Toronto: A huge shortfall in funding pensions at Nortel Networks Corp helped push it into bankruptcy protection and could continue to complicate the Canadian telecom-equipment maker’s restructuring efforts.
The shortfall, estimated at between $2.5 billion and $2.8 billion by analysts, means Nortel has to shell out hundreds of millions of dollars each year to fund it - even as it faces a grim global economy, weak sales, a big debt load and stiff competition.
Pension laws typically require that a shortfall in a pension plan be funded over five years, said James Pierlot, a lawyer at Towers Perrin in Toronto who specializes in pensions.
Simplified, this means that if Nortel’s shortfall was $2.5 billion, it would face funding requirements of $500 million a year.
“I think it’s obvious that pension funding obligations can play a role in whether or not a company is able to meet its obligations to its various creditors,” Pierlot said.
While the Toronto-based company, North America’s biggest maker of telephone gear, has had some success reducing its pension shortfall over the past several years, Nortel’s chief executive said it has again ballooned recently.
In 2005 and 2006, the deficit was between $2.5 billion and $2.7 billion. It then dropped by about $700 million in 2007. Now, however, with global equity markets in a severe downturn, things are much worse.
“It has increased dramatically since then,” chief executive Mike Zafirovski told Reuters just hours after Nortel announced it would seek court shelter from creditors on Wednesday.
The company, which currently has $2.4 billion in cash, will not say exactly how big its pension deficit is at present.
Nortel offers defined benefit pension plans in many countries. In January 2008, a large number of Canadian employees in one such plan switched to a defined contribution pension.
Defined benefit plans promise a fixed, specific benefit to pensioners. Defined contribution plans entitle pensioners to the value of the contributions made, plus any investment income -- or minus any losses -- on those contributions.
“For people who are in the defined benefit arrangement, they’re exposed to the risk of not getting all the money that they were promised,” Pierlot said.
Some sort of legal fight is likely as Nortel’s pension plans are restructured, which could further complicate the court process the company faces.
Even if Nortel faced payments of $500 million a year for the next five years to fund its pension shortfall, this alone would not have been enough to render the company insolvent.
A Nortel spokesman said the company filed for protection for a variety of reasons: “the company’s costs, balance sheet, capital structure and high debt levels, were compounded by the current severe economic downturn.”
Analysts cited slumping demand and spending cutbacks by Nortel’s telecom company customers for the bankruptcy filing, and with the stock market downturn, the growing pension liability was another setback.
“In terms of short-term cash, it wouldn’t have been a factor” in a decision to file for protection, said Duncan Stewart, an analyst at DSAM Consulting. However, when Nortel’s directors examined all of the company’s long-term liabilities, “the pension would have played a role”.