Distress investors often prefer to acquire a troubled business through an asset purchase styled as a sale of all or substantially all of the company’s business under §363 of the Bankruptcy Code “free and clear” of all liabilities, liens, claims and interests against the seller, usually including any legacy obligations. In fact, unfunded pension and retiree health obligations are a frequent driver of the so-called 363 sales. But as demonstrated by the recent ruling against Japanese firm Asahi Tec1 following the 363 sale of its U.S. subsidiary Metaldyne, the Pension Benefit Guaranty Corporation (PBGC) will assert unfunded pension liability against members of the bankrupt seller’s control group, even if they are domiciled offshore.

According to the PBGC 2012 Annual Report, as of Sept. 30, 2012, PBGC’s single-employer insurance program had a negative net position or “deficit” of $29.1 billion, meaning that for U.S. participants in the single-employer program, there exists $29.1 billion in unfunded liabilities. Similarly, the multi-employer program had a deficit of 5.2 billion.2 Not surprisingly, remediation and active management of this liability is a focus for the PBGC. The PBGC is asserting claims for the termination liability as well as the surcharge or special premium for attempting to discharge pension plan liability through a bankruptcy case.3 The Asahi Tec ruling, when coupled with the earlier Sun Capital4 and Oneida5 rulings, underscores the determination of the PBGC to assert liability against affiliates looking to not only the extent to which affiliates controlled and may have actively managed the bankrupt seller, but also the extent to which offshore affiliates subjected themselves to U.S. jurisdiction during the acquisition and ownership process.

Background

Asahi Tec Corporation (Asahi Tec or the company), a Japanese automotive parts manufacturer, acquired Metaldyne Corporation in September 2005. Metaldyne was an automotive parts manufacturer based in Michigan. At the time, Metaldyne was the contributing sponsor of a single-employer pension plan covered under Title IV of the Employee Retirement Income Security Act of 1974 (ERISA).

Prior to its acquisition of Metaldyne, Asahi Tec conducted due diligence and engaged consultants to review Metaldyne’s employee benefit and compensation programs, including analyzing the long-term benefit plan liabilities of Metaldyne and developing strategies to mitigate obligations assumed by Asahi Tec. The resulting due diligence provided Asahi Tec with reports indicating that Metaldyne had significantly underfunded long-term employee benefit obligations, and such obligations were ultimately reflected in the $1.2 billion transaction price.

Subsequently, in May 2009, Metaldyne filed a voluntary petition for relief under Chapter 11 in the Bankruptcy Court for the Southern District of New York. During the pendency of Metaldyne’s Chapter 11 case, PBGC approached Asahi Tec to inquire whether Asahi Tec planned to assume sponsorship of the pension plan given that no buyer of Metaldyne’s assets was likely to assume it. Asahi Tec indicated it did not plan to assume the pension obligations. After terminating the pension plan, PBGC was appointed as the plan’s statutory trustee, and subsequently requested again that Asahi Tec pay the amounts owed pursuant to the pension plans. When Asahi Tec declined, PBGC filed suit in the U.S. District Court for the District of Columbia seeking entry of a judgment against Asahi Tec for the full principal amount of the pension liability from the time Metaldyne entered bankruptcy as well as termination premiums and the cost of litigation. The total amount sought by PBGC was $175 million. In its complaint, PBGC argued that Asahi Tec was liable for such pension obligations due to its status as a “controlled group” member of Metaldyne under ERISA. Because Asahi Tec was a member of the “controlled group,” PBGC argued, Asahi Tec was liable for unfunded benefit liabilities and termination premiums arising from the termination of Metaldyne’s pension plan.

Motion to Dismiss Denied

In April 2011, Asahi Tec sought to dismiss PBGC’s complaint for lack of personal jurisdiction. The company argued that simply acquiring a subsidiary did not expose the parent to personal jurisdiction for claims based on the subsidiary’s liabilities. The district court denied Asahi Tec’s motion.6 According to the court, the case could not be dismissed for lack of personal jurisdiction because Asahi Tec had sufficient minimum contacts with the United States such that there was specific jurisdiction. The court stated that Asahi Tec had acquired PBGC “with its eyes wide open” and after conducting the due diligence described above was specifically informed of the possibility of controlled group liability under ERISA.7 While Asahi Tec’s arguments may have been viable with regard to vicarious liability, the court stated that the claims asserted by PBGC were based on a unique cause of action predicated solely on Asahi Tec’s status as a “controlled group” entity of Metaldyne under ERISA.

