Private Equity Funds: Beware of Pension Withdrawal Liability Incurred by a Portfolio Company
In a case of first impression decided on July 24, 2013, the First Circuit Court of Appeals ruled that a private equity fund and its portfolio companies may have joint and several liability for the pension withdrawal liabilities of a portfolio company. Under the Employee Retirement Income Security Act (ERISA), all "trades or businesses" under "common control" are deemed to be a single employer and are jointly and severally liable for the pension withdrawal liabilities incurred by any of them. The New England Teamsters Pension Plan attempted to apply this rule to collect liability amounts from the Sun Capital private equity funds, managed by Sun Capital Advisors, Inc. (SCAI), when one portfolio company, Scott Brass, Inc., declared bankruptcy and failed to pay its $4.5 million withdrawal liability.
The District Court had previously dismissed the claim, holding that the private equity funds did not constitute "trades or businesses," but rather were mere passive investors because they had no employees or business operations of their own (as distinct from the operations of the portfolio companies and of SCAI, the general partner of the funds) and because the funds merely received dividends and capital gains from fund investments. Reversing this decision, the Court of Appeals applied a fact-intensive "investment plus" approach in determining whether an entity is deemed to be a trade or business. Although the Court of Appeals agreed that merely investing to make a profit, without more, does not constitute a trade or business, the court stated that SCAI, on behalf of the funds, actively participated in the management and operations of the portfolio companies for the express purpose of improving their management and operations so that they might be sold at a profit within two to five years after acquisition. The court emphasized that management fees paid by the portfolio companies to SCAI served to offset the management fees that the funds owed to SCAI, thereby making it clear that SCAI was an agent of the funds and that the funds received an economic benefit from SCAI's efforts.
Although a private equity fund may constitute a "trade or business," withdrawal liability of a portfolio company will attach only if there also is "common control," which generally requires 80 percent ownership of the company's shares. The Sun Capital funds may avoid liability on remand of the case because they were structured to hold less than an 80 percent interest in Scott Brass.
Private equity funds with investments in unionized companies that have potential pension withdrawal liability should proceed with caution. Note also that there is similar potential exposure to the Pension Benefit Guaranty Corporation (PBGC) on account of single-employer defined benefit pension plans that are significantly underfunded. Where a private equity fund includes "investment plus" factors that could give rise to "trade or business" status, it will generally be important to assure that the fund is not deemed to own a "controlling interest" (i.e., 80 percent or more) in the portfolio company in question.
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