priority would apply to unfunded liabilities and solvency deficiencies under defined benefit plans.
As many readers will know, with a defined benefit plan, both employers and employees make regular contributions to the plan. Upon retirement, an employee will receive a prescribed amount of regular payments from the plan. The employer generally bears the obligation to ensure that a retired employee is paid the appropriate amount once he or she retires. Where an employer with a defined benefit plan becomes insolvent and the plan’s assets are insufficient to pay its pension or other benefits, the unfunded liabilities can become major issues in the insolvency, and recent court decisions have created great uncertainty for secured creditors with respect to these amounts. Indeed, in some situations, an employer may be entirely solvent except for pension liabilities but the pension liabilities may be so large that they risk the solvency of the entire enterprise, leading to a restructuring.
Of course, there are competing considerations that cause governments to provide for such deemed trusts. Lenders want commercial certainty with respect to their priority positions; employees want protection to ensure that their pension plan contributions and entitlements are not seized by secured creditors of their employers. The PBA exists in part to protect plan member interests and their pension plans over the course of their employment, and into retirement during a time when employees are likely least able to mitigate losses associated with an unpaid pension plan.
These proposed amendments will affect secured lenders and employers with pensions plans significantly. The amendments will treat pension deemed trust amounts with an enhanced priority that will defeat a normal secured lender that is providing credit to such employers.
Will the enhanced priority for deemed trusts under section 43 of the PBA apply to wind-up deficiencies/unfunded liabilities?
The question raised by the enhanced priority of the pension deemed trusts is whether section 43(c) of the PBA includes unfunded liabilities and solvency deficiencies associated with defined benefit plans, or whether the amendments are drafted to include only the normal regular contributions that an employer is required to make in the regular course. There likely would be little controversy generated by providing an enhanced priority for contributions by employees, including by payroll deductions, or with respect to the regular monthly contributions required to be made by employers. A superpriority for unfunded liabilities or solvency deficiencies would be of much greater concern to lenders.
The legislative and judicial trends in several provinces seem to point in the direction of greater protection of employees’ benefits under their pension plans. That was one of the questions under appeal in Sun Indalex Finance, LLC v United Steelworkers, 2013 SCC 6 (“Indalex”). In Indalex, the plan had not actually been wound up, so the question related to a conceptual or actuarial deficiency. A majority of the Court, in separate decisions, held that under the Ontario legislation, the wind-up deficiency under the plan was subject to the deemed trust.
The PBA’s language differs from that in Ontario, so the key question is whether the PBA’s deemed trusts in section 43(c) would extend to unfunded liabilities or a wind-up deficiency. Our interpretation is that there is a significant likelihood that the deemed trusts (and thus the enhanced priority under the PPSA) will include such unfunded liabilities and solvency deficiencies.
The language in the PBA alone does not seem to indicate whether the deemed trust would apply to unfunded liabilities. The Pension Benefits Regulations, 1993 (the “Regulations”), do, however, seem to provide some guidance.
Section 36 of the Regulations (which applies only to defined benefit plans) states that an employer is required to pay into a defined benefit plan the following payments (note that we have paraphrased):
- the amount of employer contributions on at least a monthly basis equal to the normal actuarial cost allocated to the employer;
- where the plan has an unfunded liability, payments consisting of equal payments made at least monthly that are sufficient to amortize the unfunded liability over a period not exceeding 15 years from the review date relating to the establishment of the unfunded liability; and
- where the plan has a solvency deficiency, payments consisting of equal payments made at least monthly that are sufficient to amortize the solvency deficiency over a period not exceeding five years from the review date relating to the establishment of the solvency deficiency.
These payments prescribed by the Regulations make it entirely clear that employers’ obligations under defined benefit plans encompass not only the normal contributions to the plan, but also contributions to remedy any unfunded liability or solvency deficiency. The Regulations require those shortfalls to be paid by the employer on at least a monthly basis.
