District Court Affirms Withdrawal Liability Calculations, But Appears to Leave an Opening

Working right before the holiday, New Jersey District Court Judge Kevin McNulty issued a lengthy opinion late on July 3 in Manhattan Ford Lincoln, Inc. v UAW Local 259 Pension Fund. The case concerns the withdrawal liability assessed against Manhattan Ford, a withdrawing employer from a multiemployer pension plan and the actuarial assumptions used for the calculations. While this is far from the first case on this topic, it may be instructive to contributing employers who are considering withdrawing from multiemployer plans and for consultants and actuaries who work with these plans.

Before diving too deeply into the case, we need some background for readers who do not work in the multiemployer plan world on a daily basis. As the background is geared toward the more casual reader than to the multiemployer expert, we've intentionally omitted some details.

In 1980, Congress passed and President Carter signed into law the Multiemployer Pension Plans Amendments Act (MPPAA). In part, MPPAA established the concept of withdrawal liability as a means of ensuring that employers who choose to leave those plans pay their fair share of any unfunded liabilities.

For years, one of the frustrations of many who are involved with multiemployer plans has been the lack of guidance on actuarial assumptions particularly the discount rate to be used in determining the vested benefit liability (VBL) under a plan. That said, the statutory language that provides much of the guidance that we have in this arena and the language that the fund's actuary looks to in determining the discount rate to be used in annual actuarial valuations are somewhat instructive.

Quoting from a footnote in Judge McNulty's opinion, "The main upshot, for our purposes, is that under current law, 'each' actuarial assumption must be reasonable for the purpose of minimum funding, whereas they must be reasonable 'in the aggregate' for purposes of withdrawal liability." The language here is strikingly similar yet as we will discuss later, the calculations are often very far apart.

In this particular case, the plan's Enrolled Actuary (EA) used the Segal Blend (a method developed by the Segal Company in the early days of MPPAA) as a means of discounting in order to determine the fund's VBL and therefore the unfunded vested benefits (UVB) as well. To understand this case and the distinctions we will make later, we'll have to get hypertechnical (yet still oversimplified) for a moment to explain the Segal Blend. The Segal Blend essentially does two calculations and blends them. It considers that liabilities that can be settled by plan assets are assumed to have their risk transferred and therefore use PBGC rates (the rates inherent in insurance company annuity settlements) to discount the liabilities. But, for the portion of the liabilities not covered by plan assets, it acknowledges a risk premium and uses the funding interest rate (the EA's best estimate of future investment returns).

In Manhattan Ford, the fund's calculation performed by the EA showed that the withdrawing employer owed a roughly $2.5 million withdrawal liability based on the Segal Blend. The employer challenged the calculation and an arbitrator found in favor of the fund. Manhattan Ford appealed to the District Court.

Judge McNulty found that two essential questions were raised [quoting]:

1. As a matter of ERISA law, must a pension plan's actuary use identical actuarial assumptions to calculate the plan's satisfaction of minimum funding requirements and its unfunded vested benefits ("UVB") for withdrawal liability?
2. Assuming the answer to question 1 is "no," did the Arbitrator err in this case when he found that the discount rate applied by the Pension Fund's actuary to determine Manhattan Ford's withdrawal liability, the Segal Blend, did not render the actuarial assumptions "in the aggregate, unreasonable (taking into account the experience of the plan and reasonable expectations)"?

The Judge found that answer to both questions to be "no" and granted summary judgment to the Pension Fund. Summary judgment is granted only when the Court finds that the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law. Stated differently and from an extremely non-legal perspective, the Court found that even if all of the facts claimed by Manhattan Ford were true, it still had no valid case.

Thinking about this as a consulting actuary or even putting us in the lens of a withdrawing employer, this would appear to leave little room. And, this would appear that based on the fact pattern in this case that at least in the District of New Jersey that the Segal Blend produces results that are not unreasonable (note that the burden of proof here by statute is on the withdrawing employer).

What this opinion specifically does not say, however, is that the EA's judgment is infallible or indisputable. While the opinion did not address this, that the statute gives withdrawing employers the ability to challenge withdrawal liability calculations suggests that ERISA contemplates that there are, in fact, valid challenges.

What might they be?

