Private equity and other investment fund managers can exhale (at least a little bit) following a recent court ruling that investment funds are not liable for the ERISA obligations of their portfolio companies. The ruling expressly rejects a 2007 Pension Benefit Guaranty Corporation (“PBGC”) letter ruling and contradicts an earlier court decision that supported the PBGC’s position that a private equity fund could be liable for the pension liabilities of one of its portfolio companies. While the new ruling by no means settles the issue, investment fund managers should welcome this development.
A little background might help put this decision in context. Benefits practitioners will be familiar with the ERISA controlled group rules that generally treat entities that are related by common ownership of least 80% as a single entity, regardless of any corporate separateness. Each entity of this “controlled group” can be liable for the funding obligations of pension plans sponsored by any member of the controlled group and for the withdrawal liability under a multiemployer plan in which a member participates. Controlled group members are also generally required to aggregate their plans for purposes of nondiscrimination testing, among other things. These rules are intended to prevent employers from creating separate subsidiaries solely to avoid ERISA liability and other requirements.
Many private equity and other investment funds treat each of their portfolio companies as not in the same controlled group as each other or as the fund itself. Each portfolio company, and the fund itself, effectively operates as a separate employer.
However, in 2007, the PBGC issued a letter ruling that has caused consternation in the investment funds community and was viewed by many as reaching beyond the intent and proper meaning of the controlled group rules. The PBGC held that a private equity fund was a trade or business that could be aggregated with its portfolio companies under the controlled group rules, and went on to find the particular fund jointly and severally liable for the liabilities of a pension plan sponsored by one of its portfolio companies. The letter is available here.
Three years later, in 2010, a Michigan district court issued a decision that supported the PBGC’s view that a private equity fund could be a trade or business, and thus liable for the ERISA obligations of its portfolio companies. (See Bd. of Tr., Sheet Metal Workers’ Nat’l Pension Fund v. Palladium Equity Partners, LLC, 722 F. Supp. 2d 854 (E.D. Mich. 2010).)
Under the reasoning of the letter and the Michigan case, not only might an investment fund be liable for the ERISA obligations of its portfolio companies, but the different portfolio companies might be liable for each other’s obligations. For investment funds and their portfolio companies, this uncertainty implicates pension plan liability and plan compliance, as well as ancillary issues like obligations under credit agreements, which commonly include representations and covenants related to ERISA liability, and could require the various portfolio companies – which often have little contact with each other – to communicate regularly regarding each other’s pension plans.
Given this backdrop, it is easy to see the potential significance of the recent decision in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, No. 10-10921-DPW (D. Mass. Oct. 18, 2012). Here, the Massachusetts district court found that neither of the investment funds in the case was “a trade or business” and thus the funds could not be included in the company’s controlled group. The court also found that the particular investment structure, in which the investment between two related funds was split 70%/30% – which the funds acknowledged was done in part to keep each fund’s ownership under 80% and limit the risk of ERISA controlled group aggregation – did not violate an ERISA rule which prohibits a transaction whose principal purpose is to evade or avoid pension plan liability.
There is now a clear split between the PBGC and at least one federal court on whether an investment fund can be a member of an ERISA controlled group. Investment fund managers should be aware that this uncertainty continues to exist and consider whether they may be able to structure their investments to limit the ERISA risk.