Thus, the court found that PBGC had made a prima facie showing that Asahi Tec purposefully directed activity towards the United States in connection with its acquisition of Metaldyne, including the potential for assumption of controlled group pension liability. Following the court’s decision, Asahi Tec reasserted lack of personal jurisdiction as one of its affirmative defenses in its answer to PBGC’s complaint. PBGC then moved for partial summary judgment on Asahi Tec’s affirmative defense of lack of personal jurisdiction as well as Asahi Tec’s liability for unfunded benefit liabilities and termination premiums.

Summary Judgment

On summary judgment, the district court again found in PBGC’s favor on the question of personal jurisdiction. The court reiterated that it would not offend traditional notions of due process to bring the defendant into court to answer a limited set of allegations arising directly out of the circumstances specifically considered at the time of the purchase of Metaldyne. Not only did Asahi Tec know about the underfunded pension plan, the acquisition agreement specifically mentioned ERISA and the potential for controlled group liability, and the company’s statements in connection with stock sold to finance the Metaldyne acquisition included the employee benefit obligations as a risk factor for investors to consider.

With respect to the unfunded pension plan benefit liabilities, the court looked to ERISA §1301(a)(14), to determine whether or not Asahi Tec was considered a “controlled group” member. Under ERISA, a “controlled group” consists of companies that are under “common control,” including parent corporations and their subsidiaries.8 The court held that because Metaldyne Holdings, a wholly owned subsidiary of Asahi Tec, owned 100 percent of Metaldyne’s stock on the date of termination, Asahi Tec was a member of Metaldyne’s controlled group by virtue of this indirect parent-subsidiary relationship.

The ‘Chevron’ Test

The district court then considered PBGC’s claim under ERISA §§1306 and 1307, seeking to hold Asahi Tec liable for unpaid termination premiums. Section 1306 authorizes PBGC to collect premiums on covered plans, and further §1306(a)(7)(A) imposes a termination premium if a covered plan is terminated during a bankruptcy or insolvency proceeding or by PBGC under §1342.

PBGC asserted that Asahi Tec was liable for such premiums due to the fact that Metaldyne’s plan was terminated under §1342 and Asahi Tec was liable for such premiums as a member of Metaldyne’s controlled group. In opposition, Asahi Tec argued that the language of §1306 explicitly excluded controlled group members from termination premium liability. Asahi Tec argued that §1307′s rule governing the “designated payor” of termination premiums did not apply to §1306 due to the prefatory language of §1306 stating, “Notwithstanding section 1307 of this title.”

The court stated that, under the two-step process for statutory interpretation set forth in Chevron, PBGC’s interpretation of the statute was entitled to deference.9 Under Chevron, the first step asks the court to consider whether the relevant statutory language is ambiguous. The court here held that such was the case. The court then ultimately affirmed PBGC’s interpretation of the statute based on the second step of Chevron, which instructs courts to give deference to an agency’s interpretation of a statute if such interpretation is based on a permissible construction of the statute. Because PBGC’s construction of the statutory language was supported by the statutory text and consistent with the structure and purpose of the statute as a whole, the court found that PBGC’s statutory construction prevailed.

Asahi Tec also argued that the purpose of the termination premiums is to deter a plan sponsor from shedding employment plan obligations through bankruptcy and burdening PBGC with the cost of such obligations, while a controlled group member, in contrast, need not be deterred from orchestrating such a strategic bankruptcy since the corporate family would bear responsibility for the entire unfunded pension obligations regardless. Thus, according to Asahi Tec, imposing such liability on controlled group members such as Asahi Tec would serve no deterrent purpose under the statute. The court was not convinced. It stated that deterrence was not the sole purpose of the statute, but rather, Congress intended a broader purpose to help improve the financial status of PBGC, which would ultimately better protect workers and retirees in the future. As such, the court held that imposing controlled group liability for termination premiums would actually further fulfill Congress’ intent to deter strategic bankruptcies due to the fact that it would encourage the controlled group members to assume pension liabilities during a bankruptcy rather than terminating the plan in order to escape the additional termination premium penalty.

