Sun Capital Ruling: Private Equity Investors on the Hook for Shuttering Underfunded Pensions

Public pension funds are going to get dinged when their private equity fund “partners” engage in the form of looting known as withdrawing from underfunded pension plans.

One thing that has always seemed astonishingly short-sighted is the way public pension funds have helped finance the elimination of private pension funds. Admittedly, there are not all that many defined benefit plans left standing, but the project has been underway for some time. Now that government employees are virtually the only people in the US who have defined benefit plans, the calls keep increasing to have them eliminated so as to put public workers on the same perilous footing as private sector workers. That of course ignores the fact that people in the private sector could have sought work in the public sector but didn’t and that the pensions of government workers are part of a total compensation package, as in their wages are lower by virtue of having retirement goodies.

In a ruling last month, Judge Douglas Woodlock ruled that two Sun Capital funds that had jointly purchased a company, Scott Brass, that went bankrupt, were subject to withdrawal liability of their pension fund. We’ve embedded a short memo by Wilkie Farr on the ruling as well as the decision itself at the end of the post.

The basis for the ruling. The short version is that if a “controlled group” that owns more than 80% of a company terminates an underfunded pension plan, it is responsible for withdrawal liability under ERISA. The Department of Labor did not want investors being able to close underfunded plans without incurring a serious cost; otherwise, it would be common for pension plans to be shut down any time they became underfunded, leaving beneficiaries in the lurch.

Sun Capital had sought to get around that by having two Sun Capital funds invest in a company that bought Scott Brass, with one owning 70% and the other 30% so as to fall below the 80% trigger. The Teamsters and Sun Capital sued each other, and the judge’s initial ruling in favor of Sun Capital was overruled in part and returned to Judge Woodlock to determine two issues key to deciding the case: whether the funds were engaged in a trade of business, and whether they were under “common control”.

The active nature of the investment as far as the general partners are concerned would seem to make them meet the “trade or business” test, but what about the passive limited partners?* Interestingly, they were hoist on the sharing of monitoring and transaction fees. The appeals court had already ruled that one of the two Sun funds, by virtue of the investors receiving management fee offsets, met the test. Woodlock was to determine whether the second fund, where no fee offsets had been paid but had been carried forward and were due and owing, was also in a trade or business. Woodlock concluded yes.

The second test was common control. Amusingly, Wilkie Farr sniffed that:

The District Court treated the private equity funds as if they were a “partnership-in-fact” for purposes of a specific investment, despite the fact that the funds had substantially different investors and portfolio companies, filed separate partnership tax returns, prepared separate financial statements and maintained separate bank accounts.

ERISA refers to a section of the tax code to define this issue, and former IRS resident scholar, now law professor at University of North Carolina Gregg Polsky advised the Teamsters on this case. And as you can see from this extract from the ruling, key precedents have taken a broader view of this question that formal niceties:

The agreement of the parties and their conduct in executing its terms; the contributions, if any, which each party has made to the venture; the parties’ control over income and capital and the right of each to make withdrawals; whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income; whether business was conducted in the joint names of the parties; whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers; whether separate books of account were maintained for the venture; and whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.

Luna v. Commissioner, 42 T.C. 1067, 1077-78 (1964)

As the Judge Woodlock concluded:

The two Funds were organizationally separate – and this remains important under Culbertson and Luna – but the record shows no meaningful evidence of actual independence in their relevant co-investments.

The only case that addressed similar organizational issues was Bd. of Trs., Sheet Metal Workers’ Nat’l Pension Fund v. Palladium Equity Partners, LLC. Although the case was settled before fact-finding was completed. Here, three Palladium funds had together purchased over 80% of a group of industrial painting companies which went bankrupt and withdrew from a multi-employer pension plan. The judge noted:

The Palladium court was clear that as a matter of law, partnership-in-fact and common control can be found even across formally fully independent entities.

Implications. This ruling ought to wake up private equity investors, since the Sun Capital ruling will not only result in clawbacks to satisfy the withdrawal liability but presumably opens the door to other cases. The beneficiaries of pension plans terminated and were stiffed on withdrawal liability payments by Sun Capital-type structuring for controlling groups to keep the biggest individual owner’s share below 80% would have grounds to sue, or unions representing them might act on their behalf. Similarly, the Pension Benefit Guaranty Corp., which backstops private pension funds, it itself badly underfunded and should also lodge cases. I have yet to see any commentary on what the statute of limitations is in this area and therefore which plan terminations would be exposed, but you can expect that you’ll be hearing more about this issue.


MEMO AND ORDER 3-28-2016

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  1. Ishmael


    I am sorry, but this statement is just incorrect.

    That of course ignores the fact that people in the private sector could have sought work in the public sector but didn’t and that the pensions of government workers are part of a total compensation package, as in their wages are lower by virtue of having retirement goodies.

