Compensation and Benefits Insights – April 2016

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Private Equity Funds Found Liable for Portfolio Company’s ERISA Withdrawal Liability

Authors, Kenneth A. Raskin, New York, +1 212 556 2162, kraskin@kslaw.com and Ryan Gorman, Atlanta, +1 404 572 4609, rgorman@kslaw.com

The most recent ruling in the ongoing Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund case may have a significant impact on a ubiquitous investment structure utilized by private equity funds, resulting in separate private equity funds being jointly and severally liable for multiemployer pension plan liabilities assessed against their portfolio company. While the surprising ruling is likely to be appealed, the U.S. District Court of Massachusetts’s disregard of corporate formalities should put investors in, and managers of, private equity funds on the lookout for further developments that could expand controlled group liabilities.

Background

Under the Employee Retirement Income Security Act of 1974 (“ERISA”), employers are jointly and severally liable for certain pension plan liabilities, including funding shortfalls under a multiemployer pension plan, with each "trade or business" under common control with the contributing or sponsoring employer.

In this case, Sun Capital Advisors, Inc. (“Sun Capital”) sponsored two private equity funds, Sun Capital Partners III, LP and Sun Capital Partners IV, LP (Fund III and Fund IV, the “Funds”) which were invested in various Sun Capital portfolio companies. In 2007, the Funds acquired Scott Brass, Inc., a manufacturing company, through two subsidiaries, including Sun Scott Brass, LLC (“Scott Brass”). After a few years of poor business performance, Scott Brass stopped contributing to the New England Teamsters and Trucking Industry Pension Fund, a multiemployer pension plan (the "Pension Plan") and declared bankruptcy in 2008. The Pension Plan demanded that Scott Brass pay $4.5 million in withdrawal liability, which represented its portion of unfunded vested benefits in the Pension Plan, and asserted that the Funds were jointly and severally liable for the withdrawal liability because they were each a “trade or business” under common control with Scott Brass.

In a 2013 ruling in this case previously discussed by King & Spalding here, the US Court of Appeals for the First Circuit held that a private equity fund can be a “trade or business” for purposes of ERISA’s controlled group rules if the fund is more than a passive investor. This “investment plus” standard was applied to Fund IV, as it had an active role in the management of Scott Brass, including hiring, firing and compensation-related decisions. Accordingly, the Appeals Court held that Fund IV, which owned 70% of Scott Brass, was conclusively a “trade or business” for purposes of controlled group liability. The Appeals Court held that further factual analysis was necessary to determine whether Fund III, which owned 30% of Scott Brass, was similarly a “trade or business” and whether the Funds were under common control with Scott Brass. Accordingly, the case was remanded to the US District Court for analysis of these issues.

Sun Funds are “Trades or Businesses” and constituted a “Partnership-in-Fact” with more than 80% ownership of Scott Brass

In its ruling on March 28, 2016, the US District Court for Massachusetts made two findings with regard to the Funds: (1) the Funds should be considered “trades or businesses” under the “investment plus” standard and (2) the Funds’ combined ownership of Scott Brass created a “partnership-in-fact” which owned more than 80% of Scott Brass. As a result, each Fund was held to be jointly and severally liable for the withdrawal liability incurred by Scott Brass.

Reiterating the analysis of the Appeals Court, the District Court found that the Funds were each a “trade or business” based on their active involvement in the management, supervision and operation of Scott Brass. The District Court reserved a notable portion of its analysis to the effect that “offsets” in management fees had in determining whether the Funds were a “trade or business.” The Funds received an offset against (i.e., a reduction in) the management fees they owed to their general partner equal to the management fees paid to their general partner’s wholly owned management company by Scott Brass for the management services that the management company provided to Scott Brass. According to the District Court, these offsets constituted an economic benefit to each of the Funds, which supported the argument that the Funds were each a “trade or business.” The District Court made this holding regardless of whether the offsets were utilized each year or carried forward as permitted under each Fund’s operating agreement.

Additionally, and quite notably, the District Court chose to disregard the corporate formalities of the Funds. In other words, despite the fact that neither Fund III nor Fund IV owned 80 % or more of Scott Brass, the economic realities of the investment in and management of Scott Brass created a “partnership-in-fact” between the Funds. As a result, the District Court held that the de facto partnership could itself be a “trade or business” under common control with Scott Brass, and thus jointly and severally liable for the withdrawal liability. In support of this decision, the District Court noted that the Funds, as partners in Scott Brass, intended to (and did in fact) manage the business and share in the profits and losses of Scott Brass together, as evidenced by the Funds’ respective partnership agreements, their relationship with one another, and conduct in managing the affairs of Scott Brass. The District Court made this holding despite the fact that it acknowledged that the Funds maintained separate financial statements and reports to their general partners, separate bank accounts, had mostly non-overlapping limited partners and mostly non-overlapping portfolio companies within each Fund. In the end, the District Court held that since the Funds coordinated with one another, invested jointly (e.g., co-investing in five other companies using the same organizational structure) and chose a 70/30 ownership split to avoid withdrawal liability, a partnership-in-fact was deemed to be created.