Court’s Treatment of ‘Oneida’

Lastly, Asahi Tec argued that PBGC’s claim for termination premiums was not ripe, based on the special rule for plan terminations under ERISA that the general rule on termination premiums shall not apply to plans terminated during the pendency of a bankruptcy reorganization proceeding until the date of the discharge or dismissal of such case.

Under ERISA, the “general rule” for termination premiums is that:

If there is a termination of a single-employer plan under clause (ii) or (iii) of section 1341(c)(2)(B) of this title or section 1342 of this title, there shall be payable to the corporation, with respect to each applicable 12-month period, a premium at a rate equal to $1,250 multiplied by the number of individuals who were participants in the plan immediately before the termination date.10

ERISA also has a “special rule” for plans terminated in bankruptcy reorganizations that states:

In the case of a single-employer plan terminated under section 1341(c)(2)(B) of this title or section 1342 of this title during the pendency of any bankruptcy reorganization proceeding under chapter 11 of Title 11…[the general rule on termination premiums] shall not apply to such plan until the date of the discharge or dismissal of such person in such case.11

Asahi Tec argued that because Metaldyne had not been discharged or dismissed from its Chapter 11 case, the special rule for termination premiums applied, and any claims for termination premiums had not yet arisen and thus was not yet ripe for adjudication. In support of this argument, Asahi Tec relied on the decision by the U.S. Court of Appeals for the Second Circuit in PBGC v. Oneida. In Oneida, the Second Circuit prohibited a pension plan sponsor from discharging the termination premiums it owed to PBGC during the course of the sponsor’s bankruptcy proceeding.12

In response to Asahi Tec’s arguments, PBGC agreed that under the special rule, a reorganizing debtor’s liability for termination premiums would not arise until the date of discharge or dismissal. However, PBGC argued that, in the case of Metaldyne and unlike in the case of Oneida, the special rule would not apply because Metaldyne was liquidating under Chapter 11 rather than reorganizing, and thus the special rule was inapplicable.

The court again applied the Chevron two-part test to determine which party’s interpretation of the statutory language was correct in the case of a liquidating debtor under Chapter 11, finding that both parts of the Chevron test favored the plaintiff, PBGC. In considering the statutory language, the court found the application of the special rule to liquidating debtors problematic. Under Chapter 11, a corporate debtor who liquidates all or substantially all of its assets does not obtain a discharge. Applying the special rule to such a case, liquidating debtors could arguably potentially evade termination premiums indefinitely since such debtors would never have a date of discharge or dismissal allowing the obligation to attach. The court was not persuaded that the special rule was meant to be an exception to termination premium liability imposed on liquidating debtors in this manner.

Rather, according to the court, the special rule was really a question of timing. The use of the word “until” in “ until the date of discharge or dismissal” indicates that the rule is meant to regulate when the termination premium liability will arise, not if it will arise. Thus, since Metaldyne would not be continuing its business operation after bankruptcy, the special rule did not apply and the PBGC’s claim for termination premiums was ripe under the general rule.

Other Cases

Asahi Tec is not the first recent occasion in which courts have addressed the issue of unfunded pension liabilities in the cross-border or sponsor context and held in favor of the PBGC. Other recent cases involving sponsors/cross-border complications have also highlighted the changing model for how courts are addressing unfunded pension liabilities, and the means by which PBGC has pursued payors for such unfunded obligations.