    For instance the average govt worker in the state of California makes double what the average worker in California makes, 23 police officers in Santa Monica are paid over $200,000 in salary. Federal workers are grossly over paid including in the military. A Major in the military is now paid over $100,000. Back twenty years ago when salary increases for non-govt workers went on hold, govt workers continued to get 3% annual increases. The compounding has made govt workers salaries far more than those in private industry. I even saw a story one place where they were attempting to explain why accountants for the govt need to be paid more than those in private industry which was laughable.

    The looting is taking place at the govt level the same as at the private equity level.

    1. diptherio

      So the problem isn’t that the private sector stopped giving raises to keep up with inflation, it’s that the Federal gov’t did?!? Maybe the problem is that the private sector pay is unreasonably low, not that federal employees are making too much. The problem isn’t that the gov’t is still providing good jobs, it’s that they are now the only ones doing so.

    2. tegnost

      “For instance the average govt worker in the state of California makes double what the average worker in California makes”
      Any mention from you regarding how average workers pay in cali has been affected by illegal immigration? Always get a kick out of so cal mba’s whinging about firefighter and policeman pay…those santa monica cops are probably having a more positive impact socially and economically than a medical device mba with 6 weeks of paid vacation (generously inspired/provided by those hated unions) whose main focus is offshoring to mumbai and pushing tpp as if the globe will stop spinning without it. A major in the military? That’s a viable career choice, whether or not you would make it, and 100k ain’t that much dough. Also it should go without saying that private equity see’s CalPERS pile of money and wants it all, leaving people for whom the pension was a part of their pay (you know, “sacred contractual agreement”). Having been scraped up off the road by very professional So.Cal firefighters I sincerely believe they are worth every penny. My real problems started when I got to the hospital, maybe you should direct some of your ire towards the ruthless finance/medical complex, because those weasels are way over paid.

    3. J

      Another good example is the Berkley cop who pepper sprayed all those kids. He was making $117K.

      I have relatives who got in when private/public sector were on more equal footing (the 70s) and are simply oblivious to the changes that’ve taken place in the private sector since then.

    4. reslez

      I don’t know where you get your figures. A major with 12 years in makes 84k per year. It’s easy to look that up. And if they don’t make further rank they get separated.

      Santa Monica has the best paid police force in LA county. They were not paid $200k in “salary”. A lot of that figure comes from working overtime, and much of that comes from private events. It shows up in their pay but it’s not paid for by the department, it’s paid by the party hosting the event. Anyway if you want to criticize the insane amounts of money that goes to our militarized police I’m totally on board. That’s the last place the wealthy will economize. (Not that they won’t get there, but they scrimp on everything else first.)

      As for other government workers, my family members who work at the city and county level got 0% cost of living increases for years and decades. Everything was eaten up in negotiations by their health benefits, which got crapified just like everyone else’s. The difference is public workers have unions to fight for them while people in the private sector are at the mercy of business.

      1. Ishmael

        That number was reported in the Santa Monica newspaper. On top of it the rarest thing to ever see is a police officer in Santa Monica. Of course once that newspaper article came out you saw a bunch on the street and then no more. Then there was Janet Nepalitano who was given a $500,000 plus salary to be over the UC State system. California is basically ran by govt workers. The elect all the people in the cities and top offices.

        The one thing you never see is hardly anyone leaving govt to go work for industry (unless they are basically a lobbyist). The pay and the work load is too cushy in govt and most people that work there have no skills.

        A few years ago I did some consulting for a govt unit and made some recommendations that were quite normal for business to perform but no we can not have govt units do it. I mean for instance I looked at several govt units and they did not have property details. In fact they did not even have a general ledger. All they have is a check book. They screamed and wailed and nashed their teeth.

        The other thing as I was looking every govt unit had some certificate of excellence for their financial statements. I mean everyone is excellent. Humor at its max.

        1. Yves Smith Post author

          Look, just because you have a source does not mean that it it correct.

          And your statement re no one leaving govt because the pay is so great is counterfactual. Almsost anyone in a white collar job would make more in the private sector. Most people who are in government jobs are there because the hours are better (so they can raise families) and they have better job security.

          1. jsi

            partially true. That assumes they could cut it in the professional world… not always true. But some of the time.

    5. LizinOregon

      I was gong to argue in favor of Yves’ statement with data because what she says has been true in the past. CBO periodically makes this comparison for federal workers and their analysis has historically supported her position. But then I looked at their most recent work on this and was surprised to find that in the time period of their study (2005-2010) federal compensation was on average 15% higher than private sector compensation. The only federal employee group that had compensation lower than their counterparts in the private sector was the group with professional degrees and doctorates.

