Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.
While withdrawal liability had been a fact of life for employers participating in multiemployer pension plans since 1980, throughout much of the 1990's and into the first couple of years of the 21st century it had little impact on many employers due to the strong funding position of many multiemployer plans. However, with several consecutive years of lackluster equity markets, and the inability or unwillingness of many plans to reduce benefits, many funds have experienced ballooning withdrawal liability and some have come dangerously close to funding deficiencies. This Benefits Insight reviews for employers what withdrawal liability is, how many funds have once again found themselves assessing withdrawal liability, and strategies for employers to avoid triggering an assessment of withdrawal liability.
What is Withdrawal Liability?
Withdrawal liability was created by the Multiemployer Pension Plans Amendments Act of 1980 ("MPPAA"). It applies only to multiemployer pension plans – i.e., those plans to which more than one employer contributes and which are maintained pursuant to one or more collective bargaining agreements between one or more labor organizations and more than one employer. ERISA Section 4001(a)(3), 29 U.S.C. § 1301(a)(3). It applies only to pension plans, not to group health or other "welfare" plans.
At the most basic level, withdrawal liability is a withdrawing employer's pro rata share of a multiemployer plan's "unfunded vested benefits" (UVBs). UVBs are the difference in the present value of the Fund's total vested benefit obligations and the market value of the plan's assets at the end of the plan year. Each year, the actuary for a multiemployer pension plan, as part of the annual actuarial valuation of the plan, determines whether the plan has UVBs and, if so, the amount. If there are no UVBs, then the plan is considered "fully funded." This was the case for many multiemployer pension plans in the late 1990's. Indeed, many such plans, because of their strong investment returns in the late 1990's, reached an over-funded condition where they risked contributions mandated by collective bargaining agreements not being deductible to the contributing employer. As such, trustees of many such plans made significant benefit improvements – improvements they would later live to regret.
If a fund has UVBs as of the end of a plan year, then the Fund will assess withdrawal liability for employers that withdraw in the following plan year. Because UVBs are determined in part based on market value of assets, the amount of a plan's UVBs can vary significantly year to year, based on a plan's investment experience. Moreover, prevailing interest rates can significantly affect the present value of a fund's accrued vested benefits and in the past several years interest rates have been at historic lows. Consequently, the timing of withdrawal can have a significant impact on the amount of a withdrawing employer's liability, or whether there is withdrawal liability at all.
When Does a Withdrawal Occur?
Withdrawals occur whenever an employer experiences a complete or partial elimination of the obligation to contribute to a multiemployer plan. Thus, withdrawals can be intentional – for example, an employer "bargains out" of the obligation to contribute to a plan – or unintentional – through workplace attrition an employer experiences a significant enough decline in its contribution obligation to trigger a partial withdrawal. There are two types of withdrawals from a plan: a "complete" withdrawal or a "partial" withdrawal.
A Complete Withdrawal
A complete withdrawal is an event that terminates completely the employer's obligation to contribute to a plan. ERISA Section 4203(a) defines "complete withdrawal" as (1) a permanent cessation of the employer's obligation to contribute under the plan, or (2) a permanent cessation of the employer's covered operations under the plan. 29 U.S.C. § 1383(a). All calculations and determinations regarding an employer's withdrawal are made on a "control group" basis. Thus, for an employer to have a complete withdrawal, all members of the Company's control group must have experienced a permanent cessation of their obligation to contribute under the plan. Examples of a complete withdrawal include:
- Employer ceases all regular business operations, sells its assets, and terminates all of its employees, except for a few retained temporarily to perform phase-out tasks incidental to its close of business.
- Employer ceases all normal business operations on the withdrawal date, and retains three employees to dismantle remaining equipment and clean up and contributions are made on behalf of those remaining employees.
- Employees decertify union and employer ceases compliance with collective bargaining agreement.
Obviously, because of the potential for UVBs to vary significantly year to year with the market value of assets, there has been a significant amount of litigation over when a withdrawal actually occurred and employers anticipating a withdrawal should consult with counsel as to the most favorable timing of the cessation of operations.
There are two types of partial withdrawals: (1) a 70% decline or (2) a "partial cessation" of the employer's contribution obligation.