For instance, earlier this summer, the U.S. Court of Appeals for the First Circuit found that private equity firm Sun Capital was liable for the unfunded pension liabilities of one of its investments, Scott Brass, to the New England Teamsters & Trucking Industry Pension Fund.13 The court there held that Sun Capital was liable for the multiemployer program obligations despite the fact that the private equity firm argued its funds were merely passive investors in the company, holding that one fund constituted a “trade or business” and was under “common control” sufficient to constitute an employer for purposes of the Multiemployer Pension Plan Amendments Act (MPPAA) while remanding the determination of the second fund to the district court. Of great importance in Sun Capital, as in Asahi Tec, was how the funds held Scott Brass upon its acquisition. The court found that the activities of the general partner should be attributed to the fund and its investors, due in part to the fact that the fees Scott Brass paid to the general partner of the fund were used to offset part of the 2 percent annual management fees that the limited partners normally paid to the general partner. As such, the court found that the limited partners received a direct economic benefit and could be considered as engaged in a trade or business and, thus, an employer and liable for unfunded pension liabilities under the MPPAA.

Similarly, in the single-employer context, and as the court in Asahi Tec discussed, the Second Circuit in Oneida held that PBGC’s right to recover termination premiums was not in the nature of a prepetition “claim” discharged by the debtor’s Chapter 11 plan. The court in Oneida stressed that “the bankruptcy courts should not be used as a mechanism for eliminating the burden of an underfunded pension plan” and therefore held that the termination premiums assessed against the debtor became due upon the debtor’s discharge under the special rule.14

Together, Asahi Tec, Sun Capital and Oneida illustrate the recent treatment by courts considering unfunded pension liabilities and the potential for such obligations to be laid upon sponsors and owners despite the bankrupt company’s Chapter 11 liquidation or restructuring, and despite the fact that the sponsor/owner may be in another jurisdiction or only remotely connected to the debtor through its corporate structure.15

Conclusion

In the wake of Asahi Tec, sponsors and purchasers of U.S. distressed entities should carefully consider how they acquire such U.S. entities, focus on whether ownership of the U.S. subsidiary has potential to subject them to “controlled group” liability under ERISA and revise their acquisition and corporate structure accordingly. Further, in light of Asahi Tec, foreign purchasers in particular should be cognizant that the distressed acquisition may ultimately subject the foreign purchaser to liability for unfunded benefit obligations, including termination premiums, even if the U.S. company is liquidating rather than reorganizing. While sales “free and clear” may be extremely beneficial for creditors and distress investors, the PBGC has demonstrated that such sales do not necessarily protect equity owners and affiliates.

Corinne Ball is a partner at Jones Day

Endnotes:

1. Pension Benefit Guar. v. Asahi Tec, No. 10-1936 (ABJ) (D.D.C. Oct. 4, 2013).

2. Pension Benefit Guar. 2012 Annual Report, at 1-6, available at http://pbgc.gov/documents/2012-exposure-report.pdf.

3. See 29 U.S.C. §1306(a)(7).

4. Sun Capital Partners III v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013).

5. Pension Benefit Guar. v. Oneida, 562 F.3d 154 (2d Cir. 2009).

6. Pension Benefit Guar. v. Asahi Tec, 839 F. Supp. 2d 118, 120 (D.D.C. 2012).

7. Id. at 124.

8. See 29 U.S.C. §1301(a)(14)(A)-(B); 26 U.S.C. §414(b)-(c).

9. Chevron U.S.A. v. Natural Res. Def. Council, 467 U.S. 837 (1984).

10. 29 U.S.C. §1306(a)(7)(A).

11. 29 U.S.C. §1306(a)(7)(B).

12. Oneida, 562 F.3d 154 (2d Cir. 2009).

13. Sun Capital, 724 F.3d 129 (1st Cir. 2013).

14. Oneida, 562 F.3d at 158.

15. One caveat to this recent trend, however, can be seen in cases involving a U.S. debtor and pension liabilities abroad. For instance in Nortel Networks, the U.S. Court of Appeals for the Third Circuit held that pension fund protection proceedings filed in the United Kingdom were not subject to the police power exception to the automatic stay, thus shielding the debtor from pension obligation proceedings abroad during the pendency of the U.S. bankruptcy case. In re Nortel Networks, 669 F.3d 128, 141 (3d Cir. 2011).