Pension plan liability risk

December 2019 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

December 2019 Issue

Multiemployer pension plans (MEPP) are currently facing a severe funding crisis. These plans – which are jointly administered by union and employer representatives – are underfunded by an estimated $638bn, and the relevant Pension Benefit Guaranty Corporation’s (PBGC) resources are expected to be used up by 2025. Within this context, pension plan liabilities are an important consideration for companies considering mergers and acquisitions (M&A).

Under the Employee Retirement Income Security Act (ERISA) of 1974, a seller that contributes to a MEPP may be liable for underfunding of the MEPP even if the sale or other transaction would remove the company from the seller’s controlled group, if a principal purpose of the transaction was to “evade or avoid” withdrawal liability. A recent case involving The Renco Group, Inc. demonstrates this potential risk. Renco was hit with $80m in withdrawal liability to the Steelworkers Pension Trust (SPT) following a sale by Renco of a 24.5 percent interest in one of its subsidiaries to Cerberus Capital Management, L.P., a private equity fund.

Background

Renco is a private holding company owned by billionaire Ira Rennert that invests across several industries. Renco wholly owned RG Steel, LLC, a struggling subsidiary in need of a cash infusion. In 2012, Renco sought a loan in an attempt to turn around RG Steel. Though Renco did not originally intend to offer equity in RG Steel in connection with the financing, it was unable to find a willing lender without including an equity component. After discontinuing negotiations with another prospective investor, Renco approached Cerberus with a proposal in which Cerberus would provide RG Steel with $125m of debt and equity financing.

Cerberus was amenable to the proposal, but requested penny warrants rather than a direct equity stake. However, in negotiations, Renco insisted that Cerberus acquire a direct equity stake, rejecting warrants. Renco’s lawyers believed this transaction structure would reduce Renco’s ownership interest in RG Steel to less than 80 percent such that RG Steel would exit Renco’s controlled group and Renco would therefore cease to be liable for RG Steel’s underfunded pension plans.

The Cerberus deal closed in January of 2012. When RG Steel went bankrupt later in 2012, the PBGC brought an action against Renco, alleging that Renco had entered into the transaction with Cerberus with a principal purpose of evading liability to RG Steel’s single employer pension plan (not SPT) in violation of Section 4069 of ERISA. ERISA’s joint and several liability provisions allowed the PBGC to go after a number of affiliated Renco corporations in an attempt to recover money to fund the pension plans, including a corporate entity that held Ira Rennert’s infamously large mansion in the Hamptons. Renco eventually settled with the PBGC in 2016.

The SPT dispute

In 2016, SPT sued Renco, alleging that Renco was responsible for RG Steel’s approximately $86m withdrawal liability to SPT. Renco’s settlement with the PBGC did not cover the SPT plan.

The SPT dispute entered arbitration, and on 30 September 2019, a federal court confirmed the arbitrator’s findings that Renco owed SPT approximately $80m in pension liabilities. Under Section 4212(c) of ERISA, a parent company can remain liable for withdrawal liability if it exits a subsidiary’s controlled group with the intent of evading or avoiding such liability: “[i]f a principal purpose of any transaction is to evade or avoid liability under this part, this part shall be applied and liability shall be determined and collected without regard to such transaction”.

The arbitrator found that although there were legitimate business reasons for Renco’s original decision to seek outside investment and to structure the transaction to include a direct equity component, Renco also had a principal purpose of evading or avoiding withdrawal liability in violation of ERISA. The court agreed with the arbitrator’s findings, focusing on the fact that Renco pushed Cerberus to acquire membership units in RG Steel rather than penny warrants in order to ensure Renco would cease to be a member of RG Steel’s controlled group and thus avoid liability to SPT.

Implications

The Renco case raises important questions about the broad language of Section 4212 of ERISA, which applies to multiemployer pension plans and targets transactions with a principal purpose of “evading or avoiding” MEPP liability. The parallel provision of ERISA that applies to single employer pension plans, Section 4069, only disregards transactions aimed to “evade” liability. Targeting “evasion” is common across many areas of law, and the phrase suggests wrongful action, but “avoiding” liability could be interpreted more broadly. In the majority of M&A transactions, pension liability is one of many considerations, and although the facts in Renco were egregious, as discussed below, the decision raises questions about the boundary line between practical risk minimisation and wrongful avoidance or evasion.

