In June, the US Department of Labor issued an information letter indicating that it will allow defined contribution retirement plans (such as 401(k) plans) to indirectly invest in private equity funds. While information letters are not binding, this new guidance creates a significant opportunity for plan sponsors to consider investment options that include private equity funds. However, it will be important for both plan sponsors and funds to carefully evaluate potential investments for compliance with fiduciary requirements.
On February 28, Todd Solomon and Maureen O’Brien presented a Strafford live webinar, “Private Equity Compliance With ERISA: Navigating Manager Fiduciary Duties for Funds Holding ERISA Plan Assets”. ERISA imposes fiduciary obligations on funds that hold employee benefit plan assets, including private equity managers responsible for investing fund assets. Managing those fiduciary obligations requires knowledge of the ERISA plan asset requirements. In addition, last year’s Sun Capital decision has broad implications for private equity funds and their investors. The ruling subjects funds to joint and several liabilities for the ERISA pension obligations of their portfolio companies. These slides discuss the ERISA fiduciary issues relevant to private equity funds and the implications of the most recent Sun Capital case.
Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund has been analyzed extensively over the past four years, as it has made its way from the US District Court for the District of Massachusetts to the First Circuit Court of Appeals and back again. With the case once again on appeal, we must wait to see how the latest court decision will further influence the structure of private equity deals. In the meantime, private equity funds should use the most recent District Court and First Circuit Sun Capital decisions as a road map for structuring deals where the target portfolio company has defined benefit pension plan or multiemployer pension plan liabilities.
Legal review of employee benefit plan issues represents a key opportunity for private equity funds to protect and enhance the value of their investments. Below are some important considerations to bear in mind when structuring and negotiating transactions.
Potential Areas of Non-Compliance
Dealing with historical benefit plan non-compliance can be costly and distracting to a new management team. An effective review of a target company’s employee benefit plans can foster a successful execution of a fund’s business plan by reducing ongoing risks, saving costs, helping to ensure a smooth transition for employees, and better positioning portfolio companies for future add-on acquisitions and the private equity fund’s eventual exit.
Potential Areas of Joint and Several Liability
Certain employee benefit plans carry unfunded liabilities that are joint and several liabilities of the sponsoring employee or participating employer and each member of that employer’s “controlled group.” The controlled group generally consists of all entities, whether or not incorporated, that are connected through common ownership of 80 percent or more by vote or value. Under some theories, the entire private equity fund and its portfolio companies may be deemed to be part of the controlled group and thus jointly and severally liable for such liabilities.
Single-Employer Plans Single-employer defined benefit pension plans often carry significant unfunded termination liabilities that can adversely affect the plan sponsor’s balance sheet. Private equity funds should be cautious of rules that impose joint and several liabilities for unfunded termination liabilities and annual minimum funding contributions among members of the controlled group.
Multi-Employer Plans A private equity fund acquiring a direct or indirect interest in 80 percent or more of the target may be liable for any withdrawal liability or missed contributions. Many U.S. multi-employer defined benefit pension plans assess significant liabilities against employers that cease participation in such plans (referred to as “withdrawal liability”). A key consideration for multi-employer plans is identifying and managing potential (and often significant) withdrawal liabilities in due diligence. In addition, multi-employer defined benefit pension plan liabilities can be deemed to be joint and several liabilities of the entire controlled group. Further, in an asset transaction, withdrawal liability is automatically triggered and assessed on the seller and its controlled group. Private equity buyers should be aware that sellers sometimes may seek to shift such burdens to the buyer in the purchase agreement.
Positioning for the Future – Structuring the Post-Acquisition Entity
The definitive purchase agreement should contain provisions to manage the benefit plan obligations of the private equity fund and its target. After closing, acquisition targets typically must establish and administer new employee benefit plans. This is particularly relevant in carve-out scenarios where the target had been participating in the employee benefit plans of a much larger parent company. Proper documentation and corporate governance is key to ensuring compliance with relevant rules and regulations. In particular, sellers often seek to require that buyers replicate current employee benefit plans at the seller. However, a replication of such plans may [...]
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