Few areas of law are as confusing—or as important to understand—as the growing
intersection of employment and bankruptcy law. In recent years, funding shortfalls
in multi-employer pension plans, which cover roughly 20 percent of U.S. workers
with defined-benefit plans, have increased pressure on participating employers
to reduce their contributions or even withdraw entirely. Although employers taking
these actions would incur withdrawal liability as a consequence, that liability can
likely be discharged in bankruptcy. As a result, multi-employer pension plans have
been forced to look elsewhere to collect on their withdrawal-liability claims against
In a case of first impression, the First Circuit Court of Appeals considered one such
attempt by a multi-employer pension plan (“MEPP”) to collect withdrawal liability
from a private equity fund sponsor of a bankrupt debtor. In Sun Capital Partners III,
LP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir.
2013), the First Circuit held that the private equity fund in that case was a “trade or
business” which could be held jointly and severally liable for the withdrawal liability
incurred by one of its portfolio companies. As disturbing as the decision is for the
IN THIS ISSUE
1 The First Circuit Fires a Shot Across
the Bow of Private Equity Funds:
Too Much Control of Portfolio
Companies May Lead to Pension
Plan Withdrawal Liability
5 First Impressions: Commercial
Leases May Be Assumed Within 210-
Day Deadline and Assigned Later
9 Chapter 15 Recognition Mandatory
and Fully Encumbered Assets Are
“Property of the Debtor” Protected
by Automatic Stay
13 Stockbroker Defense Shields
Ponzi-Scheme Broker Fees and
Commissions From Avoidance
16 In Brief: Another Blow to Triangular
Setoff in Bankruptcy
18 In Brief: Claims Trader Alert
19 European Perspective in Brief
20 Sovereign Debt Update
private equity industry, and especially for those funds that
suddenly find themselves with far greater exposure than they
originally anticipated, the case may also offer opportunities
for savvy investors who are willing to develop the legal structures
that can reduce their exposure to withdrawal liability
should their investments in companies with MEPPs fail.
MULTI-EMPLOYER PENSION PLANS AND CONTROL-GROUP
MEPPs are so named because more than one employer
makes contributions to the plans, which are then used to provide
benefits to all the participating businesses’ employees
upon retirement. Prior to 1980, an employer could cease making
payments to, or “withdraw” from, a MEPP and would be
liable only if the plan later became insolvent. Unfortunately,
this created a perverse incentive for employers to withdraw
as quickly as possible at the first sign of a MEPP’s distress,
or risk being left as the sole remaining contributor to fund all
the benefits on its own. To ameliorate this problem, Congress
amended the Employee Retirement Income Security Act
of 1974 (“ERISA”), 29 U.S.C. §§ 1001 et seq., in 1980 to create
withdrawal liability. In principle, under the amended ERISA,
employers that cease contributing to a MEPP are obligated
to pay their fair share of any unfunded liabilities.
At the same time, Congress also added a series of provisions
to enhance the collectability of the new withdrawal liability.
Among other things, the 1980 amendments made “trade[s] or
business[es]” that are under “common control”—which has
since been defined by regulation to mean 80 percent common
ownership—jointly and severally liable for each other’s
withdrawal liability. 29 U.S.C. § 1301(b)(1). In addition, withdrawal
liability must be assessed “without regard” to any
transaction whose “principal purpose” is to “evade or avoid”
withdrawal liability. 29 U.S.C. § 1392(c).
Despite the 1980 ERISA amendments, MEPPs in the U.S.
have not been fully funded in the aggregate since 2000,
and the funding shortfalls are getting worse. See U.S.
Gov’t Accountability Office, GAO-1 1-79, Changes Needed
to Better Protect Multiemployer Pension Benefits (2010).
Between 2008 and 2009, for example, the proportion of
MEPPs reported to be in “endangered” or “critical” status
nearly tripled from 23 percent to 68 percent. According to a
2009 study by Moody’s Investors Service, the nation’s largest
MEPPs are underfunded by approximately $165 billion,
with the number expected to continue rising. See Wesley
Smyth, Growing Multiemployer Pension Funding Shortfall
is an Increasing Credit Concern, Moody’s Global Corporate
Finance, Special Comment (Moody’s Investors Serv.), Sept.
2009. The impact on participating employers is believed to
be severe enough to influence their ability to attract investors
and financing. See id.; David Zion, Amit Varshney, and
Nichole Burnap, Crawling Out of the Shadows: Shining a Light
on Multiemployer Pension Plans, Credit Suisse, Mar. 26, 2012.