      This suggests to me that it is not a matter of looting because the looters would be in that group, but rather a reflection of the growing inequality in the private sector that has not impacted the federal workforce in the same way even though retirement benefits have been cut significantly under sequestration. Federal pay and benefits are set by law and are difficult to change, acting somewhat like union pay scales with an annual increase in each pay band that is determined by a statutory cost of living increase.

      1. Yves Smith Post author

        CBO has repeatedly cooked numbers to advance a neoliberal agenda. I’ve written posts on how they’ve done that with Medicare projects and on other issues. I don’t have time to look at their work, but I would question how they defined comparable jobs. You now have a lot of people in the private sector working in jobs below their education level, like college educated people working in retail or as baristas, which you wouldn’t have seen 20 years ago. In other words, to the extent this is true, it’s due to the un and undermployment driving people to take jobs at way below their skill levels.

      2. bob

        “The only federal employee group that had compensation lower than their counterparts in the private sector was the group with professional degrees and doctorates.”

        So, in other words, the highest paid employees, in the fed gov, were the lowest paid, compared to the private sector?

        These comparisons to averages are very misleading. Averages lie.

        Another huge issue is geography and the cost of living in different places. fed gov is going to skew to larger, more urban areas with a higher cost of living, and therefore pay.

        What’s with the talk of people in gov making too much? I think everyone deserves a raise, public and private sectors. But, if you’re below the billionaire class, you can only whine and complain about someone making too much? Pure spite.

        YOU are part of the problem.

        1. LizinOregon

          Bob, if you are addressing my post then you have misread my arguments and my intention. I am a retired federal employee who spent years working long hours for less compensation than my counterparts in the private sector. I can assure you that I harbor no spite toward government employees and believe that everyone deserves a defined benefit retirement and the generous leave benefits a govt job provides – at least for now.

          My point was that over the many years CBO has made this comparison their analysis has shown that federal employee compensation was lower for all occupations/education levels. That is the change the 2012 report shows and I thought it would be interesting to explore whether this fits in with the growing of inequality in the broader population.

  2. Harry

    Ishmael, the data you cite proves nothing. You cannot assume the labor supplied by the “average” private sector worker and the average Californian public sector worker is homogenous.

    That doesn’t mean I am not sympathetic to your broader point about looting. Just that you didn’t cite any evidence.

    1. diptherio

      According to Ishmael, it’s gov’t employees who are looting the country: you know, all of them damned Majors in the military. No, it isn’t the contractors who charge $6000 for a hammer, it’s the employees. Because gov’t employees don’t get enough hate already, we should also accuse them of looting — because they have a pension plan — rather than the private sector actors who are causing the actual problems.

      Really pisses me off, actually. It’s a classic neo-liberal talking point: private sector jobs suck @$$, so point the finger at the public sector for having it easy. It’s like crabs in a barrel. Pay no attention to the 1% ripping everybody off, look at that public employee making $100,000! He’s the problem!!!!

      1. Left in Wisconsin

        Beyond that, this same rhetoric has supported massive outsourcing of government work. Instead of paying engineers, IT’ers and other talented professionals a reasonable wage to do the public’s business competently, we outsource the work at higher cost (gotta build in that profit margin) and have it done poorly. All so we don’t have too many of those “overpaid” public employees. It’s more divide-&-conquer.

      1. Ishmael

        I read the article and I do not see that the number is bogus. They site a few add backs and attempt to infer that the number is incorrect. I have lived a lot of places and you see fewer police on the street than any place else I have ever been. One of the impacts of this is people drive crazy and I bet Santa Monica has more people ran over than any city in the US. I personally know a half a dozen.

        Now people started siting reasons for the low pay in private. I did not justify it. Tell you the truth I would like to be paid more (I work for myself and eat what I kill) all I said was I did not agree with the statement that govt employees are paid less than private industry. The CBO report is enough to support that statement.

        Governments are unfair bargainers with govt unions because it is other people’s money. They only thing which brings it to an end is when the govt units reaches the end and the piper comes due. Most govt units in the US will be in sever financial straits in the future. I got to looking today and Santa Monica has unfunded pension costs of over $360 million. This number is probably several times that amount due to the way pension obligations are figured. Also SM LT debt increased 50% from 2014 to 2015. We have Puerto Rico, Detroit, Chicago, Michigan, Connecticut, Illinois, New Mexico, Philadelphia (when I lived in Philly in the early 90’s the average city worker there was making $50,000 I do not know how they have survived this long), Pennsylvania, Baltimore, Los Angeles and California and I can go on and on.

        1. Yves Smith Post author

          The “few cops on the street” has NOTHING TO DO with pay levels.

          The maximum salary is $84,000. You said salary. Your statement was incorrect.

          Moreover, not all cops are on the street. You would never recognize a plain clothes cop and detectives spend a lot of time at the office. Precincts also need to be manned.

