Court Gives Private Equity Funds a Pass on ERISA Obligations

“ERISA treats all members of a ‘controlled group’ as a single employer for purposes of its provisions imposing liability on employers in connection with the termination of an underfunded single employer pension plan or a withdrawal from an underfunded multi-employer pension plan. As a result, if an employer terminates or withdraws from an underfunded pension plan, each member of the employer’s controlled group is jointly and severally liable for the plan’s unfunded pension liabilities (for the employer’s share of such liabilities in the case of a multi-employer plan).” (Skadden Arps)

Do private equity funds and their portfolio companies constitute a “controlled group” responsible for funding the pension plans of each portfolio company? Absolutely, says the Pension Benefit Guaranty Corporation – the federal agency that administers more than 27,000 pension plans across the country – in a landmark 2007 ruling.

In mid-October, however, a federal court disagreed. From McDermott Will & Emery:

“[T]he U.S. District Court for the District of Massachusetts became the first court to reject a multi-employer pension plan’s attempt to rely on PBGC precedent to assess a PE fund with a portfolio company’s unfunded pension liabilities… In the Sun Capital Partners case, the court determined that the one-time investment of capital by a PE fund into a portfolio company was a passive investment and did not result in the PE funds engaging in a trade or business.”

The decision is welcomed by the private equity industry because it protects PE funds from potentially significant liabilities of unfunded pension obligations that can run into the millions of dollars. How should PE funds respond to the ruling?

1. Assess liabilities:

“In order to avail themselves of the benefits of this decision, PE funds should evaluate their operations and contractual relationships to determine if such operations and relationships are comparable to those outlined by the court in the Sun Capital Partners case.” (McDermott Will & Emery)

2. Diversify holdings:

“PE funds should structure their investments across separately incorporated funds, so that no entity breaches the 80% common control threshold.” (Pillsbury)

3. Monitor future developments:

“While the decision is not technically binding outside the district of Massachusetts, it is a well-reasoned decision that may well be followed by other federal courts and cited in response to multi-employer funds and the PBGC. However, it is clearly not the final word on this issue, and investment funds should continue to be cautious about ERISA when they acquire an 80% interest in portfolio companies.” (Osler)

The updates:

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