The Bottom Line
- Chapter 7 Bankruptcy Trustees Are ERISA Fiduciaries. When a company files a chapter 7 bankruptcy petition, the chapter 7 trustee assumes ERISA fiduciary responsibilities for the company’s retirement plans, including the obligation to prudently administer and distribute plan assets solely for the benefit of participants and beneficiaries.
- The DOL’s Expanded Abandoned Plan Program. In 2024, the Department of Labor expanded its Abandoned Plan Program to allow chapter 7 bankruptcy trustees to serve as qualified termination administrators (QTAs), providing a more streamlined, cost-effective process for terminating certain retirement plans of bankrupt employers.
- Conflicting Duties Require Careful Navigation. Chapter 7 trustees face potentially conflicting obligations under ERISA and the Bankruptcy Code. Chapter 7 trustees should engage ERISA counsel to help navigate the regulatory landscape, manage the plan termination process, and address ERISA issues that arise before termination.
Tax-qualified retirement plans, including 401(k) and defined benefit pension plans, are governed by a complex framework involving regulations promulgated by the Internal Revenue Service (IRS) and Department of Labor (DOL).
The Internal Revenue Code (IRC), enforced by the IRS, imposes qualification requirements in exchange for favorable tax treatment for plan participants and employers. The Employee Retirement Income Security Act of 1974 (ERISA), enforced by the DOL, establishes fiduciary standards requiring plan administrators to act prudently and solely in the interest of plan participants, including a myriad of administrative tasks.
Under ERISA’s framework governing plan administration and participant rights, individual participants may bring complaints regarding plan operations. This has contributed to an increase in class action litigation in the retirement plan context.
For defined benefit plans, Title IV of ERISA creates a federal insurance program administered by the Pension Benefit Guaranty Corporation (PBGC), which guarantees the payment of plan benefits (subject to statutory limits) when an underfunded plan terminates.
The Bankruptcy Trustee as ERISA Fiduciary
When a company files for chapter 7 bankruptcy, a bankruptcy estate is created consisting of all the debtor’s assets. The bankruptcy estate is administered by a chapter 7 trustee whose principal mandate is to collect and reduce to money estate property for the benefit of the debtor’s creditors.
Under section 704(a)(11) of the Bankruptcy Code, a chapter 7 trustee is required to perform the obligations of an “administrator” of an employee benefit plan under ERISA Section 3(16) if the debtor (or an entity designated by the debtor) served as an administrator at the time of its bankruptcy filing. As a result, the bankruptcy trustee is responsible for the full range of ERISA fiduciary duties imposed by the DOL, including personal liability for fiduciary breaches and excise taxes on prohibited transactions.
This creates an inherent tension. As an ERISA fiduciary, the trustee owes a duty of loyalty to plan participants, while under the Bankruptcy Code, the trustee’s core obligation is to manage and liquidate estate assets for the benefit of creditors.
To address this tension, plan assets are specifically excluded from the bankruptcy estate under section 541(b)(7) of the Bankruptcy Code and must be used solely for the provision of benefits and reasonable plan expenses.
Key Steps in the Plan Termination Process
When a plan sponsor commences a chapter 7 bankruptcy case, the trustee of the bankruptcy estate is responsible for terminating and winding down all retirement plans. The termination of a 401(k) or other retirement plan in bankruptcy requires careful coordination across multiple regulatory regimes. As such, it is strongly recommended that trustees engage ERISA counsel to develop a comprehensive strategy to terminate and wind down these plans in accordance with applicable law.
Termination generally involves the following key steps:
- Collecting plan documents and records. All plan documents, trust agreements, service contracts, and participant records must be located and preserved. ERISA generally requires records to be retained for at least six years.
- Amending the plan document and adopting a termination resolution. The plan document must be updated to reflect all required provisions as of the termination date. To address any late or missed amendments, the chapter 7 trustee can utilize the IRS’s Employee Plan Compliance Resolution System (EPCRS). The trustee may also consider filing an application for an IRS favorable determination letter.
- Notifying participants and vesting all accounts. All participants become 100% vested upon plan termination. Participants and beneficiaries must receive notice of the termination and rollover notices, and reasonable efforts must be made to locate missing participants.
- Annual Form 5500 filings. The chapter 7 trustee must continue to file a Form 5500 each year until all plan assets are distributed. If the trustee discovers that historical 5500 filings are missing, the trustee can complete a corrective filing under the DOL’s amnesty program, the Delinquent Filer Voluntary Compliance Program.
- Distributing plan assets. Assets must generally be fully distributed within 12 months after the plan termination date. For defined benefit plans, the process will involve oversight by the PBGC and termination via a standard termination or distress termination depending on the plan’s funded status.
- Assessing funding status and compliance issues. Chapter 7 trustees must evaluate each defined benefit plan’s funding status and whether all contributions, including employer contributions, employee deferrals, and loan repayments, have been timely deposited in the 401(k) plan trust.
The DOL’s Expanded Abandoned Plan Program
In May 2024, the DOL published interim final rules expanding its Abandoned Plan Program to cover individual account plans, such as 401(k) plans, whose sponsors are in chapter 7 bankruptcy.
Under these amended rules, a bankruptcy trustee (or an eligible designee) may now serve as a qualified termination administrator (QTA) and utilize the program’s streamlined procedures to terminate and wind down 401(k) plans. These rules provide that a plan is deemed abandoned upon the bankruptcy court’s entry of an order for relief in the plan sponsor’s liquidation proceeding.
The expanded program offers several advantages, including:
- simplified reporting (a Special Terminal Report for Abandoned Plans (STRAP) rather than a final Form 5500),
- limited fiduciary relief for distributions to missing participants, and
- a prohibited transaction exemption (PTE 2006-06) that allows the QTA to utilize plan assets to pay reasonable compensation for termination services.
As part of the termination process, the program mandates that trustees:
- take reasonable steps to collect delinquent contributions on behalf of the plan, taking into account the value of the plan assets involved, the likelihood of a successful recovery, and the expenses expected to be incurred in connection with collection, and
- report any delinquent contributions owed to the plan, and any activity that may be evidence of other fiduciary breaches by a prior plan fiduciary, to the DOL.
Trustees should engage ERISA counsel to navigate the requirements of the DOL’s Abandoned Plan Program.