We've seen a number of calculations of withdrawal liability where all of the discounting is done using PBGC rates. To understand the significance of this, note that in recent years, PBGC rates for this purpose have often been less than 3% while funding interest rates are often in the vicinity of 8%. Conservatively, changing the discount rate from 8% to 3% could increase liabilities by anywhere from 40% to more than 100% depending on the demographics of plan participants. For purposes of an example, let's use 60% and further, for extreme simplicity, let's assume that all liabilities of our hypothetical multiemployer plan are vested.

Suppose our plan has assets of $1 billion and liabilities discounted at 8% of $1 billion. Then, the unfunded liability at 8% is $0. However, decreasing our discount rate to 3% increases our liabilities to $1.6 billion and increases our unfunded liability from $0 to $600 million. That helps us to illustrate the extreme leverage inherent in many of these calculations.

So, to return to some of the questions at hand, let's suppose that the 8% discount rate applied in the annual valuation of the plan is the EA's actuarial assumption. In fact, when he has put it on the Schedule MB to Form 5500, he has asserted under penalty of perjury that it is reasonable. And, he has similarly asserted under penalty of perjury that each of his other assumptions is reasonable. Finally, he has asserted that, in combination, these assumptions offer his best estimate of expected future experience under the plan.

Now, the EA is asked to perform a withdrawal liability calculation. In performing that calculation, he keeps all assumptions except for the discount rate the same as they were for minimum funding. But, he changes the discount rate from 8% to 3%.

If each assumption is individually reasonable, one can extrapolate that the set of assumptions, in the aggregate, is reasonable. 

Given that the unfunded liability has increased from $0 to $600 million and even conceding that the purpose of the measurement is different, this begs the question as to how the revised assumptions (only one is revised), in the aggregate, can also be reasonable.

Withdrawing and potentially withdrawing employers should weigh these issues carefully when withdrawing. In combination with counsel and with other experts including actuaries, they should also weigh these issues when appealing a determination of withdrawal liability.

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.

Federal Spending Bill Brings Multiemployer Pension Changes in Through the Back Door

It never seems to fail -- Congress needs a way to spend money or make a bill budget-neutral and pensions are the ugly stepsister. I expressed my opinion on this just last month. So, what did they do this time? Our legislators appear to have found a different stepsister this time in multiemployer pensions. I'll talk more about what happened later, but first I'll provide some background for people who aren't as familiar with multiemployer plans. For those who like names, the new law is known as the Multiemployer Pension Plan Reform Act of 2014 (MEPPRA, until someone gives me a better name).

Multiemployer pension plans were authorized by the Taft-Hartley Act. In such an arrangement often found in industries where individuals may perform jobs for a variety of different employers (construction, trucking, mining, etc), employers contribute a negotiated amount of money per unit (hour worked, mile driven, etc) of work. Unlike single-employer plans, multiemployer plans are run by a group of trustees evenly balanced among collective bargaining units or unions and management. Benefit levels are theoretically set when the trustees determine that the plan's assets are sufficient to support an increase. And, once employers choose to participate in a multiemployer plan through the collective bargaining process, it may be difficult to exit as withdrawing sponsors are subject to significant payments known as withdrawal liability.

The first really significant changes to multiemployer rules came into being with the Multiemployer Pension Plan Amendments Act in 1980. The rules were largely unchanged until our legislators saw fit to treat well funded multiemployer plans differently from more poorly funded plans in the Pension Protection Act of 2006 (PPA). PPA introduced the colored zones dependent theoretically on a plan's level of danger of not being able to support its own benefit promises.

So, what does MEPPRA do and what level of concern should participating employers have? As is often the case these days, one of the primary purposes of MEPPRA is to protect the Pension Benefit Guaranty Corporation (PBGC), the governmental agency that protects private pension benefits.

One of the most important tenets of ERISA-covered pension plans has been that benefits accrued by a participant cannot be reduced by plan amendment. This has long been one of the sacred cows of defined benefit plans (DB). Under MEPPRA, certain very poorly funded plans may be able to reduce accrued benefits of participants including those who are already retired and are receiving benefits. Such reductions are subject to a "rejection vote" by plan participants (active and no longer active), but in the case of "systemically important plans" (those where the PBGC projects it will be on the hook for at least $1 billion), the Treasury Department can override the vote of plan participants.

At the same time, premiums paid to the PBGC on behalf of each plan participant will double next year from $13 per participant to $26, further demonstrating PBGC's influence on our legislators. And, in a move that I think could bring further controversy when the rule is applied, the PBGC will have the ability to "facilitate" mergers of two multiemployer plans in order to improve their aggregate funded status.

