On Jan. 1, 2013, amendments to Ontario’s Pension Benefits Act (PBA) took effect, allowing employers to use a letter of credit (LOC) to cover up to 15% of solvency liabilities in a pension plan. For employers in the province, the welcome change may help alleviate some of the funding challenges faced by DB plan sponsors.
For many, the amendments permitting the use of a LOC are long overdue. In 2008, the Ontario Expert Commission on Pensions recommended that, subject to certain conditions, irrevocable LOCs “be permitted as security for a fixed proportion of contributions owing to a plan.” Alberta, B.C., Manitoba, Quebec and the federal jurisdiction already permit employers to use a LOC to secure a portion of a plan’s solvency liabilities, and Nova Scotia has proposed such legislation. In addition, Newfoundland currently permits LOC use as part of a solvency relief option for plans with actuarial valuation dates between Jan. 1, 2010, and Jan. 1, 2013.
By finally allowing LOCs, Ontario has given employers that are struggling, as a result of poor equity markets and low long-term interest rates, to manage underfunded pension plans an alternative means of doing so. Jointly sponsored pension plans, multi-employer pension plans, public sector pension plans, unless otherwise prescribed, and certain other plans to which special regulations already apply may not use a LOC. For other employers, such as those with limited credit capacity or those for which the cost of the LOC standby fee may be higher than the cost of borrowing money to make solvency payments, a LOC may
not be a viable option.
The PBA and regulations set out conditions and restrictions around the use of a LOC. Under the PBA, a LOC must satisfy five basic requirements:
- be an irrevocable and unconditional standby LOC made in accordance with the rules set out in International Standby Practices ISP98, International Chamber of Commerce publication No. 590;
- be made payable to the trustee of the pension fund, in trust for the fund;
- be payable in Canadian currency;
- make the issuer contractually liable to pay out money if payment is demanded
- by the trustee; and
- be subject to a trust agreement, as described in the regulations, between the issuer and plan administrator.
The required terms of the LOC and trust agreement are also prescribed under the regulations. Among other terms, a LOC must provide that the insolvency, liquidation or bankruptcy of the employer has no effect on the rights or obligations of the issuer or trustee and that the LOC cannot be assigned, except by the issuer, to another issuer. An issuer of a LOC must be a member of the Canadian Payments Association and must be a bank, credit union, caisse populaire or a co-operative credit society. An issuer must also have a credit rating at least equal to one of the ratings set out in the regulations.
The PBA and regulations also impose certain obligations on the trustee who holds a LOC in trust for a pension plan. For example, the trustee is required to demand payment of the amount of the LOC if certain circumstances exist, such as the failure of the LOC to comply with the PBA and regulations or the federal Income Tax Act.
Employers considering using a LOC should review the relevant provisions of the PBA and regulations closely. They should also consider whether the use of a LOC makes sense for their DB plan and overall business.
Kim Ozubko is counsel in the pensions and benefits practice at Blake, Cassels & Graydon, LLP