Dennis Marton walks at a rally protesting Detroit’s attempt to discharge its pension obligations in bankruptcy outside The Theodore Levin United States Courthouse in Detroit, Wednesday, Oct. 23, 2013. Recent U.S. rulings over foreign investors’ pension obligations in bankruptcy have created uncertainty for Canadian private equity firms.Paul Sancya/The Associated Press
Two recent U.S. court rulings have put Canadian private equity funds that invest south of the border at risk of covering the pension obligations of their American portfolio companies in the event of a bankruptcy.
Since a key legal decision was issued six years ago, there has been uncertainty as to whether foreign private equity funds would have to fund the pensions of the U.S. companies they invest in. Before the ruling, U.S. lawyers for Canadian firms invested there believed that foreign funds would be considered passive investors, and not trades or businesses, leaving them off the hook for pension responsibilities.
But in 2007, Pension Benefit Guaranty Corp., a U.S. federal agency that seeks to protect pension benefits in private-sector defined benefit plans, ruled that private equity funds that own 80 per cent or more of a portfolio company could be liable for under-funded pension plans in the event of a bankruptcy. The ruling created a lot of confusion until a Massachusetts district court judge ruled last fall that a union pension plan that attempted to use the 2007 ruling to its benefit was overreaching.
After the decision, many lawyers for Canadian investors were relieved, understanding that the rules had been clarified in their clients' favour.
But now the uncertainty is back. Not only was the Massachusetts court's ruling recently overturned by a federal appeals court, a federal district court in Washington, D.C. just permitted the PBGC to go after a Japanese parent company that acquired a now-bankrupt U.S. business to collect the pension underfunding.
"It's sort of a one-two punch for Canadian investment funds that invest in the U.S," said Carol Buckmann, a lawyer with Osler Hoskin & Harcourt based in Manhattan.
"There has been a great deal of concern in the legal community," she added, because the latest developments go against the way the law had been interpreted for quite some time before the 2007 decisions.
Because there is now a hefty amount of uncertainty, lawyers aren't 100 per cent sure of how to advise their clients. But there are a few options on the table. It appears that the 80 per cent ownership threshold is what could trigger the pension obligations, so private equity funds could consider staying below that level.
The rulings also reiterate the importance of conducting thorough due diligence on pension obligations when investing in the U.S., rather than just hoping that the courts will rule in your favour during a bankruptcy.
Tim Kiladze