Consider that last provision. As an example, let's say that there are two widgetmakes multiemployer pension plans and that the one for workers in states with at least four vowels in the names of those states is poorly funded while the one for workers in more vowel-challenged states is pretty well funded. In an effort to improve the aggregate funding, the PBGC comes in and facilitates a merger of the two plans. As a worker, how would you feel if you were suddenly in a poorly funded plan when you had not been previously. Perhaps the reason is that the people in the other plan have much better benefits than you do. So, the previously responsible management of your plan will be bailing out the less responsible management of the other plan. That might just make you want to say "Hmm" or perhaps something worse.

There are a number of other changes that are highly technical related to funding and to withdrawal liability (the amounts that an employer who chooses to cease participating in the plan must pay in order to get out) calculations, but these are quite complex and far beyond the scope of most readers. And, in case you were wondering, reading about those calculations will not bring chills of excitement.

All that said, what should an employer do to react to the passage of MEPPRA? There is no perfect strategy, but for employers participating in reasonably well funded plans (green zone), there should not be much that is needed. For the remainder (red zone or yellow zone) of plans, however, employers may need to weigh their options. They might consider doing some or all of the following:

• Review all of their collective bargaining agreements that cause them to be participating sponsors of multiemployer plans. Pay particular attention to the size of the plan and the plan's current zone status.
• If withdrawal from the plan is an option, request a withdrawal liability calculation to see how painful that strategy might be.
• Consider the pros and cons of remaining in the plan as part of the company's overall risk management strategy.
• Consider engaging an independent actuary (not affiliated with the plan's actuary) to assist with any strategy decisions. To the extent that the company is contemplating a strategy that could potentially inflame relations with one or more unions, it could make sense to engage this actuary through counsel.

Stay tuned. I'm sure it won't be long before pensions get to be an ugly stepsister once again.

Ruling Affects ERISA Compliance Issues for Private Equity Funds

Just last week, the First Circuit Court of Appeals ruled in New England Teamsters v. Scott Brass Holding Corp. So, what's the big deal and why am I writing about it here? Well, Scott Brass Inc. was wholly owned by a combination of Sun Capital Partners III and Sun Capital Partners IV, a pair of private equity funds under the Sun Capital Partners umbrella. Scott Brass participated in the New England Teamsters & Trucking Industry Pension Fund. When Scott Brass went into bankruptcy protection, it was assessed a withdrawal liability.

The District Court accepted the argument of Sun Capital Partners that their funds were not "trades or businesses" and were therefore not liable for withdrawal liability payments. But, the Appeals Court held that the Sun funds invested in Scott Brass "with the principal purpose of making profit." Further, although Sun argued that it had no employees, the Court noted that the partners of the Sun funds had and exercised the authority to hire, fire, and compensate employees of Scott Brass. Additionally, partners of the Sun funds were "actively involved in management and operation" of the company.

The implications of this ruling are potentially far more significant than just this withdrawal liability case. Diligent readers (I certainly hope I have a few) may recall that nearly two years ago, I wrote on retirement compliance issues for private equity funds. At least a few readers wrote to me to tell me that private equity funds were exempt because they were not, in fact, businesses.

Pshaw!

While I am not an attorney and am therefore not technically qualified to opine on what the Appeals Court said, I can read. This seems to make clear to me that at least in the states of Maine, Massachusetts, New Hampshire, and Rhode Island as well as the Commonwealth of Puerto Rico, private equity funds can be businesses. Since there primary purpose generally is to make a profit and since they tend to exercise some management authority over the companies in their portfolios, it strikes me that this ruling can be construed to make them (where they have 80% common ownership) a controlled group of companies.

So, private equity funds beware. This means that:

• you and your partners might be jointly and severally liable for funding of qualified retirement plans in the controlled group
• all those retirement plans in the controlled group are subject to the nondiscrimination, coverage and minimum participation rules of ERISA and the Internal Revenue Code
• we could say the same about welfare benefit plans and their nondiscrimination requirements

Of course, there are other requirements and pitfalls, but I thought it worth it to point out a few. The effect here could be significant. How many companies that are owned by private equity funds, for example, do their nondiscrimination testing on a controlled group? Or, conversely, how many do not? 

Somebody out there is going to latch onto this and stir up some trouble. The question to me is will other circuits follow the first?