The deemed trust in section 43(3) of the PBA applies to “any sum required to be paid into a plan by an employer as the employer’s contribution to the plan … when due pursuant to the plan”. Thus, it may be necessary to review the terms of a particular plan to determine when the contributions would be actually due.
While an employer is making the payments required to be made under (a), (b) and (c) above, it may be that the entire solvency deficiency or unfunded liability would not be considered to be “a sum required to be paid into a plan” within the meaning of section 43(3) because the amount that is due monthly could be the “make-up” payments under section 36 of the Regulations. However, in an insolvency, it is not difficult to envision section 43(3) being interpreted to include the entire shortfall.
Thus, a real risk exists that sections 35(12) and 35(13) of Bill 151 could result in unfunded liabilities and solvency deficiencies taking priority over non-PMSI security interests in insolvencies.
Case law considering section 43 of The Pension Benefits Act, 1992
The main or only court decision interpreting section 43 of the PBA is W.R.T. Equipment (Bankruptcy of), 2003 SKQB 93 (“W.R.T.”). W.R.T. Equipment Ltd. had established a defined benefit plan for its employees. The company was insolvent and made a proposal to its creditors under the Bankruptcy and Insolvency Act (the “BIA”). Although the company had made all of its regular required contributions to the plan, a significant unfunded liability existed which left deficiencies in the pension plan. An employee objected to the terms of the proposal on the grounds that the unfunded pension liabilities constituted trust funds pursuant to section 43 of the PBA, such that the pension plan members should be treated as a different class of creditor (separate from unsecured creditors).
The Court held that outside of the BIA, the plan members would have an enhanced priority under section 43(3) but provincially created statutory trusts such as those created by the PBA are not recognized under the BIA. Accordingly, the plan members were treated as ordinary unsecured creditors.
Interestingly, the amendments to the PPSA proposed in Bill 151 would potentially reverse the result in W.R.T, in that the BIA defers to priorities created in provincial personal property security legislation and Bill 151 would treat deemed trust amounts under section 43(3) as being subject to a security interest. Thus, one would expect that if a similar situation arose again after passage of Bill 151 as it is currently drafted, the plan members would likely be treated as secured creditors.
The other takeaway is that, in an insolvency, the Court in W.R.T, was prepared to treat the entire unfunded liability under the plan as being subject to the deemed trust in section 43(3). The only reason the plan members were not accorded a priority position was that the Court held there was no room for that under the BIA. It should be noted that W.R.T. was decided before the recent flurry of higher court decisions on deemed trusts in respect of pension plans, so it should be approached with some caution.
Conclusion: the stakes are getting much higher
Across Canada, the scope of pension deemed trusts have been found to vary with the specific wording of the pension legislation.
It is beyond the scope of this post to determine with certainty whether section 43 of the PBA will, combined with the provisions of Bill 151, cause the full unfunded liability or solvency deficiency of a pension plan to take priority over the claims of secured creditors who do not hold PMSIs. There are many court decisions and scholarly articles on this issue, and we have not attempted a comparative analysis of provincial regimes and their interpretation by courts. Nonetheless, while Saskatchewan has fewer companies with defined benefit plans than some other provinces, Bill 151 will undoubtedly cause concern for employers with such plans and their lenders.
 Frequently the terms unfunded liability and solvency deficiency (or wind-up deficiency) are conflated, but they are defined separately under Saskatchewan law, with an unfunded liability being the amount by which a plan’s going concern liabilities exceed its going concern assets, and a solvency deficiency being the amount by which a plan’s liabilities exceed its assets under an actuarial analysis. Thus, an unfunded liability is an actual shortfall in a plan’s ability to make its current payment obligations while a solvency deficiency is an actuarial calculation based on a notional wind-up of the plan. For simplicity, we will use both terms somewhat interchangeably in this post.
 Note that there are some exceptions in the Regulations as to what plans section 36 will apply to. There are certain specific plans that receive particular treatment, which all relate to municipal employees of Saskatoon and Regina, and there is an exemption in section 36.98 for limited liability plans where the first actuarial review dated was on or after December 31, 2016.