The Private Equity Multiemployer Plan Problem ... Litigated

For years, private equity funds have managed to do a good job of using the controlled group rules of Internal Revenue Code Section 1563 to avoid some of the complexities associated with them. In fact, where a single private equity group maintains multiple funds, it has typically ensured not having to deal with these rules by divvying up the ownership of any company among its funds. However, the United States District Court for Massachusetts may have dealt a serious blow to these strategies.

Section 1563(a) contains the key language specific to controlled groups.

(a)Controlled group of corporations For purposes of this part, the term “controlled group of corporations” means any group of—

(1)Parent-subsidiary controlled group One or more chains of corporations connected through stock ownership with a common parent corporation if—

(A)

stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each of the corporations, except the common parent corporation, is owned (within the meaning of subsection (d)(1)) by one or more of the other corporations; and

(B)

the common parent corporation owns (within the meaning of subsection (d)(1)) stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.

Long time followers of this blog may recall that Scott Brass has been fodder for issues specific to private equity funds in the past. Once again, we deal with Sun Capital Partners, here known by Sun Capital Partners III, III QP, and IV.

Scott Brass, Inc. was a bankrupt company essentially held 30% by Sun Capital III and 70% by Sun Capital IV. After going bankrupt, Scott Brass stopped contributing to the New England Teamsters pension fund and was assessed a withdrawal liability by the multiemployer plan.

Under the Multiemployer Pension Plan Amendments Act of 1980 (MPPAA), members of a controlled group may be jointly and severably liable for withdrawal liability payments. But, Sun Capital argued that Scott Brass was neither part of a controlled group with parent Sun Capital III nor one with parent Sun Capital IV.

The courts thought differently. Relying on ERISA Section 4001, in which we see outlined the PBGC's definition of controlled group, the courts in this case looked at substance over form. That is, the courts saw that there is, in fact, a single entity that owns Scott Brass, Inc,, despite the complex legal structure that was developed surrounding the company. In fact, the Managing Partners of Sun Capital freely admitted that the structure that they created was largely to avoid the possibility of joint and several liability for withdrawal liability.

The court ruled in favor of the Teamsters Fund. While this will surely be appealed to the First Circuit and perhaps to the Supreme Court if the First Circuit fails to overturn, this case provides an avenue by which multiemployer plans may seek payments of withdrawal liability that have previously not been available to them.

Private equity funds in similar situation should consider these potential liabilities both in due diligence and in their ongoing risk management assessments.