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Mortgage Lender Bankruptcy Highlights Risk of Losing Nonqualified Plan Benefits

    Client Alerts
  • September 28, 2007

Separate articles published last week highlighted the potential impact on nonqualified deferred compensation plans when the sponsoring company files for bankruptcy.  American Home Mortgage, which filed for bankruptcy last month, had previously established a nonqualified plan that allowed certain employees to defer compensation in excess of the amounts they could defer to the company’s 401(k) plan.  The company maintained a rabbi trust for the nonqualified plan to hold and invest the deferrals.  In order for participating employees to avoid taxes on the deferred amounts until they received them, the assets of the rabbi trust were subject to the claims of the company’s general creditors in the event of its bankruptcy.  Thus, the company’s bankruptcy resulted in these assets being treated as any other company assets, and employees who had deferred compensation into the plan became nonsecured creditors of the company.  The articles quoted one participating former employee as stating that the $36,341.05 amount she had saved was “crucial to her survival.”  However, with numerous creditors having priority claims on the company’s assets, it’s entirely possible that she and others will likely see little or none of that money.  On its Web site, the company notes that under the trust provisions, benefit distributions are frozen and participants will be contacted “[i]f funds become available for withdrawal.”


An attorney representing a group of affected employees filed an objection to the release of the trust assets, which included various claims, including claims that the company or its trustee may have “acted inappropriately” with respect to distributions and contributions, that contributions were “inappropriately induced” and that participants were provided “little if any discussion of the risks associated with insolvency.”


This situation highlights some important considerations for nonqualified plans:


  • Participants must understand that deferrals to nonqualified plans (including any employer contributions) could be lost in the event of their employer’s bankruptcy.  Company officials who are responsible for the administration of such plans should take reasonable steps to make sure that eligible employees are aware of the risks of plan participation in the event of bankruptcy in order to avoid getting caught up in legal claims by participants.
  • Participants have limited recourse under nonqualified plans, which generally are exempt from ERISA’s fiduciary rules and other protections.
  • Trustees of rabbi trusts also may want to consider taking a more active role in making sure that participants are aware of the risks associated with nonqualified plans in order to avoid getting caught up in legal claims by participants.