Should Pensions Be Protected in a Corporate Bankruptcy?
Businesses fail for a variety of reasons.
When this occurs, it’s important to be aware that it impacts more than just the owners and the shareholders in the business.
It also affects the employees in a variety of ways.
If a business files for bankruptcy, then it is unlikely that those who are retired or nearly retired will receive the promised pensions.
This is particularly true if the pension was underfunded.
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We have already seen the impact of this before.
Indeed, two corporate bankruptcies in Canada resulted in more than 40,000 pensioners with little to survive on and certainly far less than they had originally anticipated.
The cases of both Nortel and Sears Canada in 2009 and 2017 respectively, should have been a wake-up call and highlighted key issues with similar pension programs.
It certainly brought attention to the problems faced by senior employees who do have a pension with a private business.
In this article, we’ll explore how pensions will be impacted if there is a corporate bankruptcy and what issues pensioners can be faced with here.
We’ll also look at some advice on what you can do if this happens to you.
How Does Corporate Bankruptcy Impact Pensions?
Corporate bankruptcy is similar to a bankruptcy of a private individual.
In a case like this, a licensed insolvency trustee will be required to find as much cash as possible within the business to pass on to creditors who are owed money.
To do this, assets the company owns are claimed and then sold on.
This includes everything from inventory to equipment.
When everything has been sold off, the Trustee has cash that can be distributed to all the creditors.
The first payments will always go towards government claims as well as secure creditors such as banks.
If there is money, then this can be claimed by employees.
They will be the first people in line and they will be exploring whether they can claim for wages that have been left unpaid.
They can claim $2000 or as much as six months in unpaid wages.
Unfortunately, the pensioners are the very last group that gets to claim as creditors.
They should receive pro-rated portions of the dividends that can be paid to unsecured creditors.
Usually, however, there will not be enough in the accounts to cover the cost for these individuals when there is a bankruptcy.
The most they will typically receive is limited to a few pennies on the dollar.
This can ultimately result in an income shortfall.
It’s not all bad news however because, in Ontario, there will be the option of accessing a Benefits Guarantee Fund.
This will provide insurance which means that private-sector pensions can be funded up to $1000 per month.
However, this will only occur in a set of specific circumstances.
Beyond this, there are no laws currently in place that ensure that these pensions are fully funded in the event that a business goes bankrupt.
It’s important to ask whether pensions should be protected in this situation.
Will Pensions Be Given Protection?
There are numerous critics and financial experts who believe that pensioners should be protected if a business does go bankrupt.
Indeed, many want to ensure that pensioners are a top priority.
To understand why this is the case, we need to dive into what a pension in business means for an employee.
Ultimately, if an employee chooses to save a pension with a company, they are being paid less than what they were working to ensure that their pension is funded.
So, if they lose that pension, then they are losing an agreement that they made in good faith with the business.
Exploring this issue from that particular angle, it makes a lot of sense to ensure that pensioners are protected.
However, there are a few issues to contend with when taking this stance.
Issues with Lending
When a bank lends to a business, they will always explore the assets of the company.
They will lend against a percentage of the value of these assets – usually at a point between 75 and 80%.
If a law is put in place to protect pensioners above creditors, then lenders will need to consider this before they provide a company with credit that they need.
This could ultimately lead to a shortfall in the value of assets that the company has and that they can use to secure loans.
This could lead to less availability for lending.
The problem here is that the pensions could suffer because they are often not fully funded.
Instead, they are pooled and then invested in various areas.
The market is often volatile so this could result in a loss.
If there are tighter restrictions on lends for companies, then they may not be able to effectively deal with the shortfall that is caused as a result.
This means that banks aren’t going to lend because businesses become a greater risk.
That could lead to more filing for bankruptcy as they are unable to get the credit they need to operate on the market.
How Would Businesses React?
If protection is brought in for pensioners, then this would potentially put businesses at risk of not gaining the credit they need from banks.
They would have to correct this situation and many fear the action would be simple.
Businesses would stop offering a pension plan for employees of the business.
This will be the case if things become too complicated for the business and too risky.
Again, this is going to have an impact on the employee who now won’t be able to gain the money they need for retirement.
Or, at the very least will find it far more difficult to save.
This is already starting to occur because employers are moving towards an RRSP matching program.
This is cleaner and simpler for the business but won’t provide as many benefits for the employees.
What Is The Answer?
So instead of offering legal protection for pensioners, what is the right action that should be taken here.
Well, ideally, lawmakers should impose a different type of protection and ensure that shareholders are unable to take cash in dividends if there is a pension shortfall.
This does happen, as we have seen with businesses in the past.
For instance, it’s worth exploring the case of Sears Canada.
The main shareholder took billions from the company.
Indeed, the American hedge fund siphoned off $1.5 billion in one year and another $850 million over several other years.
During this time there was a massive pension shortfall that was worth more than $267 million.
If the shareholder had not siphoned money out of the company, then there would have been cash available to cover the pension shortfall.
Unfortunately, this wasn’t the case.
So putting rules in place would definitely benefit the employees that have pensioners in the business.
Indeed, many would argue that this is definitely a more effective form of pension protection.
It doesn’t have the same downsides as other options.
How Can You Protect Yourself?
At this point, you might be wondering whether there is a way to ensure that you are protected if you do have a pension in a business.
There are numerous steps that you can take here.
For instance, you can think about checking your pension statements that should arrive annually.
It’s worth checking the pension ratio.
If the ratio is higher than 100%, assets in the business would cover obligations.
If the ratio is lower than 100%, there could be a shortfall.
However, things can change over time.
You should also be exploring how the business itself is performing.
If the company, for instance, is laying off a lot of team members, this could be a sign that the business is in trouble.
You might want to start preparing for the worst in this type of situation.
It could also be worth contacting the regulators of the plan.
This will be important if you are not receiving an annual statement for your pensions.
There are numerous regulators that could be looking after your plan.
You need to know the right organization to call to find out if there is a funding deficit that could impact you.
An organization such as the Financial Services Commission of Ontario will also be able to tell you whether the business is taking steps to handle a shortfall.
Of course, you should also be making sure that you are thinking about your own financial situation.
Ideally, you should be saving for issues and ensure that you know a pension will always be less than you are earning.
You should be thinking about clearing any debts you have.
If you are struggling here, get in touch.
A professional member of our team can help ensure that you find the relief you need with the right financial plan in place.