First Circuit Appeals Court Reverses Finding of Controlled Group Pension Liability Due to ‘Partnership in Fact’

Morgan Lewis

Morgan Lewis

The US Court of Appeals for the First Circuit recently reversed a prior decision of the US District Court for the District of Massachusetts, which had held that two private equity funds were trades or businesses in common control with a bankrupt portfolio company, and were therefore liable for the multiemployer pension plan withdrawal liability of the bankrupt company. In the prior decision, the district court had rejected the funds’ choice of organizational structure, holding that such choice should not automatically determine whether investment funds that are trades or businesses may be part of the same controlled group of businesses if a partnership-in-fact existed between them.

Notably, the First Circuit, in overruling the prior district court decision, did not go so far as to hold that companies’ choice of organizational structures will be respected in all cases. Rather, it looked to an eight-factor test that had previously been adopted by the 1964 US Tax Court case Luna v. IRS Commissioner and held that, in this particular situation, most of the Luna factors pointed away from supporting a finding that a partnership-in-fact had been created.


Under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code of 1986, as amended (the Code), members of the same “controlled group” are jointly and severally liable for certain employee benefit liabilities of each group member, including single-employer defined benefit plan funding and Pension Benefit Guaranty Corporation (PBGC) premiums, medical plan COBRA obligations, and multiemployer pension plan withdrawal and termination liability. Under ERISA and the Code, a controlled group generally requires a common ownership/control threshold (at least 80% for a parent-subsidiary relationship or, for a brother-sister relationship, five or fewer individuals with 80% overall ownership and 50% identical ownership) among trades or businesses.

Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund

The case history of Sun Capital spans nearly a decade (i.e., 2010–2019) and has several different rulings that warrant some additional detail. As a precursor to these decisions, in 2007, the PBGC issued an opinion letter in which it took the position that a private equity fund was a trade or business, rather than a mere passive investor, and therefore could be held jointly and severally liable for the unfunded pension liabilities of one of its portfolio companies. This PBGC opinion letter was judicially endorsed in a Michigan federal district court case, Sheet Metal Workers National Pension Fund v. Palladium Equity Partners, LLC. However, prior to the Sun Capital decisions, the PBGC view was not addressed by any federal circuit courts of appeals.

From a factual standpoint, the case involved certain private equity funds managed by affiliates of Sun Capital Partners, Inc. (Sun Capital). The funds at issue were referred to as Sun Fund III and Sun Fund IV (together, the Funds). The Funds owned 30% and 70%, respectively, of an LLC, which through a holding company owned 100% of Scott Brass, Inc. (SBI). SBI was the entity that incurred withdrawal liability with respect to a multiemployer pension plan. The multiemployer pension fund demanded withdrawal liability from SBI (which could not pay subsequent to its bankruptcy) and also from the Funds, claiming the Funds were trades or businesses that were part of a joint venture under common control with SBI and were therefore part of a “controlled group” with SBI, even though neither owned 80% of SBI.

In 2010, the Funds brought an action for declaratory relief in district court, asserting that the Funds were not trades or businesses, and also that even if they were, they were not part of a joint venture and thus not under common control with SBI. In 2012, the district court ruled that the Funds were not trades or businesses. Upon appeal by the pension fund, the First Circuit reversed that ruling and held that a private equity fund could, depending on the facts and circumstances, be held jointly and severally liable as a “trade or business” (i.e., not a mere passive investor) for the unfunded pension obligations of its portfolio companies under an “investment plus” analysis. The First Circuit further held that, based on the facts and circumstances, Sun Fund III was a “trade or business.” (Notably, this particular ruling has not been overturned, and the November 22, 2019 decision of the First Circuit addressed a different issue, so the “trade or business” ruling remains applicable law in the First Circuit.)

The First Circuit then remanded the case to the district court for further proceedings to determine (1) whether Sun Fund IV was also a “trade or business” and (2) whether Sun Fund III and Sun Fund IV were under “common control” with SBI. Upon remand, the district court held that Sun Fund IV was also a trade or business and that both Funds were under common control with SBI.

Regarding whether the Funds were under common control, the district court addressed the issue of whether to ignore the structure chosen by the Funds (i.e., a less than 80% investment by Sun Fund III and a greater than 20% investment by related, although not parallel, Sun Fund IV) and to “deem [a] partnership-in-fact” to exist between the Funds rather than the legal entity formed below them. On this issue, in 2016, the district court held that the investments by the Funds in an LLC that owned SBI were disregarded; instead, it deemed the Funds to have formed a general partnership-in-fact that indirectly owned 100% of SBI, and thus as general partners the Funds had joint and several liability for SBI’s pension obligations. Sun Capital appealed this decision.