Sun Capital represents a loss for private equity
funds that currently own or regularly invest in companies
with pension liabilities. Private equity funds
must actively consider the decision’s impact on
their current and potential investments. In particular,
funds should promptly reassess their potential
exposure to the withdrawal liability of their portfolio
companies, as that liability can arise suddenly and
in devastating amounts, sometimes exceeding even
the original acquisition price.
Sun Capital Advisors, Inc. (“Sun Capital”), like most private
equity firms, creates funds in which investors may pool their
capital. The firm then finds underperforming companies
for the funds to acquire, with the expectation that the businesses
can be resold for a profit in two to five years. In most
cases, the funds have no employees or offices, but the general
partner of each fund (a Sun Capital affiliate) owns a Sun
Capital management company that provides managerial
and consulting services in exchange for fees from both the
funds and the portfolio companies. As is common in the
industry, when the portfolio companies pay these fees, the
funds receive an offset against what they owe to the management
company. See Sun Capital, 724 F.3d at 134–35.
In 2006, two Sun Capital funds—Sun Capital III and Sun
Capital IV—acquired 30 percent and 70 percent stakes,
respectively, in Scott Brass, Inc. (“Scott Brass”), a brass and
copper manufacturer, for the aggregate amount of $3 million.
Although Scott Brass was, at the time of the acquisition,
still current on payments owed to its MEPP, the New England
Teamsters and Trucking Industry Pension Fund (“NETTI”), Sun
Capital had reduced its purchase price by 25 percent due to
concerns about the company’s unfunded pension liabilities.
In the fall of 2008, following a collapse in the price of copper,
Scott Brass breached its loan covenants and was unable
to obtain sufficient credit to stay in business. The company
stopped making pension contributions in October 2008, and
an involuntary-bankruptcy petition was filed against the company
the following month in Rhode Island.
In December 2008, NETTI demanded that Scott Brass
pay more than $4.5 million in withdrawal liability and also
demanded payment from the two Sun Capital funds. The
funds sued NETTI in district court, seeking a declaratory
judgment that they were not jointly and severally liable for
the withdrawal liability. NETTI disputed the funds’ position
and filed a counterclaim alleging that the funds had sought
to “evade or avoid” withdrawal liability in violation of 29 U.S.C.
§ 1392(c) by structuring their purchase of Scott Brass to keep
any single fund from holding an 80 percent controlling stake.
Four months later, the district court granted summary judgment
in favor of the funds on both issues. The court reasoned
that, since the funds were “passive” and had no employees
or offices, neither was a “trade or business” under 29 U.S.C. §
1301(b)(1). Moreover, the court held, the funds did not “evade
or avoid” withdrawal liability because, at the time of the purchase,
the liability was merely “a prospective, uncertain
future risk.” See Sun Capital Partners III, LP v. New England
Teamsters & Trucking Indus. Pension Fund, 903 F. Supp. 2d
107, 124 (D. Mass. 2012). NETTI appealed to the First Circuit.
THE FIRST CIRCUIT’S RULING
A three-judge panel reversed the district court’s decision
on the “trade or business” prong of 29 U.S.C. § 1301(b)(1), but
affirmed the lower court’s holding that the “evade or avoid”
provisions of 29 U.S.C. § 1392(c) did not apply. The panel then
remanded the case to the district court to determine whether
the second prong of the test for imposing joint and several
liability under 29 U.S.C. § 1301(b)(1)—i.e., “common control”—
had been met.
The First Circuit began by noting that the phrase “trade
or business” in 29 U.S.C. § 1301(b)(1) is not defined in U.S.
Treasury regulations and has not been given a “definitive,
uniform definition” by the U.S. Supreme Court. Moreover,
the court reasoned, Supreme Court precedent regarding
the same term’s meaning for tax purposes would have little
relevance to the ERISA context (citing Comm’r of Internal
Revenue v. Groetzinger, 480 U.S. 23, 27 (1987)). Therefore,
the only relevant guidance available for the court was an
unpublished 2007 letter from the Pension Benefit Guaranty
Corporation (the “PBGC”), in which the PBGC informally adjudicated
a dispute between a pension plan and a private
equity fund. There, the PBGC applied an “investment plus”
standard, under which a private equity fund is considered a
trade or business if it: (i) has engaged in an activity with the
primary purpose of income or profit; and (ii) has conducted
that activity with continuity and regularity.
