Private Equity Fund Pension Liabilities Arising from Portfolio Company Holdings

Pension liabilities of portfolio companies may be the responsibility of their investor private equity funds.  The Court of Appeals for the First Circuit recently determined in the case of Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund that a private equity fund can be responsible for its investee companies’ pension liabilities if it meets the “trade or business under common control” criteria for purposes of ERISA.  The implications of this court ruling for the private equity funds’ financial statements are that these potential pension liabilities will have to be disclosed in the notes to the financial statements and/or recorded as a contingent liability on the balance sheet if they meet certain criteria.

In the case referred to above the Court determined that the private equity fund holding shares in a portfolio company was a trade or business.  In making its determination the Court looked at the degree of involvement of the private equity fund in the operation of the portfolio company.  The Court took into consideration the organizational documents of the private equity fund and its investee company, which provided for the general partner of the private equity fund to make decisions about hiring, terminating, and compensation of the portfolio company employees and the management and consulting fees that were paid by the portfolio company to the general partner which offset the management fees paid by the fund.  It also took into consideration the private equity funds offering documents which state that the fund actively participates in the operations and management of its portfolio companies.

The Court has not made the determination on the question of common control and the case has been sent back to the District Court for this determination.  If the District Court decides that the criteria of common control has been met under the ERISA rules then the private equity fund would have to disclose the potential pension liability in the notes to its financial statements and/or record a liability on the balance sheet if the criteria of  FASB Topic 450 have been met.

A disclosure of the potential pension liability of the investee company would have to be included in the notes to the private equity funds financial statements if there is a reasonable possibility that this pension liability would have to be paid by the fund.  The fund would have to record the pension liability on its balance sheet if it is probable that it would have to pay this liability and the amount of liability can be reasonably estimated.

Based on the facts that the Court analyzed in making its decision private equity funds that take an active participation in the management of their investee companies could be considered trade or business under the ERISA rules.  These private equity funds need to perform due diligence prior to making investments to determine if the potential investee company has a pension plan that can burden the fund with a potential liability.  Additionally, if the fund manager wants to invest in a company that has a pension plan with a potential liability for the fund, it might want to consider an organizational structure where it does not meet the ERISA criteria of common control.  The fund manager should also review and revise with counsel its fund documents and offering memorandum that relate to its involvement with portfolio companies.