Dividends and deficits
Former Sears Canada employees have been trying to protect their pensions as far back as 2009
Sears Canada pensioners saw it coming.
In 2013 they predicted that Sears Canada would go out of business, stranding them with an enormous deficit in the pension plan they had been contributing to for most of their working lives.
A deficit would mean reduced pension payouts in retirement — reductions many of them could ill afford. They saw it coming and they tried to fix it.
They wrote to Sears Canada CEO Calvin McDonald in 2013, they met with Sears Canada chairman Brandon Stranzl in 2016. They communicated repeatedly with the Financial Services Commission of Ontario (FSCO). They wrote to Premier Kathleen Wynne and to every Ontario MPP. They met with representatives from Ontario’s finance ministry.
In all, the list of actions taken by members of the Sears Store and Catalogue Retiree Group (SCRG) runs across three pages of an affidavit filed in court that lists 41steps taken to address the shortfall, as well as some of the responses — and those are just the steps taken since 2012.
They had begun expressing concern as far back as 2009.
And yet, when Sears Canada applied for protection from creditors on June 22 last year, the deficit in the defined benefit pension plan was $266.8 million. Sears Canada pensioners — 16,000 of them — now face the prospect of reduced pension incomes.
Their health and welfare fund, which helped them pay for things like prescription drugs, has been wiped out.
It wasn’t for lack of trying that they failed.
“We knew then that it was wrong. If the Ontario government had taken action in 2014 or 2015, we wouldn’t be here, the pension plan would have been wound up, the deficit issue would have been addressed,” said Ken Eady, a spokesman for SCRG, and one of three court-appointed representatives in the insolvency.
The Sears Canada failure once again exposed problems with defined benefit pensions, pension regulations and weaknesses in the federal acts governing bankruptcies and creditor protection applications that could affect more Canadians if fixes aren’t made.
In fact, pensioners are asking why fixes haven’t been made yet, after the financial collapse of Nortel in 2009 left 20,000 pensioners in the lurch.
“The legal and regulatory backdrop has not changed one whit,” said Michael Campbell, vice-president Nortel Retirees and former employees Protection Canada (NRPC), and court-appointed representative for the Nortel Companies’ Creditors Arrangement Act (CCAA) legal proceedings.
Campbell points to one improvement: The monthly maximum payment under Ontario’s existing Pension Benefits Guarantee Fund (PBGF) is slated to increase to $1,500 from $1,000 a month.
The PBGF is a special fund that was established by the Government of Ontario to cover pension shortfalls for certain defined benefit pension plans, in the event of a company insolvency. But Campbell also points out that the fund only covers workers in Ontario, and is not adjusted for inflation.
The Nortel case is in its ninth year before the courts. Nortel pensioners in Ontario had their pensions reduced by 30 per cent — not indexed to inflation. The original plan had an indexing provision.
There is hope they may get another 10 per cent after all the assets of the estate are distributed, according to Campbell.
Nortel employees in other provinces saw their pensions drop by half — Ontario workers are better off because they are protected by the PBGF.
A recent report from the Canadian Centre for Policy Alternatives found that many of Canada’s largest companies had defined benefit pension plans in a deficit position in 2016.
And it’s likely that the practice of underfunding pensions is more advanced at private companies, operating without the same scrutiny as their publicly traded counterparts, according to the report.
(A defined benefit pension plan promises a specified pension payment based on a formula that typically includes employee earnings, years of service and age.)
For decades, joining the Sears defined benefit pension plan was a mandatory condition of employment, as it was at many companies booming in an era of postwar prosperity fuelled by population growth.
Robust pension plans were a way of attracting and keeping good employees. The Sears plan offered a guaranteed retirement income, benefits, an employee discount in retirement and spousal continuance of the pension.
Sears had a philosophy of looking after employees who would in turn care about the company and take care of customers, according to an affidavit filed in court by William Turner, a long-time employee of Sears Canada, on behalf of the pensioners.
A number of factors conspired to undermine defined benefit pension plans in Canada in general: Medical advances increased life expectancy and created longer retirements than predicted, and unforeseen and seismic economic events — most recently the global financial crisis of 2008 — undermined returns.
Long periods of low interest rates — pension funds were historically big purchasers of bonds — are another contributing factor to pension deficits.
Cracks began appearing in the late 1980s after population growth slowed, global competition increased and Canadian companies began going out of business carrying significant pension deficits, notably Massey Combines Corp. in 1988.
Despite the challenges, the Sears pension fund managed to rack up a surplus of $65 million by 2004. But it was about to face another problem.
In 2005, U.S. hedge fund manager Edward Lampert gained control of Sears Roebuck in the U.S., becoming the controlling shareholder of Sears Canada. He would retain a controlling interest in Sears Canada, through Sears Holdings and later through his hedge fund, ESL & Associates, that has fluctuated, but which continues to this day.
Between Dec. 9, 2005 and Dec. 9, 2013, Sears Canada paid $3.4 billion in dividends to shareholders, including $2 billion in 2005, $377 million in 2010, $102 million in 2012 and $509 million in 2013.
The dividends were being funded by the sale of some of the company’s most important assets, including the Sears Credit and Financial Services operations, which was profitable and contributed a large portion of Sears Canada’s total earnings. It was sold for $2.4 billion in 2005. Sears sold leases to flagship stores in Toronto, Calgary and Vancouver.
Same-store sales dropped every year after 2005. Operating income dropped every year after 2007, swinging to losses in 2011 that deepened annually.
