Back in 2013, when an appeals court judge used federal income tax principles for purposes of employee benefits law, players in the private equity market stood up and took notice. At stake was the determination that a private equity fund constituted a “trade or business” that is under “common control” with a portfolio company and, therefore, on the hook for pension fund debt.
Our story began in 2007 when two funds of the private equity firm Sun Capital Partners purchased the business of Scott Brass, a Rhode Island brass and copper manufacturing company. A year later, Scott Brass went bankrupt and stopped contributing to its pension fund. The pension fund, run by the New England Teamsters and Trucking Industry Pension Fund, argued that Sun Capital’s funds met the definition of a “trade or business” that is under “common control” and, therefore, under federal law the funds were liable for the $4.5 million pension fund debt of Scott Brass. The U.S. Court of Appeals for the First Circuit found that one of the funds did constitute a “trade or business” and sent the case back to the District Court to determine whether the other fund also met the definition of a “trade or business.”
On March 28th of this year, U.S. District Court Judge Douglas P. Woodlock (for the District of Massachusetts) found not only that the other fund also met the test as a trade or business but that the two funds were also a “partnership in fact” that was under common control with Scott Brass and, therefore, liable for the pension fund debt. The question is whether Judge Woodlock’s ruling will be upheld on appeal and whether other courts will adopt it.
What’s at stake? For one, the decision provides a basis for challenging the favorable manner in which private equity firms are currently taxed:
“In theory, if the I.R.S. were to adopt the same reasoning in a tax context, it could kill the goose that lays the golden eggs of the private equity industry: its huge tax breaks. It could do it in a way that would turn the investing world upside down.” – Libby Lewis, The New York Times
For another, the decision could affect the calculus in valuing target companies:
“Before now, private equity firms viewed companies with underfunded pension plans as undervalued targets because the firms were not responsible for funding the plans. Now that this ruling may render firms responsible to fund target companies’ pension plans, such companies will not be as attractive.” – Marissa B. Wiley, Nixon Peabody
Where tax and labor laws collide, private equity firms stop and take notice. Is this the end of its favorable tax breaks? A drastic change in how to value potentially lucrative deals? The private equity world is watching.