In late July of this year, the U.S. Court of Appeals for the First Circuit reversed a Massachusetts District Court, and in a decision of first impression, held that one of Sun Capital Partner’s private equity funds was liable for an unfunded pension liability generated by its bankrupt portfolio company, Scott Brass, Inc. While this case arose under the Employment Income Security Act of 1974, as amended (“ERISA”), in reaching its decision, the First Circuit held that: (i) the general partner of the private equity fund was engaged in the “trade or business” of managing the fund (and its portfolio companies); and (ii) that such trade or business could be attributed to the fund itself in order to support imposition of the unfunded pension plan liability.

I. TRADITIONAL PRIVATE EQUITY FUND STRUCTURING AND TAXATION

A. Private Equity Fund Structuring Virtually all private equity funds are structured as limited partnerships. The general partner (“GP”) is usually paid a 2 percent management fee and 20 percent share of the ultimate profits (the so-called “2 and 20 rule”). The limited partners (“LPs”) are usually paid a preferred return on their invested equity and (in addition to a return of their invested equity) 80 percent of the back-end profits. The fund’s primary economic objective is usually to “invest” in portfolio companies. The LP investors rely on the GP to provide top-end market management and intervention to maximize value and then monetize that value by selling the portfolio company, usually within a five year horizon.