Terminating a union contract can be an expensive proposition for a business, where there is a pension fund involved.
Pension Fund Withdrawal Liability
Can Cripple Companies
When Terminating Union Relationships
By Christopher W. Olmsted
Terminating a union contract can be an expensive proposition for a business, if there is a pension fund involved. Under federal law, the union pension fund can assess a “withdrawal liability” to cover unfunded pension benefits.
Some businesses have set up a separate enterprise to take on unionized projects, but this is not a panacea for withdrawal liability. In a recent 9th Circuit Court of Appeal decision titled Resilient Floor Covering Pension Fund v. M & M Installation, Inc., the court addressed the issue of whether a non-union company may be liable on an alter-ego theory for pension fund withdrawal liability incurred by a union company when there is commonality between the union and non-union firms.
A Good Business Plan Goes Sour
Simas Floor Co., Inc. is a non-union residential and commercial flooring contractor with offices in Northern California. It is owned in equal shares by three cousins. The company is a non-union shop.
Several years ago, the owners saw opportunities to work on union jobs, but they did not want Simas to sign a collective bargaining agreement. (Presumably doing so would have priced the company out of non-union projects.) So in 1994, the owners of Simas Floor formed M & M Installation, Inc. It was created to serve as a union signatory flooring contractor to allow non-union Simas Floor to bid on union jobs by subcontracting the work to M & M. In union circles, this type of dual operation, one union and one not, is called a “double breasted” operation.
M & M entered into collective bargaining agreements for its flooring installers with the local union, Carpet, Resilient Flooring and Sign Workers Local Union No. 1237. These union agreements required M&M to make contributions to the union pension (Resilient Floor Covering Pension Fund) on behalf of M&M’s flooring installers.
Simas controlled M & M. Simas gave M & M its work assignments. It hired, fired, supervised and disciplined M&M’s workers. M & M passed profits through to Simas Floor rather than itself making a profit.
When the CBA came up for renewal, the union demanded that M & M make Simas’ Sacramento location also sign the CBA. M & M refused. An impasse and strike resulted. Then M & M repudiated the agreement and also stopped making contributions to the pension fund.
That’s when things got expensive. When M & M withdrew from the union, the Pension Fund assessed a $2,414,228.00 withdrawal liability under federal union law (explained below). The $2.4 million was to be paid in quarterly installments of $43,945.20 for twenty years. M & M made quarterly payments for a while, from December 2004 through April 30, 2008. Then the construction industry crashed in the recession and the company shut down operations and went out of business.
Labor Laws Hamstring Non-Union Company
After M & M shut down and stopped making pension fund contributions, the union fund turned its guns on Simas. The union pension fund contended that Simas was liable for the remaining 16 years of withdrawal liability payments to the tune of $176,000 per year. After demand for payment and a dispute, the union fund contended that the entire remaining balance was due all at once under an “accelerated payment” provision of federal union law.
A lawsuit followed. The pension fund sued for Simas for the multi-million dollar withdrawal liability. The fund lawyers argued that Simas was liable as the “alter ego” of M &M and also was a “successor employer” of the M & M workers. Simas contended that it was not liable for M & M’s contributions because it was a separate entity not a party to the union contract, and not formed for the purpose of avoiding union obligations (since it predated M & M).
At trial, the court sided with the union pension fund. Simas was held liable for M & M’s withdrawal liability. The company appealed.
Overview of Union Pension Laws
Two federal laws spelled doom for the company in the trial court.
NLRA/LMRA. The Labor Management Relations Act (LMRA), which is also known as the Taft-Hartley Act. The Taft–Hartley Act amended the National Labor Relations Act (NLRA) which is also known informally as the Wagner Act. Generally, the NLRA and LMRA regulate businesses and unions with respect to union activity. The laws ban certain types of company action (“unfair labor practices”) which might interfere with lawful union activity (organizing, bargaining). The law also regulates, to a lesser extent, union conduct.
The law also regulates union pensions, which technically are called “multi-employer pension plans.” These are “multi-employer” plans because more than one employer contributes funds. The pensions are maintained pursuant to collective bargaining contracts between employers and a union or group of unions.
ERISA. The Employee Retirement Income Security Act of 1974 (ERISA) is a federal statute that establishes minimum standards for pension plans in private industry. ERISA requires plans to provide participants with plan information including important information about plan features and funding; provides fiduciary responsibilities for those who manage and control plan assets; requires plans to establish a grievance and appeals process for participants to get benefits from their plans; and gives participants the right to sue for benefits and breaches of fiduciary duty.
As the federal law was originally written, if a company’s obligation to make contributions ended for any reason (like the CBA terminated), then the employer had no further financial obligations. Under ERISA, a federal law regulating pensions, in exchange for making a form of insurance premium payments to the government, union pension funds were backed by the federal government if they ran short of money.
