Court Says Private Equity Funds Are Liable For Pension Liabilities of Portfolio Company

If you open a box and a dog pops out, your enthusiasm will be curbed if you were expecting something else. Surely this is how several private equity funds must feel now about one of their investments. According to "Private Equity Funds Liable to Union Pension Plan" by Jacklyn Wille (Pension & Benefits Daily, March 30, 2016), a federal judge recently ruled that several Sun Capital funds are "jointly liable for more than $4.5 million in withdrawal liability" that one of its portfolio companies, Scott Brass, "owed to a Teamsters pension fund." (You can visit Bloomberg Law to read the March 28, 2016 decision by clicking here.)

I will defer to attorneys to address the legal issues. So far, I found two commentaries on the heels of this 2016 legal decision. See "District Court Concludes Private Equity Fund Is Liable for Pension Obligations of the Portfolio Company" (Fried Frank Harris Shriver & Jacobson LLP, March 30, 2016) and "Private Equity Funds Held Liable for Pension Liabilities of a Portfolio Company" (Sullivan & Cromwell, March 31, 2016).

From my perspective as an economist, any surprise claim on future cash flows could be disastrous if it is large enough to jeopardize the ongoing viability of a business. Even if a business has sufficient resources to maintain itself as an ongoing concern, utilizing cash for something that was not planned for could lead to a lower growth rate than originally expected. Keep in mind that pension funds, endowments and foundations frequently allocate monies to private equity on the basis of expected returns for this asset class.

Projecting cash flows as part of due diligence is nothing new for many investors. That said, I am not convinced that all enterprise investigations fully address the impact of an underfunded defined benefit plan. I was recently contacted by a firm that was tasked to render a fairness opinion and wanted my views about pension math. The investment bankers were reviewing documents from bidders that radically differed with regard to the treatment of the target company's benefit plan burden. When I was asked to speak and also write about pensions and enterprise value, the invitation came from a senior valuation executive who felt that the topic was not being adequately addressed. See "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" by Dr. Susan Mangiero (Business Valuation Update, July 2013). Email me if you would like a copy of my 2013 slides about this topic.

In 2013, when this Sun Capital case originally made its way to the court, it struck me as an important issue. (I was not involved in this matter as an expert.) Several editors agreed and I ended up co-writing two articles with Groom Law Group partner David Levine. I've uploaded one of these articles to this pension blog. Click here to read "Private Equity Funds and Pension Plans: A Changing Dynamic" (CFA Institute Magazine, March/April 2014). At my request, Attorney Levine responded to this 2016 decision by emailing the following: "In short, while some private equity firms have already moved to evaluate and, in some cases, clarify their fund structures, this case is likely to lead to a second look at their structures and methods of involvement with their portfolio companies."

If certain limited partners are not already asking questions of their private equity fund general partners about the nature of portfolio company pension plans, controlling interest status and deal structure, their due diligence could quickly change in the aftermath of the 2016 Sun Capital litigation.

Interested persons can click on the links provided below to read earlier blog posts about this topic:

Union Plans and Politics

Since I created this pension blog over nine years ago, I have been surprised and puzzled as to why retirement plan issues have been given short shrift by politicians. I understand that rescinding benefits is likely to lose votes but there comes a time when reality intrudes and it becomes impossible to ignore that the emperor has no clothes.

With the passage of the Multiemployer Pension Reform Act of 2014, the tide appears to be slowly turning. Lawmakers worked with union plan trustees to craft an arrangement that allows for a reduction of pension benefits as a way to avoid disaster. According to "Congress passes major change to law on union pensions," the executive director of the National Coordinating Committee for Multiemployer Plans ("NCCMP") praised the new legislation as a "tourniquet on a gigantic gaping wound." A quick look at the U.S. Department of Labor website reveals a large number of multiemployer pension plans that are considered "critical" or "endangered." In its February 2015 assessment of "high-risk areas," the U.S. Government Accountability Office listed the Pension Benefit Guaranty Corporation ("PBGC") as having an "uncertain" future. Although it has one of the biggest federal portfolios in excess of $89 billion, "exposure to future losses for underfunded plans" is $184 billion with "the deficit in the multiemployer program, composed of about 1,400 plans" showing a rise of more than four hundred percent. In contrast, single-employe programs covered by the PBGC had improved although "still accounted for $19.3 billion of PBGC's overall deficit."

Despite an urging from U.S. presidential candidate Bernie Sanders (I-Vermont) to repeal the Multiemployer Pension Reform Act of 2004, at least one union plan is forging ahead to cut benefits. See "Teamsters plan moves to cut retiree benefits(Benefits Pro, April 10, 2015).

Let's see how the campaigns unfold in the months leading up to the 2016 elections. How will candidates tackle union pensions as well as public retirement plan economics, Social Security, Medicare and corporate retirement plans with gaps in their funding?