Friday, August 2, 2013
New York Times DealBook: Sun Capital Court Ruling Threatens Structure of Private Equity, by Vic Fleischer (San Diego):
Last week, the United States Court of Appeals for the First Circuit issued a ruling that will make it harder for private equity funds to walk away from the unfunded pension liabilities of companies they have bought if the company goes bankrupt.
Specifically, the court ruled that one of Sun Capital’s private equity funds was “not merely a ‘passive’ investor” but actively involved in the operations of Scott Brass Inc., a portfolio company that went bankrupt in 2008. The case was brought by the New England Teamsters and Trucking Industry Pension Fund.
The case is undoubtedly important for private equity deals. Firms must consider the greater risk of unfunded pension liability when valuing targets. Portfolio companies may be grouped together to take advantage of certain pension qualifications. But the implications of the case potentially go beyond pension law.
The taxation of private equity funds is built on the premise that the funds are merely investors in portfolio companies and are not engaged in a “trade or business” for tax purposes – in other words, they are not actively involved in the business. But the court found in the Sun Capital case that a private equity fund was engaged in a trade or business for purposes of the Employee Retirement Income and Security Act, also known as Erisa. It is not a big leap to argue that the fund was engaged in a trade or business for tax purposes. And then it gets really interesting.