A 70% contribution decline which constitutes a partial withdrawal occurs if, during each plan year in the "three year testing period" (i.e., the plan year in which the withdrawal allegedly occurred and the immediately preceding two plan years), the employer's "contribution base units" do not exceed 30% of its contribution base units for the "high base year." "Contribution base units" are the units based on which an employer contributes to the plan. In most cases, this will be hours, days or weeks worked, although in some industries it may be tons mined or tons of a given commodity consumed in the manufacturing process. The "number of contribution units for the high base year" is an average number of contribution base units for the two plan years in which the employer's contribution base units were the highest, within the five plan years immediately preceding the three-year testing period. See ERISA Section 4205(b)(1)(A); 29 U.S.C. § 1385(b)(1)(A).
Here is a generic example of how the "70% decline" test works. XYZ Corp., an employer, is a party to a collective bargaining agreement which obligates it to contribute to a multiemployer plan based on hours worked. XYZ Corp. contributed on the following number of hours for Years 1 through Year 5: 38,000; 42,000; 44,000; 41,000 and 38,000. In Years 6 and 7, XYZ contributed on 12,000 and 11,000 hours respectively. In Year 8, XYZ contributed on 8,000 hours. The "three year testing period" for determining whether XYZ had a partial withdrawal in Year 8 is Years 6, 7 and 8 (i.e., the plan year in which the withdrawal allegedly occurred and the two immediately preceding plan years). XYZ's contribution base units for the high base year was 43,000 – the average number of contribution base units for the two "highest" plan years in the five plan years immediately preceding the three year testing period (42,000 in Year 2 and 44,000 in Year 3). XYZ's contribution base units for each plan year in the three-year testing period (Years 6-8) do not exceed 30% of 43,000 (i.e. 12,900). Thus, there was a 70% contribution decline and a partial withdrawal in Year 8.
As the numbers in the above example indicate, it takes a fairly precipitous decline in contribution base units that extends over a number of years to trigger a partial withdrawal pursuant to the 70% decline rule. Obviously, the greatest risk of a partial withdrawal triggered by a 70% decline is where an employer reduces a large number of contribution base units (by closing a production facility, for example) and where that production facility participates in a small or regional fund. Put another way, the larger the reduction and the fewer the total number of contribution base units an employer has for a given plan, the greater the risk of a partial withdrawal triggered by a 70% decline.
Partial Cessation of the Obligation to Contribute
A partial cessation occurs in one of two ways:
- the employer permanently ceases to have an obligation to contribute under one or more but fewer than all collective bargaining agreements under which the employer has been obligated to contribute to the plan but continues to perform work in the jurisdiction of the collective bargaining agreement of the type for which contributions were previously required or transfers such work to another location; or
- an employer permanently ceases to have an obligation to contribute under the plan with respect to work performed at one or more but fewer than all of its facilities, but continues to perform work at the facility of the type for which the obligation to contribute ceased.
ERISA Section 4205(b)(2)(A)(i) and (ii), 29 U.S.C. § 1385(b)(2)(A)(i) and (ii).
The Pension Benefit Guaranty Corporation ("PBGC") has provided some helpful interpretation of this language. For example, if an employer closes a plant where it has an obligation to contribute to the plan and transfers that work to another location, there will be no "partial cessation" of the obligation to contribute under subparagraph (1) above, so long as the employer has an obligation to contribute to the plan at the other facility. See PBGC Op. Letter No. 83-20 (1983). Moreover, an employer's cessation of operations at a facility due to a shutdown, where the employer continues contributions to the plan for other facilities, is generally not a partial cessation of the employer's contribution obligations. See PBGC Op. Letter No. 82-5 (1982).1
Here are some specific examples of situations that would or would not trigger "partial cessations" of the obligation to contribute:
- Employer closes a production facility where it currently contributes to one fund for production employees and another fund for maintenance employees. The maintenance work ceases to exist (because there is no longer a facility to maintain) and the production work at the location gets transferred to another location where contributions are made to the same fund.
In this instance, there is no partial withdrawal from the production fund, because the employer continues to make contributions to that fund for the work at the other locations. As for the maintenance employees, there is no withdrawal, assuming the employer continues to contribute to the fund at other locations.
