A groundbreaking legal decision that could give pension funds and the Pension Benefit Guaranty Corp. more muscle in recovering pension liabilities has private equity firms suddenly paying a lot more attention to deals in which pension benefits are involved.
“This is clearly very new territory,” said attorney Michael Kreps, a principal with Groom Law Group in Washington. “From the pension fund side, they've got some pretty good precedent now. A lot of (pension) funds are now thinking, "we have more options than we had six months ago,'” he said.
“For the PBGC, it's a potential game changer,” Mr. Kreps said. The agency's multiemployer insurance program is expected to run out of money by 2025, and taking on one or more plans now headed for insolvency would hasten that crisis.
The case, brought by New England Teamsters & Trucking Industry Pension Fund, Burlington, Mass., against several Sun Capital Partners Inc. funds, is under appeal, but “there's exposure right now,” said private equity consultant David Fann, president and CEO of TorreyCove Capital Partners LLC in San Diego. “Anything that has a similar fact pattern will probably end in court. It opens the door for a lot of other lawsuits where private equity (companies) have withdrawn from pension plans.”
Jed Brickner, a New York partner in law firm Latham & Watkins LLP who advises private equity and other funds, agreed.
“If this ended up being the law of the land, it would significantly change the way that private equity investments are structured where the target has significant pension liability,” Mr. Brickner said. “Before the decision, the market thought transactions structured like Sun Capital were safe.”
Until now, private equity firms and their limited partner investors typically have not had to worry about being on the hook for pension liabilities under the Employee Retirement Income Security Act. The firms' individual funds are considered investors, rather than a controlling “trade or business” that would be responsible under ERISA, and their primary regulator is the Internal Revenue Service, where 80% ownership of a portfolio company is considered the threshold for company control. Many funds are structured to avoid that 80%, and few even calculate pension liabilities in their valuations, experts say.
On March 28, U.S. District Court Judge Douglas Woodlock for the District of Massachusetts in Boston saw it much differently, in a case involving pension withdrawal liability of a defunct portfolio company, Scott Brass Inc., owned by two Sun Capital Partners funds. While the two funds, Sun Capital Partners III and Sun Capital Partners IV, only owned 30% and 70%, respectively, “the substantial overlap” between the way the funds operated made them not only a trade or business, but “a partnership-in-fact,” Mr. Woodlock said in his decision. “It is the conduct of the funds that gives rise to a partnership.”