Between 2005 and 2011, the average dividend yield for Sears shareholders was 17.8 per cent, compared to the average dividend yield of approximately 3 per cent for companies on the TSX.
In a letter dated Jan 20, 2014, the lawyer representing pensioners put the issue to Sears Canada this way:
“The substance of Sears Canada’s management conduct is asset stripping, and has resulted in a company with negative operating earnings and cash flow and deteriorating key performance measures.
“Sears is on a path where it will not have sufficient cash to meet its funding obligations under the Sears Canada Plan and retiree benefit plans.”
The fact that Sears was selling off assets to pay handsome dividends to shareholders has raised the question of governance. The dividend payments were approved by a board of directors.
“What is the fiduciary duty of a corporate board in this kind of situation? It’s a question that is unresolved and it could only be resolved, I think through a court case, and I don’t think it’s an open-and-shut case,” said Keith Ambachtsheer, director emeritus, International Centre for Pension Management and adjunct professor of finance, Rotman School of Management, University of Toronto.
Richard Leblanc, an associate professor of law at York University and author of The Handbook of Board Governance, echoes that concern.
“Directors should have put their hand up and said: ‘Why are we approving dividends when we are under financial distress,’” Leblanc said.
This week, the firm in charge of the Sears Canada insolvency issued a report on progress made so far and said it was reviewing dividend payments made in 2012 and 2013.
FSCO, the agency responsible for regulating pensions in Ontario, and one of the agencies pensioners appealed to for help over the years, said Sears Canada was acting lawfully.
“FSCO’s review of the file showed that Sears Canada was complying with the pension plan funding requirements under the Pension Benefits Act (PBA) before the company entered CCAA protection,” according to a statement from Malon Edwards, a spokesperson for the agency that oversees pension funds in Ontario.
“It should be noted that FSCO does not have the authority to require Sears to add more money to the pension fund than required under the PBA.”
Sears Holdings and Sears Canada declined to comment.
A spokesperson from the office of Navdeep Bains, Minister of Innovation, Science and Economic Development, released this statement:
“Our government is monitoring developments in relation to Sears and continues to assess whether additional protection is needed for employees’ pensions when a company goes bankrupt. Most privately-sponsored pension plans are governed by provincial laws and regulations.”
The issue for retirees, according to Campbell, is that unlike other creditors, pensioners are in no position to replace lost retirement income.
“We had pensioners at Nortel that were — when their pensions were cut 50 per cent — they were moving in with each other, they were selling their homes and moving into apartments. They were bunking together to share costs so they could survive,” Campbell said.
“The question I ask people — imagine in your household, if one day you woke up and you had a 50 per cent salary cut overnight. What would you do? How could you handle that? That is what our pensioners saw.”
Reforming pensions is fraught with peril.
One proposed solution is for pensioners to be declared “super-priority” in a bankruptcy, putting them ahead of other lenders when the assets of the company are divided up.
But the federal Bankruptcy and Insolvency Act (BIA) and the CCAA must consider more than just the interests of pensioners in insolvency — creditors, lenders and suppliers have different, and often competing, interests.
Giving pensioners super-priority in a bankruptcy or insolvency could interfere with lending — banks would be less interested in loaning money to an enterprise if they won’t be the first to be repaid in the event of a bankruptcy, making it difficult for companies to qualify for money they may need to successfully restructure and save jobs.
And companies are allowed to run pension deficits under Ontario law, as long as they are repaying the deficit on a schedule. Companies were given additional solvency relief following the 2008 financial crisis, allowing them to postpone payments, relief that continues to this day. Critics take issue with that. “In the Sears case, they took that solvency relief and the legislation allowed them to do it — at the same time that they were selling assets and paying dividends to shareholders,” Eady said.
“This is a contributory pension plan, it is not something that was given to us. It was a condition of employment. That contribution came out of the money you might have set aside if you wanted to put it into a registered fund,” he said.
“For many, many years — I think well over a decade, Sears didn’t have to put any money into the plan. The employee contributions and growth in the market and interest rates carried the plan. So in a sense — it’s how I feel, anyway — that’s my money.”
Jim Leech, author of an award-winning business book on pensions, The Third Rail, believes companies should be made to keep to a five-year schedule when paying back pension deficits.
“A number of corporations argued over the past decade that it’s too hard on us and we should be able to spread it out over a longer period of time, because it’s not like we’re going to go bankrupt, but the fact of the matter is, some of them did go bankrupt,” Leech said.
“The solvency rules were put in place for a purpose. If a plan is in deficit, the company needs to make it up in a relatively short period of time because if you let it hang out there for a long time, it becomes chronic and if the company goes under, the employees are going to be left with a huge deficit in the pension plan.
He added that the good news is that interest rates are going up and asset values have come back from the financial crisis.
“I think generally speaking, the vast majority of the defined benefit plans are in much stronger positions today than they were five, 10 years ago.”
Despite some of the drawbacks to the defined benefit system that have emerged, Leech maintains they remain the best way to provide financial security in retirement.
He suggests a hybrid structure — something between a defined benefit and defined contribution model, where the risks are shared between companies and employees.
He points to the Ontario Municipal Employees Retirement System and the Healthcare of Ontario Pension Plan, as examples of jointly sponsored pension plans that work.
Ambachtsheer believes defined benefit pensions are a creature of the past.
“Decades ago, people assumed that returns would always be high — you could run these things as a profit centre,” said Ambachtsheer.
“Well, you know, the world changes.”
Between 2005 and 2011, the average dividend yield for Sears shareholders was 17.8 per cent, well above average