Delinquency Funds

[Guest Keith N]

Has anyone had any experience with Delinquency funds? I have a client who is contemplating creating a fund in which the penalties collected on late contributions from contributing employers are deposited. These amounts will then be used to help pay for the DC allocations for employees of other employers who have defaulted on their payments.

My questions are:

1) Is this possible?

2) What kind of fund is the delinquency fund? (VEBA?)

3) How can I legally transfer $$ from one trust to another?

[KJohnson]

First Solution: Convert your MPP Plan to a Profit Sharing Plan with a stated contribution obligation in the CBA and the Code problems for delinquencies go away. I don't think you lose anything by doing this . Look at the following from the multiemployer audit guidelines:

Service with Employer Who Fails to Make Required Contributions

A pension plan (including a money purchase pension plan) under which service credit or allocation of contributions is conditioned on an employer's making required contributions violates the definitely determinable benefit rule for pension plans of Reg. 1.401-1(B)(1)(i). It does this by allowing an employer's actions, in effect, to determine the amount of benefits accrued by its employees. It also violates the requirement that all years of service with the employers maintaining the plan be taken into account for participation and vesting purposes as well. If the plan trustees are unable to collect the full amount owed, the plan may incur an accumulated funding deficiency. See DOL Reg. 2530.210 and Rev. Rul. 85-130, 1985-2 C.B. 137.

In contrast, because the definitely determinable benefit rule does not apply to profit-sharing plans, multiemployer profit-sharing plans may provide that a delinquency in contributions will be allocated only to the delinquent employer's employees. This does not violate the definite allocation formula requirement of Reg. sec. 1.401-1(B)(1)(ii). (Note that IRC 401(a)(27)(B) requires that a plan intended to be either a money purchase pension plan or a profit-sharing plan must be so designated in order to be a qualified plan.)

If you stick with an MPP I think the second solution is to not make it a separate fund but to simply make it a subaccount or suspense account of your dc plan and then look to rules on allocations and valuations. I would wait until the end of the year and "wipe out" this sub account by applying any amounts to delinquencies and treating the rest as basic earnings (assuming you are currently treating liquidated damages as earnings rather than allocating them to particular participants). If you draft your plan correctly and make sure that all money is allocated by the end of the Plan Year it may be the best solution ot a difficult problem.

Several years ago I asked Wickersham the question how you get around this in a multi MPP and his response was "its a problem and thats why you get paid the big bucks"

[Guest Keith N]

Thank you for your comments. I believe the plan currently is a PS plan. I don't think the Trustees intend on allocating all of the money out of the account each year. They intend to let this fund build up until an employer defaults. At that point, they will take money from this fund and allocate it to the effected participants.

Just to clarify, the trustees intend to take all penalties from late contributions (both DB & DC) and put them into this fund or account. Since the DB benefits will be provided regarless of whether or not the money actually comes in, this delinquency account will only be used to restore the DC balances of the employee of defaulting employers, since in the DC plan, money is only allocated if it is received.

Another solution may be to create a "delinquency" account inside the DC plan. This would be similar to a forfeiture account, although the money would not be distributed pro rata to the participants. They delinquency account could be physically held in a checking account at a local bank in the name of the Trust.

[KJohnson]

All I can say is that I see your problem. I believe that the IRS frowns on having unallocated subaccounts at the end of the plan year in a dc plan (absent a specific code provision such as 415.) I don't think you could set it up as a VEBA because I think I recall that a transfer to a qualified retirement plan is not a VEBA provided benefit and you risk triggering the 100% excise tax because of the transfer (assuming it could otherwise be accomplished).

I also seek some tricky drafntig issues in both the CBA and the Plans where you are taking liquidated damages attrributable to one plan and "assigning" them to another plan. This would especially be troubling in taking the DB damages and "giving them" to the DC plan. Although these problems may not be insurmountable the idea gives me that "queazy" feeling under both the Code and the Act regarding PT's, definitiely determinable, sole and exclusive benefit etc. Also Taft Hartley issues might spring up and you may want to be sure that such a fund would fall under one of the 302© categories.

Since moving "down South" I don't do nearly as much multi work so maybe someone else would have an idea.

