Pension liability shifted upstream.
It is unexpected that a private equity firm would be liable for the debts of its portfolio companies, which are separate legal entities. Pension funds, however, are specially regulated (by the Employee Retirement Income Security Act of 1974, commonly called "ERISA" as amended by the Multi-Employer Pension Plan Amendment Act of 1980 (MPPAA) and recent court decisions have made clear an intent to protect pension funds for employees and avoid having payment responsibility fall upon the Pension Benefit Guaranty Company (PBGC), which was established under ERISA to insure covered employee pension benefits.
Sun Capital had acquired and owned Scott Brass, Inc., a leading producer of high-end metals including brass and copper, through a series of related investment LLCs. At the time of the acquisition, Scott Brass participated in an underfunded multi-employer pension plan, the New England Teamsters & Trucking Industry Pension Fund (the "Teamsters Fund").
In late 2008, declining copper prices reduced the value of Scott Brass' inventory, in turn resulting in a breach of its loan covenants. To conserve cash and at the behest of Sun Capital, Scott Brass stopped making contributions to the Teamsters Fund. Under applicable ERISA provisions, stopping contributions was deemed a withdrawal from the Teamsters Fund, in which case Scott Brass became liable for its proportionate share of the Teamsters Fund's unfunded vested benefits, totaling approximately $4.5 million.
The Teamsters Fund demanded that Scott Brass pay the $4.5 million withdrawal liability, and also demanded payment from Sun Capital as a partner or joint venturer in common control with Scott Brass. In response, Sun Capital filed a declaratory judgment action, seeking a ruling of no joint and several liability of Sun Capital.
In finding Sun Capital jointly and severally liable with Scott Brass for the $4.5 million withdrawal liability, the First Circuit of Appeals Court noted that:
1. The MPPAA was enacted to protect pension benefit plans by creating a disincentive for employers to withdraw from plans;
2. The liability provisions for "withdrawal" in MPPAA is also designed to protect the PBGC, as the guarantor of an underfunding liability; and
3. The MPPAA provides that affiliated companies that are in a "trade or business" and are under common control are considered a single employer.
The Court concluded that Sun Capital was in fact a trade or business, among other reasons because it had a management agreement regarding Scott Brass, received management and advisory fees from Scott Brass, and was in a position to exercise control of the management of Scott Brass.
Similarly, the U.S. Court of Appeals for the Second Circuit, in Oneida Ltd. v. PBGC (2009) upheld the PBGC's entitlement to a special termination premium under ERISA. As the guarantor of underfunded pension plans, PBGC is often the largest unsecured creditor of a Chapter 11 debtor. The Sun Capital and Oneida cases indicate an intent on the part of the federal courts to protect pension plans and to assist the financially burdened PBGC.
The Sun Capital case is a notable departure from the prevailing view that private equity funds are not liable for withdrawal or underfunding liabilities, despite common control, because private equity funds and the portfolio companies are not a "trade or business."
This decision will impact investors in private equity, lenders to private equity funds or their portfolio companies, and suppliers who extend credit to portfolio companies, that may be faced with a sudden withdrawal of financial support for the suppliers' customer.
Creditors of portfolio companies may use this ruling to reallocate pension liabilities to the private equity owner, making more of the portfolio company's assets available for its creditors. Private equity companies will no doubt explore ownership, acquisition and relationship structures to minimize the risk created by this ruling.
We hope you have found this article informative and useful. Please let us know if you have any comments or questions.
DAVID CONAWAY, ESQ.
David H. Conaway, Esq. is chairman of the Bankruptcy, Insolvency and Creditors' Rights Group at Shumaker, Loop & Kendrick, LLP. He can be reached at firstname.lastname@example.org or 704-945-2149.
Article originally appeared in the September 2013 Shumaker, Loop & Kendrick, LLP newsletter.
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