Key takeaways for private equity funds

The District Court’s latest decision in the Sun Capital case is contrary to the industry-wide assumption that private equity funds are sheltered from withdrawal liability due to the fact that they are not “trades or businesses.” While this decision may be appealed, and has limited applicability outside of the First Circuit (Massachusetts, Maine, New Hampshire, Rhode Island and Puerto Rico), private equity funds must heed the warning regarding co-investments by entities that, under traditional controlled group rules, are unrelated.

Despite the fact that the “partnership-in-fact” analysis in the Sun Capital case was limited to multiemployer plan withdrawal liability, if this holding was applied to other areas where controlled group rules are relevant (e.g., single employer defined benefit plan underfunding, Affordable Care Act compliance, qualified retirement plan nondiscrimination and coverage testing, compensation deduction limits under Code Section 162(m)(6)), it would have a significant impact. 

Given the prevalence of this co-investment structure in the private equity industry, funds should be particularly cautious of the following factors which could expose them to controlled group liability, such as withdrawal liability:

  • The existence of management fee offset arrangements;
     
  • A lack of meaningful independence in relevant co-investments;
     
  • Actively and jointly managing and operating a portfolio company;
     
  • A history of co-investing in many companies using the same organizational structure;
     
  • The level of overlap of limited partners, governance and co-invested portfolio companies; and
     
  • Keeping ownership interests below 80% with a specific intent to avoid controlled group liability.

If similar jurisdictions follow the lead of the Sun Capital case, relying on a less than 80% ownership threshold may no longer be sufficient to shield co-investors from significant liability. One potential solution could be to utilize a completely unrelated third party investor with a different investment strategy than the other investing funds with an ownership stake of at least 21%. This approach would likely avoid any determination of a “partnership in fact” with more than 80% ownership, thus avoiding withdrawal liability. Additionally, private equity funds should seek to obtain complete indemnities from sellers in the event a fund incurs withdrawal liability.

King & Spalding will continue to monitor developments in the Sun Capital case and similar cases that may arise in other jurisdictions.

Department of Labor Updates Fiduciary Guidance Regarding “Social Investing”

Author, Mark Kelly, Atlanta, +1 404 572 2755, mkelly@kslaw.com

The Department of Labor (DOL) has issued Interpretive Bulletin 2015-01 (IB 2015-01) to provide new fiduciary guidance regarding “social investing”, including economically targeted investments (ETI) and the extent to which fiduciaries may consider environmental, social and governance (ESG) factors in making plan investment choices.

Background

For years, fiduciaries have questioned whether and to what extent they could consider an investment’s collateral economic or social benefits in addition to such investment’s applicable risk and return profile.  In the preamble to DOL Interpretive Bulletin 94-1 (IB 94-1), the DOL stated that sections 403 and 404 of ERISA do not prevent plan fiduciaries from investing plan assets in ETIs as long as the investment is appropriate for the plan and has an expected rate of return that is commensurate with the rate of return of alternative investments with similar risk characteristics.  Under this “all things being equal” standard, collateral economic or social benefits could be a tiebreaker when choosing among investments with otherwise equal risks and returns. However, a fiduciary could not accept lower expected returns or take on greater risks in order to secure collateral benefits.

In 2008, the DOL replaced IB 94-1 with Interpretive Bulletin 2008-01 (IB 2008-1). While the 2008 guidance reiterated the “all things being equal” standard, it also indicated that a fiduciary’s consideration of collateral, non-economic factors in selecting plan investments should be rare and, when considered, should be documented in a manner that demonstrates compliance with ERISA’s rigorous fiduciary standards.

In the new guidance, the DOL acknowledges that in the seven years since IB 2008-01 was published, fiduciaries have been unduly discouraged from considering ETIs and ESG factors. In particular, the DOL noted that IB 2008-1 may have dissuaded fiduciaries from (1) pursuing investment strategies that consider ESG factors, even where they are used solely to evaluate the economic benefits of investments and identify economically superior investments, and (2) investing in ETIs even where economically equivalent.

Overview of Interpretive Bulletin 2015-01

In an effort to correct the misperceptions caused by IB 2008-1, the DOL has withdrawn the 2008 guidance and replaced it with IB 2015-01.  IB 2015-01 confirms the “all things being equal” standard originally stated in IB 94-1. Thus, plans may invest in ETIs that provide collateral benefits so long as the investment is appropriate for the plan, and is economically and financially equivalent to competing investment choices  based on the investment objectives, return, risk and other financial attributes.