- Same as the above example, except that the fund transfers the production work from the closed plant to another plant where contributions on behalf of production employees are made to another fund, or to no fund.
In this instance, there would be a partial withdrawal because the employer is "transfer[ring] such work to another location" within the meaning of ERISA Section 4205(b)(2)(A)(i).
- Employer has a production facility with two crafts covered by separate bargaining agreements. The employer lays off all members of one craft and transfers that work to another facility where no contributions are made to the fund.
This fact pattern clearly satisfies the statute's definition of a partial withdrawal.
- Same fact pattern above, except that both crafts are covered by the same collective bargaining agreement.
Assuming that work at the facility – and the existing collective bargaining agreement – continues, this fact pattern would not constitute a partial withdrawal, unless the layoff triggers a 70% decline. For a transfer of work to another facility to constitute a partial withdrawal, the employer must "permanently ceas[e] to have an obligation to contribute under one or more but fewer than all collective bargaining agreements under which the employer has been obligated to contribute under the plan..." ERISA Section 4205(b)(2)(A)(i); 29 U.S.C. § 385(b)(2)(A)(i). In this instance, the employer is simply laying off some employees covered by the contract; it continues to make contributions under the existing collective bargaining agreement on behalf of the remaining craft employees.
- Same fact pattern as above, except that the work is contracted out to a third party firm, and perhaps even transferred overseas.
In this fact pattern, there would not be a partial withdrawal, regardless of whether the employees were covered by the same contract as the production employees at the plant. The PBGC has concluded that the "transfer or work" partial withdrawal is limited "to situations in which the same employer continues to perform work in the jurisdiction of the collective bargaining agreement or transfers the same type of work to another one of its own locations. An employer that permanently ceases covered work under one of its collective bargaining agreements and instead contracts to buy the service or product from an independent third party therefore does not ‘transfer such work to another location’ within the meaning of section 4205(b)(2)(A)(i) of ERISA." PBGC Op. Let. 86-17 (Aug. 13, 1986). Of course the work transfer could trigger a "70% decline" partial withdrawal.
How Much is the Withdrawal Liability?
As noted above, there are several variables to determining the amount of withdrawal liability. In addition to the amount of UVBs and applicable interest rates, Funds are permitted to use one of several approved methods for calculating withdrawal liability. These methods are briefly described below:
The first method is called the presumptive method because it applies if the fund has not selected another method. Under this method, the plan first determines UVBs in existence when MPPAA was adopted on September 26, 1980. Each employer in the plan at that time is allocated a portion of this initial "pool" of UVBs, based on the employer's contributions to the plan over the past 5 years. This initial allocation in the first pool is reduced by 5% each year. In the next year, the plan's actual UVBs are compared to this reduced initial pool, and if there is a shortfall (or credit) the amount of the shortfall (or credit) is added to a new pool. Again, each of the pools are allocated to contributing employers in proportion to their shares of the plan's total contributions for the previous five years. The process is repeated each successive year, so that each year's pool is gradually phased out over twenty years. The effect of this method is largely to protect newly entering employers from being charged for underfunding that existed before they entered the plan.
Modified Presumptive Method
This method is also known as the "two pool" method. This formula divides the plan's UVBs into two segments – those that existed prior to September 26, 1980 (pool 1) and those that accrue after that date (pool 2). Pool 1 is allocated to all employers participating in the fund as of September 26, 1980, based on their shares of the plan's total contributions over the last five years. Pool 2 is the change – either positive or negative – in UVBs between September 26, 1980 and the end of the plan year preceding the year of an employer's withdrawal.2 Funds that use this formula fully amortized Pool 1 as of 1995. Thus, employers that withdraw after 1995 are exposed to all shortfalls in funding just as if the fund used the "Rolling Five" method, discussed below.
Under this method, the fund allocates to a withdrawing employer the UVBs as of the end of the plan year preceding the withdrawal on the basis of the employer's proportionate share of the plan's total contributions during the preceding five years. Obviously, under this method, to the extent that an employer's level of participation increases in a plan, so too does its share of any UVBs.