After reviewing the PBGC letter, the First Circuit panel concluded
that “some form of an ‘investment plus’ approach is
appropriate,” although it expressly declined to establish any
guidelines for what “plus” might entail. Undertaking a “very
fact-specific approach,” the court emphasized the following
facts in the case before it:
• The funds’ limited partnership agreements stated that the
funds would be actively involved in the management of the
• The funds’ general partners had significant management
authority over the funds, including the power to make decisions
about hiring, compensating, or terminating the funds’
• The funds’ private-placement memoranda stated that individuals
who work for the funds’ general partners would
develop and implement restructuring plans for the portfolio
companies and would be involved in “even small details,”
such as signing checks for new portfolio companies and
holding frequent meetings with senior staff.
• The funds’ controlling stake allowed them to appoint two
employees of Sun Capital to Scott Brass’s board of directors—
enough to control the board.
• Sun Capital provided personnel to Scott Brass who
became “immersed in details” involving the company’s
management and operation.
• At least one of the funds, Sun Capital IV, had received an
offset of $186,368.44 against fees it otherwise would have
had to pay to its general partner. This offset would never
have been available to an “ordinary, passive investor” and
therefore could not be construed as an “ordinary investment
activity” flowing solely from investment returns.
According to the First Circuit, the “sum” of all these factors
allowed the “plus” in the “investment plus” test to be
met. “Most significantly,” the court opined, the offset of fees
allowed the funds to “funnel management and consulting
fees” to their general partners, proving that the funds
received income besides dividends and capital gains. In
addition, although the general partners were not the same
corporate entity as the funds, the general partners had acted
as the funds’ agents—after all, the court concluded, the
funds’ entire investment strategy “could only be achieved by
active management through an agent, since the Sun Funds
themselves had no employees.”
The First Circuit then turned to the “evade or avoid” issue.
Twenty-nine U.S.C. § 1392(c) imposes withdrawal liability “without
regard” to any transaction whose principal purpose is to
evade or avoid such liability. According to the court, however,
there was “no way of knowing” what would have occurred if
the allegedly wrongful transaction—i.e., the purchase of Scott
Brass in 30 percent and 70 percent proportions—had been
disregarded. In fact, it was “doubtful” that Sun Capital IV would
have purchased a 100 percent stake. The First Circuit noted
that it was easy to distinguish the case from a scenario in
which an entity with a controlling stake of 80 percent or more
tries to reduce its stake in order to avoid withdrawal liability.
Sun Capital represents a loss for private equity funds that currently
own or regularly invest in companies with pension liabilities.
Private equity funds must actively consider the decision’s
impact on their current and potential investments. In particular,
funds should promptly reassess their potential exposure to the
withdrawal liability of their portfolio companies, as that liability
can arise suddenly and in devastating amounts, sometimes
exceeding even the original acquisition price.
Should a fund discover that it has significant exposure, it may
want to consider making changes to its management structure.
Specifically, although a fund may wish to continue to
collect management fees and participate in the active dayto-
day management of its portfolio companies, there may be
circumstances in which the potential downside of withdrawal
liability simply outweighs the benefits of active management
arrangements. Funds must also be mindful, however, that
the later such changes are made, the greater the risk will be
that a court will find that such changes were implemented to
evade or avoid withdrawal liability under 29 U.S.C. § 1392(c).
Sun Capital also will likely diminish investor interest in distressed
businesses that currently participate in MEPPs. The
increased risk of incurring withdrawal liability may deter the
very investors who offer these companies their best chance
at a successful restructuring. In some cases, private equity
funds may simply wait to acquire a distressed company until
after it has entered bankruptcy, with the goal of purchasing
the business free and clear of any withdrawal liability. Such a
prospect, however, is unavailable to an underperforming, but
solvent, corporation or its employees and pensioners.
It bears noting that, while a private equity fund may now be
considered a “trade or business” for purposes of ERISA in the
First Circuit under Sun Capital, the case does provide some
helpful guidance on how a fund should structure its investment
in its portfolio companies to prevent withdrawal liability
under the “common control” rules. The Sun Capital decision
sets clear precedent that a private equity fund can structure
the purchase of a company that participates in a MEPP in a
manner that does not trigger the “common control” threshold.
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The First Circuit fires a shot across the bow of private equity funds: too much control of portfolio companies may lead to pension plan withdrawal liability
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