Priority Creditor Rights for Pension Funds

It is very rare for a company-funded pension to actually go bankrupt. It is for this reason that the events which happen after a pension-related bankruptcy are not commonly known to the investors.

When a sponsoring company goes bankrupt, its liabilities are more than its assets. Also, there are many creditors who have been given different priorities by the law.

It is not necessary that the pension fund has to go bankrupt if the sponsoring company also goes bankrupt. However, it is highly probable that such a bankruptcy will happen even if the pension fund is fully funded. Theoretically, it may be possible to separate the assets of the sponsoring firm from that of the pension fund. However, in real life, such complete ring-fencing is not feasible.

Now, the question arises about the priority which is given to pension funds. One argument is that since pensions are nothing but deferred wages, they should be given the same priority as wages. Wages have a very low priority when it comes to bankruptcy proceedings. The senior creditors are paid out first and wages are paid only if there is money left after making such payments.

The argument is considered to be quite old and in most developed parts of the western world, there is a new system in place. As per this new system, pension liabilities are given the top priority. There are varying degrees of this priority.

In some cases, pension investors are given priority only over unsecured creditors whereas in other cases they are given priority even over secured creditors. This means that after paying the taxes due, the company has to pay its pension liabilities in full before it can pay any other creditors. This is called priority creditor rights for pension fund investors.

In this article, we will have a closer look at why priority creditor rights are important for pension fund investors.

Reasons Why Pension Funds Should be Given Priority

There have been several arguments and counterarguments made with regard to priority creditor rights. Some of the arguments in favor of priority creditor rights are as follows:

1. Pension fund investors are a large and unorganized group. Other creditor groups are much more organized as compared to employees who invest in pensions. It is for this reason that they cannot afford the best legal representation to secure their interests. As a result, pension fund investors are often not treated well.

   Many governments all over the world have decided to create laws favoring these investors for precisely this reason. This has been done to ensure that pension fund investors are at least treated as well as other investors.

2. Pension fund investors tend to be employees. Employees do not have the same information about the company that other creditors do.

   For instance, banks and other creditors may ask for certain information before they give a loan to a company. However, employees cannot do that. Hence, there is a fundamental information asymmetry that works against the interests of pension fund investors. This lack of information makes it impossible for them to accurately guess the probability of default and take action accordingly.

3. Even if we believe that the above point is incorrect and it is indeed possible for the pension fund investors to obtain correct and timely information about the functioning of the markets, then too these investors are at a disadvantage. This is because pension fund investors do not have an option to diversify. They receive benefits only if they invest in pension funds.

   On the other hand, other investors do not face any compulsion. They can invest in any other company and still gain the same benefits. Here too, it is easy to see why the pension funds are at a disadvantage.

4. Pension funds are typically the last and the largest source of earning for pension fund investors. Many of these investors are close to retirement. Hence, if they lose their savings, they will not have the time to gain them back. This would put a lot of pressure on the government-sponsored welfare mechanisms which would ultimately end up being a burden on the taxpayer. In order to avoid this situation, governments tend to give priority to pension investors.

5. Also, if a company goes bankrupt, then the pensioners would be the workers of such a company. This means that they will lose their jobs as well as their savings. Such a situation would render them in severe financial duress.

   Hence, in order to avoid this double blow, pension investors need to be given higher priority over other investors when it comes to the bankruptcy of a firm.

6. Lastly, the legal framework of many countries does not provide complete protection to pension investors. This is because of the fact that issues like wages, leaves, and even working conditions are covered under labor law. However, when it comes to pension funds, many countries do not have explicit laws which protect the interests of the workers.

The bottom line is that in many countries of the world pensioners are provided priority rights. But this is not the case in many developed countries including the United States as well. Also, even if such priority rights are provided, a more comprehensive framework is required for the development and functioning of pension funds.

Authorship/Referencing - About the Author(s)

The article is Written and Reviewed by Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.