Further, the Renco case highlights that Section 4212(c) does not only capture transactions that had an evasive intent at the outset. The court explicitly noted that Renco had legitimate business reasons for seeking a capital infusion and for the inclusion of an equity component. However, the arbitrator found, and the court confirmed, that the structure of the deal was motivated by a desire to avoid pension liability, and therefore this was “a primary purpose” of the transaction within the meaning of ERISA.

Findings of liability under Section 4212(c) are rare, but the Renco case is similar to a 1999 case in which Sherwin-Williams Company sold a wholly-owned subsidiary. The Sixth Circuit found that the company’s main purpose was to divest itself of a subsidiary that was losing money, but the principal purpose for the type of sale was to avoid highly expensive ERISA liability. The court noted that, “[t]he less ‘healthy and viable the corporate entity’ at the sale date, the more likely, on a circumstantial basis, that ERISA Section 4212(c) motivations were involved”.

In another case, Supervalu argued that Section 4212(c) liability only applies to transactions that do not include bona fide and arm’s length negotiation. Supervalu had been a contributing employer to a MEPP, but negotiated with the fund to withdraw before the vesting date, so that it would not be subject to withdrawal liability, in exchange for additional payments to employees. The Third Circuit held that the transaction would be disregarded under Section 4212(c), and Supervalu would remain responsible for withdrawal liability. The court found that Supervalu had a principal purpose of evading or avoiding withdrawal liability and declined to consider whether the transaction was born of bona fide and arm’s length collective bargaining.

Notably, the legislative history of Section 4212 suggests a narrower interpretation of the “principal purpose” language. There is no specific comment on the phrasing, but the Congressional record states that the intent was to allow courts to disregard “sham transactions” – such as an employer “going out of business” and then resuming business under a different name. It also calls out for scrutiny “transactions which are less than bona fide and arms’ length”. However, the court in Supervalu specifically declined to consider the legislative history, saying that “a principal purpose” and “evade and avoid” have clear meanings, and do not only apply to fraudulent transactions.

The court’s finding in Renco seems to have been strongly influenced by certain facts of the case that suggested an evasive intent. During negotiations, Cerberus initially indicated its desire for an equity interest, but only in the form of penny warrants. An email from Cerberus chief executive Daniel Wolf emphatically stated that Cerberus was uninterested in a direct equity stake. However, two nights later at a dinner meeting at Ira Rennert’s home, the deal was finalised to include a direct equity stake. Renco’s lawyer testified that Renco insisted on membership units to prevent any argument that warrants were insufficient to remove Renco from RG Steel’s controlled group.

Moreover, a few days before the closing of the Cerberus transaction, Ira Rennert’s son Ari spoke with the PBGC and refused to make any guarantees regarding funding the single employer pension plans, claiming that no deals affecting the status of pension plans were imminent. In arbitration, Renco tried to claim that it was unaware of the likely magnitude of withdrawal liability for SPT, but the arbitrator found that if they were explicitly considering the single employer plans, they must have been aware of the much larger exposure for SPT, and the court agreed with this finding.

Conclusion

While the Renco case makes clear that the structure of a transaction could potentially result in liability for a former subsidiary’s pension obligations, there is no suggestion that this wider interpretation will be broadly applied. The court’s reasoning seems heavily influenced by the specific facts of the Renco transaction, which supported a finding that there was an intent to evade or avoid pension obligations within the meaning of the statute. Further, Section 4212(c) liability is rarely applied. Nonetheless, careful consideration should be given to any proposed transaction or restructuring involving an entity with an underfunded MEPP.

Arthur H. Kohn is a partner at Cleary Gottlieb Steen & Hamilton LLP. He can be contacted on +1 (212) 225 2920 or by email: akohn@cgsh.com.

Arthur H. Kohn

Cleary Gottlieb Steen & Hamilton LLP