Saturday, August 17, 2013

Federal Appeals Panel Rules Private Equity Fund Not Passive Investor in Bankrupt Company

A First Circuit panel ruled that a private equity fund was not a passive investor in, but sufficiently operated, managed, and was advantaged by its relationship with, a company that went bankrupt. The fund’s controlling stake in the company placed it in a position where it was intimately involved in the management and operation of the company. The case presented important issues of first impression as to withdrawal liability for the pro rata share of unfunded vested benefits to a multiemployer pension fund of a bankrupt company. (Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Industry Pension Fund, CA-1, No. 12-2312, July 24, 2013).

The fund argued that it cannot be a trade or business within the meaning of ERISA because that would be inconsistent with two Supreme Court decisions, Higgins v. Commissioner of Internal Revenue, 312 U.S. 212 (1941), and Whipple v. Commissioner of Internal Revenue, 373 U.S. 193 (1963) which interpreted that phrase. The fund contended that cases interpreting the phrase "trade or business" as used anywhere in the Internal Revenue Code are binding because Congress intended for that phrase to be a term of art with a consistent meaning across uses. But the appeals court rejected the proposition that, apart from the provisions covered by 26 U.S.C. § 414(c), interpretations of other provisions of the Internal Revenue Code are determinative of the issue of whether an entity is a "trade or business" under ERISA. The panel cited a Third Circuit opinion explaining that a term used for tax purposes does not have to have the same meaning for purposes of a pension fund plan.

The fund also made a policy argument that Congress never intended such a result in the control group provision in ERISA because the purpose of that provision is to prevent an employer from circumventing ERISA obligations by divvying up its business operations into separate entities. It is not, said the fund, intended to reach owners of a business so as to require them to dig into their own pockets to pay withdrawal liability for a company they own.

These are fine lines, remarked the court, adding that the various arrangements and entities meant precisely to shield the fund from liability may be viewed as an attempt to divvy up operations to avoid ERISA obligations. The panel recognized that Congress may wish to encourage investment in distressed companies by curtailing the risk to investors in such employers of acquiring ERISA withdrawal liability. If so, however, Congress has not been explicit, and it may prefer instead to rely on the usual pricing mechanism in the private market for assumption of risk.