If you are trusting a Rabbi Trust to protect your retirement savings, then you might have been a little taken aback this past November if you read the headline, “Ruby Tuesday Tells Court (And Retirees): ‘Pension Funds Are Ours.”
In his article published in entirety below, Attorney Mike Melbinger does (as always) a thorough job breaking down the sequence of events impacting the Ruby Tuesday nonqualified plan participants. And as Bruce Brownell, Managing Director Fulcrum Partners observed, ‘“Although the 409A statute is more than a decade old, we occasionally see unanticipated stress tests which inevitably move to litigation.
“The Ruby Tuesday case is just such an example. It reminds us to keep our clients current on all the moving parts in a change of ownership or change in financial condition scenario. …Or both, as we see here.”
–the following was first published 12/15/2020 by the Executive Compensation Blog–
Bankrupt Company’s Deferred Compensation Plan Funded by a Rabbi Trust – What Could Go Right? Hint: It’s not 409A
Like many restaurant chains, Ruby Tuesday was devastated by the dining out restrictions imposed in light of the COVID-19 pandemic. Ruby Tuesday filed for bankruptcy reorganization under Chapter 11 of the Bankruptcy Code in October 2020, In re RTI Holding Company LLC, U.S. Bankruptcy Court for the District of Delaware, 2020.
The Non-Qualified Plans
The company maintained three non-qualified plans, including a Supplemental Executive Retirement Plan (SERP) and a Deferred Compensation Plan (the DCP) (collectively the Plans”). The company also maintained a rabbi trust funded with more than $25 million in life insurance contracts on some of the Plan participants. Apparently, the company had ordered the rabbi trustee to cease payments to participants under the Plans as of August 1, 2020. The company did not provide an explanation to Plan participants. Immediately upon filing for bankruptcy, the company filed a motion for an order authorizing the company to exercise its ownership rights over the assets held in the rabbi trust. An ad hoc group of participants in the Plans filed an objection to the company’s motion, resulting in this litigation.
Like all rabbi trust, this one explicitly provided that the “Fund assets shall be treated as general assets of the Plan Sponsor and shall remain subject to claims of the general creditors of the Plan Sponsor under applicable state and federal law.” The trust also provided that “upon receipt of written notice from the company’s board of directors of the “insolvency” of the company (as defined in the trust), “the Trustee shall suspend all further payments to participants or their beneficiaries and shall hold the assets of the Trust for the benefit of the creditors of the Plan Sponsor in the manner directed by a court of competent jurisdiction.”
What made this case different from other cases of non-qualified plan participants losing their plan benefits upon their companies’ bankruptcy was the fact that Ruby Tuesday had terminated the Plans effective March 1, 2019. Lump sum distributions were expected to be made to the participants in the Plan after March 1, 2020, as required by Code Sec. 409A, well before the bankruptcy petition was filed, and no later than March 1, 2021.
Governing Law – Sec. 409A
The Treasury Regulations under Code Sec. 409A provide that a plan may provide for the acceleration of the time and form of a payment upon the company’s termination and liquidation of the plan. Accelerated distributions may be made following the company’s termination and liquidation of the plan pursuant to a resolution or other irrevocable action taken by the company within the 30 days preceding or the 12 months following a change in control event; provided that all participants are required to receive all deferred compensation and benefits under the terminated plan within 12 months of the date of the company’s irrevocably action to terminate.
Alternatively, accelerated distributions may be made following the company’s termination and liquidation of the plan, if (i) the termination and liquidation does not occur proximate to a downturn in the financial health of the company, (ii) no payments in liquidation of the plan are made within 12 months of the date the company takes all necessary action to irrevocably terminate and liquidate the plan (other than payments that would be payable under the terms of the plan if the action to terminate the plan had not occurred), and (iii) All payments are made within 24 months of the date the company takes all necessary action to irrevocably terminate and liquidate the plan.
The differences between the two type of plan terminations are significant. Under a termination following change in control, all participants are required to receive all deferred compensation and benefits under the terminated plan all distributions must be complete within 12 months of the date of the company’s irrevocably action to terminate the plan. Under a termination outside of a change in control, no distributions may be made within 12 months of the date of the company’s action to irrevocably terminate the plan, but all distributions must be complete within 24 months of the company’s action to irrevocably terminate the plan.
So What Went Wrong?
First, there seemed to be some confusion among the parties as to whether the company had terminated the Plans following a change in control. Prior to its purchase by NRD Capital, LLC on December 21, 2017, the company had been a publicly-traded company. The participants argued that the Plans’ termination due to a change of control effectively divested the company of any legal or equitable interest in the trust assets. The participants also argued that the rabbi trust assets should have been distributed to them on or before March 1, 2020, in accordance with regulations under Sec. 409A, well before the bankruptcy petition was filed.
However, the bankruptcy court judge viewed the termination to have been made according to the alternative section of the 409A regulations, which prohibit a plan termination that is “proximate to a downturn in the financial health of the company” and, in any event, does not require that all payments be made until 24 months of the date of the company’s action to terminate. The bankruptcy court judge observed that that subsection provides explicitly that no payments in liquidation of the plan may be made within 12 months of the date the company takes all necessary action to irrevocably terminate and liquidate the plan. The bankruptcy court judge held that the company supported its contention that it was insolvent as of March 1, 2020 and was therefore not required to make the payments.
Therefore, according to the trusts and settled law, the Plan participants had no greater legal rights than any other general unsecured creditor.
Subsequent to the court’s ruling in favor of the company, the parties engaged in settlement discussions, and on December 1, the company and its debtor-affiliates, filed a motion for entry of an order approving a settlement with the Plan participants. Under the proposed settlement, the company would pay the fees and costs of counsel for the Plan participants through the effective date of the settlement, up to the maximum aggregate amount of $275,000. From and after the effective date, the company and the Plan participants will engage in good faith discussions regarding the allowed amounts of claims asserted by individual Plan participants (the “Claims Reconciliation Process”). At the conclusion of the Claims Reconciliation Process, the company would pay the fees and costs of counsel for the Plan participants counsel in connection with the Claims Reconciliation Process, up to the maximum aggregate amount of $50,000.
The settlement acknowledges that the case involves provisions of ERISA*, the Internal Revenue Code, the interplay between those statutes and the Bankruptcy Code, and potentially other complex issues of trust and tax law. The settlement eliminates the need for appellate litigation regarding these complex issues.
*ERISA The Employee Retirement Income Security Act of 1974 www.dol.gov/general/topic/retirement/erisa
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