[Guest Keith N]

Thanks again for your comments. I share your "queazy feeling" which is why I posted the question. I have heard that this animal is out there, I just haven't found anyone who is actually doing it. I think this Plan intends on drafting a document and submitting it to the IRS for a ruling. I just wondered if anyone else had any experience.

[pjkoehler]

KeithN: Can you shed a little light on the meaning of "delinquency funds." I'm guessing that what you mean is that these are penalties imposed under the CBA on nonelective contributions that were not timely deposited by a contributing employer. I think the principal issue here is a "plan asset" issue. If the CBA obligates the delinquent employer to pay the penalty to the pension trust, then it may be argued that the penalties payments are "plan assets" subject to ERISA and the Code's anti-diversion rules. With regard to the "delinquency" penalties received in connection with late DC plan deposits, I think the trustees are on thin ice creating an unallocated suspense account that treats these amounts as something other than employer contributions, UNLESS the plan has specific language in it that provides for this and you have an up to date IRS determination letter that considered it. The reason is that the penalties are amounts paid in by a contributing employer, so it's difficult to rationalize any treatment other than as an employer contribution, especially in a profit sharing plan. The general qualification requirement that a profit sharing plan provide a "definite predetermined formula for allocating the contributions made to the plan" looms large here. Better to seek an amendement to the CBA next time it reopens to identify the penalties as direct payments to the plan's administrative organization rather than the trust, which would just go to offset the expense to the trust anyway and avoid the administrative hassles of managing an unallocated suspense account even if the IRS gave its approval.

[KJohnson]

PJK--I think the liquidated damages, once paid, are definitely plan assets. Whether they are "contributions" I guess is open to debate. While you can't always mix "ERISA and Code" speak, Section 502(g)(2) of ERISA provides for the recovery of contributions, interest, liquidated damages and attorneys fees. The rationale for the liquidated damages is to recover the administrative costs to the plan for colleciton (which is borne by all participants). Thus, I can see multi allocating the recovery of contributions and interest to the applicable participant for a delinquent employer but providing that the recovery of liquidated damages and attorneys fees offsets expenses in general.

That said, I don't think it really matters whether you treat it as a contribution. I think your point about being specific on the allocation formula is very important. The allocation formula could contain something like; 1) allocation of contribuitons actually made to participants; 2) allocation of liquidated damages collected to the accounts of those participants employed by delinquent employers-- but only to the extent of contributions that should have been made. I think this would get you past the need for a definite formula (Of course you probably then must have a third step that if the plan subsequently collects the delinquent contribuitons providing that those contribuitons go into the "liquidated damages" subaccount.)

Where I get concerned is the "carry over" from Plan Year to Plan Year. In essence, if you do not allocate the amount in the liquidated damages account your plan assets are going to be in excess of your participant balances at the end of the year.

Also as previously mentioned you would have to think long and hard about a method of getting liquidated damages based on DB contributions over to the DC Plan. I suppose that you could say in your CBA that your formula for profit sharing contribuitons is $X per hour worked plus an additional amount based on any delinquency to the db plan. (This then would undoubtedly be a contribution). You can base your contribuiton in the CBA on anything you want (the UMWA Funds used to use tons of coal mined). Then, however, if you are in court on a db delinquency, how do you deal with the mandatory language of 502(g)(2)? Would the employer owe "double" liquidated damages? (i.e. the statutory damages to the DB plan and the contractual contribution to the DC Plan?)

[pjkoehler]

KJohnson: Even if the "delinquency funds" are "plan assets," using them to pay the service fee of the plan's administrative ogranization falls squarely within a permitted use: "defraying reasonable expenses of administering the plan." See ERISA Sec. 404(a)(1)(A)(ii). Every multi I've advised was paid a fee negotiated with the trustees directly from plan assets. How else would the plan's administrative organization be paid? Presumably, the plan has a single administrative organization for the purpose of administering both DB and DC. What could be simpler than using this small stream of additional revenue for the purpose of paying the administrative organization as received. The fee arrangement would then simply have to be modified to provide the corresponding offset. This avoids any impact on the financial activities within the DC plan accounts and the qualification issue of maintaining an unallocated suspense account. I mean money is still fungible, isn't it?

[KJohnson]

PJK--I was just adressing your point with regard to the liquidated damages being treated as contributions.

