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Bankrupt Non-government Non-profit

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Unlike governmental 457(b) plans, which are held in a trust for the benefit of the employees, there is a theoretical risk that if a non-government entity files for bankruptcy, a 457(b) participant can lose all or part of his 457b contributions, since the money technically remains with the employer and the participant becomes, in bankruptcy, just another unsecured creditor.


Does anyone know if this theoretical risk has come to pass for anyone in the past? Has there actually been an occasion where, say, a not-for-profit hospital went under and 457b participants lost the money in their plan? Is there anyone I can talk to with actual experience with, or knowledge of, such a situation? Thanks.


Dan Otter


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I have one story for you that does not involve bankruptcy, and one that sort of does.


I had as clients a gang of four steel executives. They had run a steel company into the ground by keeping one money-losing plant open and crushing the company's profitable processing businesses. One of their perks was a non-funded NQDCP. No secular trust, no springing rabbi trusts, no guarantees. And no independent person to evaluate and authorize payment of claims.


An aggressive, turnaround-oriented company bought them in a tender offer and fired my guys immediately. They then simply refused to pay their benefits.


A year later, and a year's worth of fees from our litigators down the hole, they were running out of money. The prospective (not including fees already incurred) legal fees were around 30-40% of the total benefits, and the estimated time was 2 years. Plus, there was a pretty fair argument for offsets, ranging from expense reimbursement finagling to a corporate waste claim (which would have resulted in a zero recovery).


So we got them 50%, and felt pretty good about the result.


The moral here is that bankruptcy isn't the only risk.


The second was a church hospital asset sale, where a hospital's assets were sold and about 200 employees were let go. The nonprofit entity that had operated the hospital went into state law receivership, complex litigation involving the usual bankruptcy stuff, plus an Attorney General's lawyer.


The receivership was in front of a judge whose ordinary work load was wills and trusts, and who therefore had essentially no business, management or creditors rights knowledge. The judge, frankly, appeared overwhelmed, and gave enormous benefit of the doubt to the larger law firms he was used to dealing with. The lawyer from the AG seemed to see his job as preserving the assets of the nonprofit by opposing all unsecured claims.


I ended up working for the lawyer for the fired employees on wage claims. Fortunately, the hospital's DB plan was in good shape. Ultimately, I found a state statute that gave a priority and lien for about 1/3 of the employees' wages and accrued paid time off, and the group settled for that amount, against my recommendation that they wait and take the secured amount plus some percentage of the unsecured amount. Again, time pressure was too much of a problem.


The lesson here was that bankruptcy is not the only risk for charities, there is also the risk of receivership. It was both more complex than bankruptcy and more fluid, because of the issues mentioned above and because the court was dealing with the claims to some extent as they came up, without the discipline inherent in a bankruptcy, with the result that standards tightened up over time.


The real lessons from these two situations are that (1) you want your money set aside, (2) you want a third party making benefit determinations and (3) litigation ain't free or risk-free.


Tom Geer

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