The Private Equity Growth Capital Council (PEGCC) has warned that a recent ruling making Sun Capital Partners responsible for one of its bankrupt portfolio companies’ pension liabilities will have a “chilling effect” on private equity investment.
The PEGCC, a trade body for the private equity industry, filed a “friend of the court” brief with the First Circuit US Court of Appeals. In the brief, the group said that exposing private equity funds to portfolio companies’ pension liabilities is “virtually guaranteed to sow confusion in an industry that identifies and assesses risks ex ante, before investing.” PEGCC cited studies that found US multiemployer pension plans are underfunded by an estimated $369 billion, underscoring the industry's perceived amount of pension liability risk following the Sun decision.
“I don’t think the court fully understood the implications of its decision,” said one private equity legal expert closely monitoring the case, who believes the court may decide whether or not to grant Sun Capital’s request for a rehearing in the coming weeks.
I don’t think the court fully understood the implications of its decision
A US appeals court decision issued in July ruled that Sun Capital fit the definition of a “trade or business” due to its significant operational and management involvement in its portfolio company Scott Brass, a metals manufacturer. As a business, the Sun Capital fund was in essence deemed the parent owner of Scott Brass, and thus potentially liable for its pension liabilities under the Employee Retirement Income Security Act.
If deemed a business, GPs “will have a strong incentive to avoid companies with particularly problematic (and large or partially unfunded) pension funds, including traditional manufacturing industries so central to the health of the US economy,” the PEGCC said.
In the Sun Capital case, the court applied an “investment-plus” test that found Sun Capital’s ownership stakes in Scott Brass went above and beyond that of a normal passive investor. The court said it’s test took into account a number of factors, including GP-appointed board members and marketing literature, cautioning that no one factor alone decided its decision.
The PEGCC said the court’s investment-plus test “creates confusion as to what features [GPs] must avoid in order to safeguard the characterization of their investments”.