The preamble to the 2015 guidance also acknowledges that in some cases ESG factors may have a direct relationship to the economic and financial value of the plan’s investment. In such instances, the ESG issues are not merely collateral considerations or tie-breakers, but rather should be considered as part of the fiduciary’s primary investment analysis. Thus, when a fiduciary prudently concludes that such an investment is justified based solely on the economic merits of the investment, there is no need to evaluate collateral goals as tie-breakers.

In addition, the 2015 guidance makes it clear that ERISA does not prohibit a fiduciary from addressing ETIs or incorporating ESG factors in the plan’s investment policy statement, or using ESG-related tools, metrics and analyses to evaluate an investment or to choose among otherwise equivalent investments. Nor does ERISA prevent a fiduciary from considering whether and how potential investment managers consider ETIs or use ESG criteria in their investment practices, provided that the investment manager’s practices are consistent with ERISA and the principles of IB 2015-01.

Finally, a fiduciary does not need to treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration ESG factors, and no special documentation is required for such investments. As with any investment, the appropriate level of documentation to demonstrate compliance with ERISA’s fiduciary responsibility provisions depends on the facts and circumstances.

May and June 2016 Filing and Notice Deadlines for Qualified Retirement and Health and Welfare Plans

Author, Ryan Gorman, Atlanta, +1 404 572 4609, rgorman@kslaw.com

Employers and plan sponsors must comply with numerous filing and notice deadlines for their retirement and health and welfare plans. Failure to comply with these deadlines can result in costly penalties.  To avoid such penalties, employers should remain informed with respect to the filing and notice deadlines associated with their plans.

The filing and notice deadline table below provides key filing and notice deadlines common to calendar year plans for the next two months. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is generally delayed until the next business day.  Please note that the deadlines will generally be different if your plan year is not the calendar year. Please also note that the table is not a complete list of all applicable filing and notice deadlines (including any available exceptions and/or extensions), just the most common ones. King & Spalding is happy to assist you with any questions you may have regarding compliance with the filing and notice requirements for your employee benefit plans. 


Deadline

Item

Action

Affected Plans

May 14
(within 45 days after the close of the first quarter of  plan year)

Benefit Statements for Participant-Directed Plans

Deadline for plan administrator to send benefit statement for the first quarter of the plan year to participants in participant-directed defined contribution plans.

 

Defined Contribution Plans that allow participants to direct investments

Quarterly Fee Disclosure

Deadline for plan administrator to disclose fees and administrative expenses deducted from participant accounts during the first quarter of the plan year. Note that the quarterly fee disclosure may be included in the quarterly benefit statement or as a stand-alone document.

May 15
(the 15th day of the 5th month after the end of the plan year)

IRS Forms 990 and 990-EZ

Deadline for tax-exempt trusts associated with qualified retirement plans and voluntary employee beneficiary associations (VEBAs) to file Forms 990 or 990-EZ with the IRS for prior year. A 3-month extension may be obtained by filing a Form 8868, which must be filed by this date.

 

Qualified Retirement Plans*

Voluntary Employee Beneficiary Associations

May 31 (if filing paper forms)

IRS Form 1094-B Transmittal Forms

Deadline for providers of minimum essential coverage to transmit forms to IRS reporting the months during the year that individuals enrolled in the group health plan satisfied the individual mandate by enrolling in minimum essential coverage. This deadline was extended from its original deadline of February 29.

Self-Insured Group Health Plans and Group Health Plan Insurers

IRS Form 1094-C Transmittal Forms

Deadline for plan sponsors that employed an average of at least 50 full-time employees  in 2015 (also known as “Applicable Large Employers” or “ALEs”) to transmit forms to IRS reporting whether the ALEs offered an opportunity to enroll in (and whether employees did enroll in) minimum essential coverage under the ALE’s sponsored plan. This deadline was extended from its original deadline of February 29.

Applicable Large Employers

June 30
(last day of 6th month following the plan year)

Excess Contributions

Deadline for plan administrator to distribute eligible automatic contribution arrangements (EACA) excess contributions and earnings from the prior year to avoid 10% excise tax.

 

401(k) Plans with EACA

June 30
(if filing electronically)

IRS Form 1094-B Transmittal Forms

Deadline for providers of minimum essential coverage to transmit forms electronically to IRS reporting the months during the year that individuals enrolled in the group health plan satisfied the individual mandate by enrolling in minimum essential coverage. This deadline was extended from its original deadline of March 31.

Self-Insured Group Health Plans and Group Health Plan Insurers

IRS Form 1094-C Transmittal Forms

Deadline for ALEs to transmit forms to IRS electronically reporting whether the ALEs offered an opportunity to enroll in (and whether employees did enroll in) minimum essential coverage under the ALE’s sponsored plan. This deadline was extended from its original deadline of March 31.

Applicable Large Employers

* Qualified Retirement Plans include all defined benefit and defined contribution plans that are intended to satisfy Internal Revenue Code §401(a).          

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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