First Circuit Reversal

On appeal of the partnership-in-fact issue, the First Circuit reversed the district court, holding that the applicable Luna test had not been met. The First Circuit also could not conclude that Congress intended to impose liability in this scenario. As part of its application of the Luna factors, the court noted that both of the following factors favored a finding of a de facto partnership: (1) the Funds’ “exercising mutual control over and assuming mutual responsibilities for the enterprise” by “identifying, acquiring and selling portfolio companies together”; and (2) the overall organizational control, given that two Sun Capital principals in control of the Funds’ general partners essentially ran the Funds, and the Funds pooled their resources and expertise in a subsidiary entity.

However, the court then noted that each of the following Luna factors favored a finding of no partnership-in-fact: (1) the Funds did not intend to join together in the conduct of an enterprise, but rather expressly disclaimed any sort of partnership (e.g., the Funds’ creation of an LLC through which to acquire SBI shows an intent to not form a partnership); (2) the business was not “conducted in the joint names of the parties”; (3) the parties did not “represent to others that they were joint partners”; (4) the Funds “filed separate tax returns”; (5) the Funds “kept separate books” and maintained “separate bank accounts”; and (6) the Funds had a significantly different group of investors (even though there was some overlap). In addition, the court noted that Sun Fund III and Sun Fund IV did not operate in parallel, i.e., did not invest in the same companies at a fixed or even variable ratio, which the court said shows some independence in activity or structure. Lastly, the court indicated it was reluctant to impose withdrawal liability on private investors, such as private equity funds and their limited partners, based on facts such as these, because the court said there was no clear “indication of congressional intent” to do so and/or any directly applicable formal guidance from the PBGC.


Although this latest decision will likely be welcomed by private equity funds because it limits the broad reach of the “partnership-in-fact” rationale applied by the district court, it is important to note two things that this decision does not do:

  1. The First Circuit did not overturn its prior holding that a private equity fund can be held liable as a controlled group member with its portfolio company as a “trade or business” under an “investment plus” analysis if it has a sufficient ownership interest to satisfy the controlled group test.
  2. The First Circuit rejected the view that a court is bound by the corporate form chosen by the parties and, therefore, is precluded from recognizing the existence of a partnership-in-fact where two funds together own the operating company. Instead, it held that if two different funds have formed a partnership-in-fact under the multifactor Luna test, they can be held jointly and severally liable as general partners for the debts of such partnership.

Notably, given that the First Circuit specifically recognized the fact that the Funds were not investing in parallel as a factor that weighed against a partnership-in-fact, this leaves open the question of whether it would have handed down the same ruling had Sun Fund III and Sun Fund IV been parallel funds.[1]

Shortly after the First Circuit’s November 22 decision, the multiemployer plan filed a petition for rehearing claiming that the court (1) should have used the partnership test laid out by the US Supreme Court in its 1949 decision in Commissioner v. Culbertson, as opposed to the multifactor test laid out by the Tax Court in the 1964 Luna decision; and (2) clearly misstated the purpose of the federal pension law (e.g., that it included encouraging equity investment in companies with multiemployer pension plan obligations).

As it is not clear whether the First Circuit’s holdings will be upheld on appeal or whether its analysis will be adopted by other circuits, the decision continues to raise many questions about potential pension liability for private equity funds and other investors. At the very least, private equity firms that are considering investing in an entity with potential single-employer or multiemployer pension liability should continue to plan carefully.

[1] Note that dicta in each of the Sun Capital decisions indicates that parallel funds within Sun Fund III and Sun Fund IV were all grouped together. However, presumably Sun Capital agreed to do so for the sake of simplicity and because grouping those underlying parallel funds was essentially irrelevant to the question of whether Sun Fund III and Sun Fund IV were part of the same controlled group, rather than an agreement to do so on its merits (i.e., because if the court were going to group Sun Fund III and Sun Fund IV together under a partnership-in-fact analysis it would have obviously done the same with the parallel funds under the same type of analysis, whereas establishing that Sun III and Sun Fund IV were separate unrelated entities made the aggregation of the underlying parallel funds irrelevant).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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