I don't see what you are getting at as far as a possible solution of Keith N's problem. The goal is not to use "late fees" or liquidated damages to offset expenses of the plan but to allocate them to the accounts of participants of delinquent employers.

I suppose that you could allocate them as received (assuming a plan provision to the effect) but that may lead some employers to think--If we are going to be delinquent its better to be delinquent at the beginning of the year because our employees will then be the first to be made whole (and believe me cash strapped employers will "game" any multiemployer delinquency system that may be set up).

I think the best thing to do would be to wait until the end of the year to do an allocation of the entire account. Then you would not have a "carry over" suspense account, yet all participants of delinquent employers would be treated ratably with a pro-rata allocation of their delinquent contribuitons. (I really doubt that liquidated damages collected will come close to making up outstanding delinquencies for a year.)

[pjkoehler]

KJohnson: Why are you referring to the "delinquency funds" as "liquidated damages?" I don't recall that description being used by KeithN. As a matter of contract law, "liquidated damages" establish a limitation on the breaching party's liability for nonperformance. I very much doubt that the CBA provides that a delinquent employer's liability to the trust is limited to these minor fees. It's like saying a taxpayer's payment of interest and negligence penalties are "liquidated damages" for the undepayment of his tax liability. Obviously, the delinquent employer is also llable for the delinquent contribution itself, so what you call "liquidated damages" is, in fact a "penalty," which is an additional liability over and above the plan's damages from nonperformance. It seems to me that it would be unduly budensome to modify (or manually override) the plan's administrative system to make special allocations to ever shifting groups of employees of delinquent employers, plus the investment earnings thereon.

The administrative organization's annual fee will be absorbed by the DC plan accounts one way or another. Sure, it's accross the board, whereas the delinquency funds are theoretically targeted to identifiable employees. It's not the same, but is the net difference worth the additional cost that the administrative organization will presumably reflect in addtional fees for making these special allocations, which are then spread to all the plan participants?

[KJohnson]

PJK-- While you and Keith used the term "penalties" on delinquent contributions with regard to the method of funding the "delinquency fund", I doubt that many multis are actually calling these fees penalties because if they are, they could not be collected (as a contractual matter) in a number of Circuits--including I believe yours--Idaho Plumbers and Pipefitters Health and Welfare Fund v. United Mechanical Contractors, 875 F.2d 212 (9th Cir.1989).

There are two alternatives. First they can be "liquidated damages" on upaid contribuitons under 502(g)(2) of ERISA in which case the plan document can "charge" whatever it wants (up to 20%) irrespective of whether it would be a penalty under common law. However, to fall under 502(g)(2) these must be "liqudiated damages as provided in the plan." Thus, to collect the Plan must have a "liquidated damages" provision.

Second the plan could use the term liquidated damages (not penalties) and they may be collected as a contractual matter (usually a 301 suit). I believe that the Courts have stated that in instances where an employer is delinquent but pays the delinquency prior to when suit is brought, 502(g)(2) is inapplicable to the attempt to enforce the plan's liquidated damages provision because there are no "upaid contributions" at the time of suit. Therefore as a matter of "federal common law" a number of Courts have stated that the liquidated damages clause must be analyzed to see if it is really is a good faith estimate of the administrative and other costs to a Plan that arise from the delinquency over and above interest. If they fail under this test, thouse courts have said the liquidated damages clause is, in actuality, a penalty and cannot be enforced.

Going back to Keith N's quesiton. How would you go about "funding" the accounts of participants of delinquent employers if that is what the Trustees wanted to do (or are required to do in the case of a MPP). I had posed to Wickersham merely treating it as an administrative expense of the Plan. However, he did not believe that such a charge fell within the definition of an administative expense that could be assesed against the accounts of other participants.

[pjkoehler]

Kjohnson: I believe you may have misinterpreted KeithN's question. His issue regards "late contributions," not "delinquent contributions," with respect to which a plan fiduciary may bring a 502(g)(2) collection action for with respect to the employer's violation of 515. The way I understand KeithN's facts, the CBA determines when an employer's contribution liability is "late" and imposes an additional charge as a deterrent. This is an additional cash flow to the plan above and beyond the required MPP funding liability. The trustees would like it to benefit exclusively the employees of the delinquent employer. While laudable as an egalitarian gesture, its fraught with peril.