Deferred Compensation Plan From A Bankrupt Business Funded By A Rabbi Trust – What Could Be Right? Hint: it’s not 409A

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Like many restaurant chains, Ruby Tuesday has been devastated by dining restrictions imposed in light of the COVID-19 pandemic. Ruby Tuesday filed for receivership under Chapter 11 of the Bankruptcy Code in October 2020, In re RTI Holding Company LLC, United States Bankruptcy Court for the District of Delaware, 2020.

Ineligible plans

The Company has maintained three unqualified plans, including a Supplementary Executive Retirement Plan (SERP) and a Deferred Compensation Plan (the DCP) (collectively the “Plans”). The company also maintained a funded rabbi trust 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 plan members effective August 1, 2020. The company did not provide any explanation to plan members. Immediately after filing for bankruptcy, the company filed for an order allowing the company to exercise its ownership rights over the assets held in the rabbi trust. An ad hoc group of Plan members filed an objection to the Company’s motion, resulting in this litigation.

Like all rabbinical trusts, this one explicitly provided that “the assets of the fund shall be treated as general assets of the plan sponsor and will remain subject to the claims of general creditors of the plan sponsor under applicable state and federal laws.” The trust also provided that “upon receipt of written notice from the board of directors of the corporation of the” insolvency “of the corporation (as defined in the trust),” the trustee will suspend all other payments to participants. or to their beneficiaries and will hold the trust assets for the benefit of the creditors of the plan sponsor as ordered by a court of competent jurisdiction.

What made this case different from other cases of unqualified plan members losing their plan benefits as a result of their business bankruptcy was the fact that Ruby Tuesday terminated the plans effective March 1, 2019. lump sum distributions were to be paid to participants. in the plan after March 1, 2020, as required by Code Sec. 409A, well before the filing of the bankruptcy application, and no later than March 1, 2021.

Applicable law – Sec. 409A

The Treasury Regulations under Section of the Code. 409A provide that a plan may provide for the acceleration of the time and form of a payment upon termination and liquidation of the plan by the company. Expedited distributions may be made following termination by the company and liquidation of the plan by resolution or other irrevocable action taken by the company within 30 days prior to or within 12 months following a change of control event; provided that all participants are required to receive all compensation and deferred benefits under the terminated plan within 12 months of the date of the Company’s irrevocable decision to terminate its activities.

Alternatively, accelerated distributions can be made after the termination and liquidation of the plan by the company, if (i) the termination and liquidation does not occur in the vicinity of a downturn in the financial health of the company, (ii) no Plan wind-up payments are made within 12 months of the date on which the Company takes all necessary steps to terminate and irrevocably wind up the plan (other than payments that would be payable under the plan if the plan termination action does not exist). ‘had not occurred), and (iii) All payments are made within 24 months of the date on which the company takes all necessary steps to terminate and irrevocably liquidate the plan.

The differences between the two types of plan terminations are significant. In the event of termination following a change of control, all participants are required to receive all compensation and deferred benefits under the terminated plan, all distributions must be complete within 12 months of the date of the company’s irrevocable action to terminate the plan. In the context of a termination outside of a change of control, no distribution can 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 end the plan.

So what went wrong?

First, there appeared to be some confusion between the parties as to whether the company terminated the plans following a change of control. Prior to its purchase by NRD Capital, LLC on December 21, 2017, the company was a publicly traded company. The participants argued that the termination of the plans due to a change of control effectively deprived the company of any legal or equitable interest in the assets of the trust. Participants also argued that the assets of the rabbi trust should have been distributed to them by March 1, 2020, in accordance with regulations under sec. 409A, well before the filing of the bankruptcy application.

However, the bankruptcy court judge considered that the termination had been effected in accordance with alternative article of Regulation 409A, which prohibits plan termination “close to a downturn in the financial health of the company” and, in any event, does not require that all payments be made before 24 months from the date of the company’s termination action. The bankruptcy judge observed that this paragraph explicitly provides that no payment in liquidation of the plan can be made within 12 months of the date on which the company takes all the necessary measures to terminate and irrevocably liquidate the plan. The bankruptcy judge ruled that the company supported its claim that it was insolvent on March 1, 2020 and therefore was not required to make the payments.

Therefore, according to the trusts and established law, plan participants had no greater legal rights than any other general unsecured creditor.

Rules

Following the court ruling in favor of the company, the parties began settlement discussions, and on December 1, the company and its affiliated debtors filed a motion for the entry of an order approving a settlement with plan members. Under the proposed settlement, the Company would pay the legal fees and legal costs of plan members until the effective date of the settlement, up to a maximum aggregate amount of $ 275,000. From the Effective Date, the Company and Plan Members will engage in good faith discussions regarding the allowable amounts of claims claimed by individual Plan Members (the “Claim Reconciliation Process”). . Upon completion of the claim reconciliation process, the Company would pay the fees and expenses of counsel for plan members as part of the claim reconciliation process, up to a maximum aggregate amount of $ 50,000.

The settlement recognizes that the case involves provisions of the ERISA, the Internal Revenue Code, the interplay between those laws and the Bankruptcy Code, and potentially other complex fiduciary and tax law issues. The settlement eliminates the need for appellate litigation regarding these complex issues.


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