What is a 'Distress Termination'

A distress termination occurs when a company's benefits plan ends because of insufficient funds to cover the expenses associated with paying the employees' earned benefits.

BREAKING DOWN 'Distress Termination'

A distress termination is allowed if an organization meets one of four distress tests as outlined by the Employee Retirement Income Security Act of 1974 (ERISA). They are:

  • Reorganization distress test. Under the reorganization distress test the company must be in reorganization in bankruptcy or insolvency proceedings; and bankruptcy court must find that unless the plan is terminated, the company cannot pay all its debts under a plan of reorganization and cannot continue in business outside a Chapter 11.
  • Business continuation distress test. Under the business continuation distress test, the company must demonstrate to the Pension Benefit Guaranty Corporation (PBGC) that, unless a distress termination occurs, the company cannot pay its debts when due; and continue in business.
  • Liquidation distress test. The company must have filed, or had filed against it, a petition seeking liquidation under federal or state law which has not been dismissed.
  • Pension cost test. A company must demonstrate to the PBGC’s satisfaction that the company’s costs of providing pension benefits have become unreasonably burdensome solely as a result of declining covered employment.

Of the four tests, the most commonly used are the reorganization distress test and the business continuation distress test. The two tests are substantively similar but each has a different focus. The focus of the business continuation distress test is the company’s ability to remain in business outside of bankruptcy, as determined by the PBGC rather than a court. The focus of the reorganization distress test is on the company’s ability to emerge successfully from bankruptcy, as determined by the bankruptcy court.

The PBGC protects the pensions of private defined benefit pension plans, and pays benefits to pensioners of failed pension plans. If the plan has enough money to pay all of the benefits that have been earned, it can be terminated in a standard termination. Once a plan is terminated, all activities, such as benefit accruals and vesting, end. However, a plan that does not have enough assets to pay its liabilities can only be terminated in a distress or involuntary termination.

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