That changed when ERISA was amended in 1980 with the Multi-Employer Pension Plan Amendments Act (MPPAA). The amendment required pension funds to collect “withdrawal liability” from companies whose contribution obligations terminated.
Why? For several decades now, union pension funds have been critically underfunded. The unions granted benefits based on unrealistic stock market predictions, which are way too generous and beyond the ability of the pension funds to pay. Moreover, they have made disastrous investment decisions. Of course, when an employer drops out, the pension fund is deprived of funds which could have otherwise been invested and paid out to workers. The benefits coming due to retired workers in the future are “unfunded,” meaning the pension plan won’t have enough money to pay what it has promised. On average, pension funds have only 62% of the funds needed to pay retirees. Many union pension funds are multi-millions of dollars in the hole.
MPPAA was designed to partly fill that hole, at employers’ expense. The law requires that when a company terminates its participation, it must pay a proportionate share of the pension plan’s unfunded liabilities. This is what is referred to as “withdrawal liability.”
The law provides formulas for calculating withdrawal liability. The formulas are quite complex, and we won’t attempt to describe them here.
The withdrawal liability is often the death knell for a company. In many cases, the withdrawal penalty far exceeds a company’s net worth. For example, in the M & M case, the penalty was $2.4 million.
Withdrawal Liability For Non-Union Company?
Companies can be caught off guard when it comes to withdrawal liability. The rules for determining liability are complex and can be contrary to common sense. The intent is to strongly discourage companies from withdrawing.
For example, if one company buys the assets of a unionized company, withdrawal liability may be imposed on the acquiring company unless the sale is an “arms-length” transaction and the acquiring company continues to make ongoing contributions at the same level as the acquired company. Moreover, among several other requirements, the acquiring company must post a bond to ensure that the contributions are made.
The law includes a “catch all” provision. The MPPAA provides: “If a principal purpose of any transaction is to evade or avoid liability under the MPPAA, the Act shall be applied and liability shall be determined and collected without regard to such transaction.”
The law does have a small business exception, known as the “de minimis rule,” but the exception is narrow. An employer’s withdrawal liability may be eliminated or reduced by up to $50,000 or 3/4 of one percent of the plan’s unfunded vested liabilities, whichever is less. The exception is quite narrow because the $50,000 credit is very often dwarfed by withdrawal liability. On average, an employer with a dozen employees will face withdrawal liability well in excess of $50,000.
M & M Appeal: Return to Trial Court
On appeal the court considered Simas’ liability as an alter ego employer of M & M. The MPPAA withdrawal liability is imposed on an “employer” that withdraws from a pension plan. As a separate corporation, but related entity, was Simas liable along with M & M?
In the M & M case, the 9th Circuit appellate court returned the case back to the trial court for further proceedings.
The appellate court held that in determining that Simas owed withdrawal liability as the alter ego of M & M, the trial court applied the wrong standard. The proper test is found in a 1994 case titled UA Local 343 v. Nor-Cal Plumbing, Inc. The Nor-Cal alter ego test requires proof (1) that the two firms have “common ownership, management, operations, and labor relations,” and (2) that the non-union firm is used “in a sham effort to avoid collective bargaining obligations.”
The court also noted that there is an issue as to whether or not this alter ego theory even applies under the MPPAA. The trial court was directed to consider whether the company can even be held liable under this alter ego theory, or whether is liable only under § 1392(c). Section 1392(c) provides that “[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 trial court was directed to hear evidence and apply the correct legal standard. Simas’ fate is yet to be determined.
Analysis: Contractors Be Wary
The court’s decision highlights the heavy-handed federal labor laws. If company signs a collective bargaining agreement which includes obligations to contribute to a pension fund, it should consider that it cannot withdraw without potentially significant financial liability.
The decision also highlights the risks associated with a “double-breasted” operation involving two related companies, one unionized and the other not. If the unionized company should withdraw or fail, in some circumstances the non-unionized company may share the resulting withdrawal liability.
During this economic downturn, construction firms in particular are tempted to seek government funded union work. But beware of the “tar baby.” Once in, there might not be a way out. Company owners planning such an endeavor should carefully study federal labor law and seek legal advice on how to minimize the risk of withdrawal liability.
Is your union’s pension fund underfunded? Review the U.S. Department of Labor’s Critical Status List.
Wall Street Journal article regarding pension underfunding.
Related topic: Federal proposed rule regarding employer’s mandate to post notice of union rights. NLRA Publication .
Download entire January 2011 Legal Update in PDF format.
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This article is intended as a brief overview of the law and are not intended to substitute as legal advice. Any questions or concerns regarding any statute or case law should be addressed to a licensed attorney. Copyright © 2011 by Barker Olmsted & Barnier, APLC. San Diego, California. All rights reserved.