          Look I live in Manhattan. We have a lot of cops. I NEVER see them on the street except 1. On St. Patrick’s Day when they are out in force and 2. When the President is in town, 3. Managing parade routes and 4. When there is an accident. I see way more of our firemen because they shop at one of my neighborhood grocery stores.

    2. Ishmael

      See above. In fact most state workers probably have a skill level below most private workers.

  3. Tom Figueiredo

    Being a police officer is a very dangerous occupation. A good wage and pension is necessary to recruit, and retain quality people (hey isn’t that the argument they use to justify multi million dollar salaries for bank fat cats?). The reason government employees are paid more than a lot of private sector workers is due to the fact that less private sector workers are in unions. While the public sector wages have not grown since the “great recession”, non union private sector wages have fallen even farther behind. The solution to this is to repeal the Taft/Hartley act, and right to work for less laws. The goal would be not to lower public sector but raise private sector wages. This would go a long way towards reducing income inequality. You would not want uneducated, incompetent government workers would you? Unless you are a banker or corporate crook hell bent on the destruction of our government, and our nation.

    1. Vatch

      Being a police officer is a very dangerous occupation.

      I have no argument with your assertion that a good wage and pension is required to recruit quality people, but I don’t think that police work is as dangerous for police officers as people often claim. It can be very dangerous for some people who are in proximity to the police officers. And in some locations, I’m sure that police work is very stressful.

      Here’s some statistical data about the deadliest jobs in the United States:

      The most dangerous jobs are fishing and logging. And the Bloomberg article says that taxi drivers are more likely to be murdered than police officers are.

    2. cnchal

      Many private sector workers were in labor competition with China and Mexico. Now unemployed and not making money. Who is the public sector going to tax, with a profitless and looted by Pirate Equity private sector?

      . . .You would not want uneducated, incompetent government workers would you?. . .

      No we don’t want that, but Flint happened irregardless of the best of intentions. To attempt to save a few million, a billion dollars of physical damage was done, which doesn’t include the health damage to the people of Flint.

      I agree that police work is dangerous. So is working at a seven eleven when dark out, or felling trees or driving a cab or working on a fishing boat. I would point out though, that money isn’t the main motivator to becoming a police officer. Power over another person is a bigger one.

      Balance has been lost.

      1. Jim

        “…but Flint happened irregardless of the best of intentions”??? No, Flint happened precisely because the people most hell-bent on destroying the public sector, and privatizing everything, made a conscious decision to switch from a safer water supply to one that was obviously toxic as hell. Why should we even be discussing what their stated intentions (translation: spin) were? Actions are what count.

        The people of Flint were not permitted to participate in this decision – remember “emergency rule” in Michigan?

        1. cnchal

          Flint is a particularly good example. Results are what count, action is the way to get there.

          Up to now, there has been no smoking gun in the form of a memo or warning from the public servants entrusted with making sure the water supply was safe, that switching to the Flint River would lead to this disaster.

          Either it was due to ineptitude or someone or a group of someones that knew kept quiet, which brings up a few questions. One of which is, how can they live with themselves?

          The intent was to save money, by not paying Detroit for their water. Nobody would want Flint’s privatized water system for the simple reason there is no money in it. The people there have been the victims of outsourcing for decades, and whatever businesses are there, don’t generate enough profit to be taxed enough to support privatized water.

          I do not believe for a second that it was the intent to poison the people of Flint. The people involved are not banksters.

          The people of Flint that work for businesses in that area are very unlikely to have a pension, where as the employees of the city do. It is the result of decades of sending wealth creating work to cheap labor nations, and the elite grabbing that wealth for themselves.

          There is $2 trillion in profits held aloft by the likes of Wal Mart and Apple, never to touch an ordinary person again.

          What I find interesting about this Sun Capital Pirate Equity story, is that the maneuver of sending two pirate dingy’s to capture Scott Brass, one with a 30% share and the other a 70% share to hide in the weeds and do their dirty deed was called out. They got caught by their own cleverness, but their backers, the public pension funds got caught right alongside.

          We might even see the spectacle of public pension funds paying private pension funds, and then the public pension funds go right back to the private sector demanding to be made whole, because now they are even further in the hole.

          Round and round it goes, swirling in the toilet bowl.

    3. Ishmael

      In fact that is also a myth. There is a long list of careers which have a higher death and injury rate above being a police officer.

      1. Yves Smith Post author

        And how are they paid? Being a derrickhand is very dangerous and highly paid. So are a lot of types of construction work. You haven’t proven your point.

        The riskiest job is being a commercial fisherman. And guess what? I have relatives in that line of work. They fish because….drumroll….they love being on the ocean and like the flexibility of hours. So they get compensated in other ways.

  4. Left in Wisconsin

    Thanks for this post. Unfortunately, private-sector defined-benefit pension plans are going the way of the dodo (except for Social Security). But hopefully this will make a few PE sc()mbags less willing to pillage the ones that are left.

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