September 13, 2005

The most heavily publicized provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Act”), signed into law on April 20, 2005, limited the availability of bankruptcy relief for debtors by establishing a means test that a debtor must pass before filing for Chapter 7 bankruptcy, also known as liquidation bankruptcy. Yet, there are significant provisions of the Act that focus on employee benefits and executive compensation. These changes, described below, are generally effective as of October 17, 2005.

Retirement Plan Provisions

Retirement Plan Assets. The Act has expanded the list of permitted exclusions from an individual’s bankruptcy estate to include assets held in 401(a) qualified plans, 403 tax-sheltered annuities, individual retirement arrangements (“IRAs”), Roth IRAs, simplified employee pensions, SIMPLE retirement accounts, 414 church and governmental plans, 457 deferred compensation plans, and 501(a) plans funded solely with employee contributions. However, to claim these exemptions, the debtor must provide evidence that the plans which contain these assets are tax-qualified. This evidence may be provided by producing the plan’s determination letter, or, if none is available, by showing there has been no adverse determination as to the plan’s tax- qualified status made by a court or the Internal Revenue Service and that the plan is substantially compliant with the code (or, if not, the debtor is not responsible for the failure). The exclusion for IRAs and Roth IRAs is limited to $1 million (exclusive of both direct and indirect rollover contributions), although this cap may be increased in appropriate circumstances.

The Act also provides protection for plan contributions that have been withheld from a debtor’s pay but are not yet deposited in the plan’s trust at the time of a bankruptcy filing. This protection is more limited than the protection for assets already held in trust. It applies only to contributions withheld in connection with ERISA-covered plans, 414(d) governmental plans, 403(b) tax-deferred annuities, and 457 deferred compensation plans.

In the case of a bankrupt employer, the Act also provides plan participants with greater protection for their unpaid wages and benefits.

Effective as of April 20, 2005, the Act increased the dollar limit on priority claims for unpaid wages and benefits from $4,925 to $10,000 for each participant. These claims have priority over many other unsecured claims against the employer in bankruptcy.

Plan Loans. The Act provides that individual debtors may not discharge in bankruptcy any loan amounts owed to an ERISA or tax-qualified plan, and individual debtors may not materially modify the terms of their loan agreements. The debtor’s employer is also permitted to continue withholding loan repayments from the debtor’s wages.

Plan Administration. In an effort to prevent orphan retirement plans from being created when plan sponsors go bankrupt, the Act requires the debtor/sponsor who is administering the plan (or any entity designated by the sponsor to administer the plan) to continue performing its duties with respect to any ERISA-qualified plans when the debtor/sponsor declares bankruptcy, unless the bankruptcy trustee assumes these obligations. This will force bankrupt sponsors to terminate or transfer sponsorship of their plans before ceasing to exist.

Executive Compensation Plans

Generally, the Act limits a bankrupt employer’s ability to provide payments or give bonuses to insider employees that are outside the normal course of business and are not justified by the facts and circumstances of the case after the filing of a bankruptcy petition. In particular, a bankrupt employer may not make severance payments or pay retention bonuses unless certain requirements are met. Retention bonuses paid for the purpose of inducing the insider to remain with the bankrupt employer’s business may not be made unless the bankruptcy court finds that:

· the bonus is essential to retention of the employee because the employee has a bona fide job offer, promising equal or greater compensation, from another business;

· the services of the employee are essential to the survival of the business; and

· either (i) the amount of the retention bonus is not greater than an amount equal to 10 times the amount of the average similar payment made to non-management employees during the year in which the bonus is paid; or (ii) if no payments were made to non-management employees, the bonus is not greater than 25% of any payment made to the insider during the previous calendar year.

Severance payments to insider employees of a bankrupt employer may not be made unless the bankruptcy court finds that:

· the payments are part of a program that is generally applicable to all full-time employees; and

· the amount of the payment is not greater than 10 times the amount of the average severance payment made to non-management employees during the calendar year in which the payment is made.

In addition, the Act has significantly increased the power of bankruptcy trustees to prevent fraudulent transfers to insiders by allowing for the nullification of any transfer made within two years of the bankruptcy petition. Prior to the Act’s passage, this nullification power was limited to one year prior to the petition. While this expanded power makes it easier to stop fraudulent transfers, the insider can overturn such a nullification by showing that such payments were made in the normal course of business. There is also an exception for payments with an aggregate value of $5,000 or less.

Health Plans

Health Insurance Contributions. The Act excludes an individual’s contributions made to any health insurance plan regulated by state law (including those plans that may be subject to ERISA) from his or her bankruptcy estate. Such contributions must be withheld from the debtor employee’s wages or be made as employee contributions. The Act also clarifies that these contributions to health insurance plans (as well as other payments for health insurance, disability insurance, and health savings accounts) for the debtor, the debtor’s spouse, and dependents are part of the debtor’s monthly expenses. Assuming that these contributions are reasonably necessary, they will be taken into account in developing a bankruptcy plan for the debtor.

Retiree Health Plans. Current law requires that a committee of retired employees be appointed to represent retirees if a bankrupt employer decides to modify or cease to pay retiree health benefits. The Act requires that the bankruptcy court must order the creation of this committee and that the bankruptcy trustee is responsible for appointing the committee.

The Act also adds a provision requiring that, effective immediately, if an employer modifies retiree health benefits during the 180-day period prior to the bankruptcy filing and the employer was insolvent on that date, the court must order reinstatement of the original benefits. This order is unnecessary in cases where the modified retiree health benefits are more equitable to retirees.