Direct Attribution Method
Under this method, the fund determines the value of vested benefits earned by the employer's current and former employees, less the employer's share of the plan's assets. The statute provides three alternative methods for determining the employer's share of the plan assets. The first of these is taking the total value of plan assets and multiplying them by a fraction, the numerator of which is the total value of all vested benefits attributable to service with the employer, and the denominator of which is all vested benefits accrued under the plan. The second method is to use a fraction, the numerator of which is the sum of all contributions, calculated with interest, which have been made by the employer for the plan year preceding the withdrawal, and all preceding plan years, and the denominator of which is the sum of all contributions (calculated with interest) by all employers The third method uses the same fraction determined in the second method, but both the numerator and denominator are reduced by the benefit payments to the employees of the employer (in the case of the numerator) and all benefit payments by the fund (in the case of the denominator).
Other Factors Affecting Withdrawal Liability
In addition to the factors noted above, other variables can affect the amount of withdrawal liability actually assessed against an employer. For example, funds with participating employers in certain industries (construction and retail food, for example) are permitted – but not required – to apply different rules in determining whether a withdrawal has occurred. In addition, the law permits, and many funds have adopted, de minimis exceptions to the assessment of withdrawal liability where the withdrawal of a unit made up of very few participants will not result in the assessment of withdrawal liability by the plan. Under ERISA section 4209(a), 29 U.S.C. § 1389(a), the withdrawal liability otherwise to be assessed against an employer is reduced by the lesser of ¾ of 1% of the plan's UVBs as of the close of the of the plan year preceding the withdrawal, or $50,000. This de minimis amount is reduced to the extent that withdrawal liability exceeds $100,000. Thus, if the $50,000 amount applies, it is fully phased out when an employer's withdrawal liability (computed without reference to the de minimis deduction) exceeds $150,000. Employers who anticipate a withdrawal should determine whether one or more of these exceptions to the general rules will apply.
The Bottom Line
Withdrawal liability can impose a crushing financial burden on employers who do not expect it or who unwittingly trigger a withdrawal. Here are some practical steps that employers can take to avoid withdrawal liability, or to prepare for it if a withdrawal is anticipated:
- Stay out of multiemployer pension plans! Employers who are not in these plans should avoid them. Employers who are already in them should look for the bargaining opportunity to cease contributions at a time when the plan is fully funded.
- Ascertain the plan's funded status every year. The best practice for an employer that participates in multiemployer plans is to annually write to the administrator of each multiemployer plan to which the employer contributes and request a calculation of the employer's withdrawal liability were the employer to withdraw during that plan year. Employers have a statutory right to this information; funds have the right to charge for the calculation, and most do – although generally not a significant amount.
- Closely investigate whether multiemployer plans are implicated in any anticipated sale or acquisition. Many transactions have been derailed at the eleventh hour because the parties failed to anticipate that the transaction would trigger a withdrawal and/or failed to account for the financial impact the withdrawal would have. Stock sales, if structured correctly, should not trigger withdrawals. Asset sales can be structured so that they do not trigger withdrawals, but several procedural safeguards and terms must be included in the purchase and sale agreement.
- Don't play the guessing game! Remember that a withdrawal liability calculation or estimate is a snapshot in time. Don't assume that a withdrawal calculation from one plan year will not change significantly for the next plan year. UVB amounts – and the resulting withdrawal liability – can vary widely from year to year. It is very difficult – if not impossible – to accurately predict the amount of a withdrawal liability assessment.
- If a fund makes an assessment, do not delay! Employers can and do successfully challenge withdrawal liability assessments, but it is important that employers not delay when receiving an assessment. Employers must timely request arbitration in order to initiate a challenge, and these time limits are jurisdictional. Counsel should be consulted immediately when an assessment is received.
For further assistance, please consult with one of our attorneys in the Employee Benefits Practice Group.
1 One court disagrees with the interpretation of Section 4205 taken by the PBGC. I.A.M. National Pension Fund v. Fraser Ship Yards, 698 F. Supp. 326 (D.D.C. 1988). However, it appears that the court did not consider the opinions of the PBGC in its decision; subsequent commentators have questioned whether Fraser is good law.
2 Pool 1 liability is reduced over a 15-year amortization schedule.
Kevin L. Wright is a Shareholder in Littler Mendelson's Washington, D.C. office. If you would like further information, please contact your Littler attorney at 1.888.Littler, email@example.com or Mr. Wright at firstname.lastname@example.org.