Private Equity Fund May Be “Trade or Business” Under ERISA

by Morgan Lewis

First Circuit holds that an investment fund may be responsible for controlled group pension liabilities of portfolio companies.

On July 24, the U.S. Court of Appeals for the First Circuit issued a significant decision addressing the potential liability of private equity funds under the Employee Retirement Income Security Act (ERISA). In Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, the First Circuit found that a private equity fund qualified as a "trade or business" under ERISA and thus was potentially liable for withdrawal liability owed to a multiemployer pension plan by a portfolio company in which the fund had invested.[1] Although not binding on other circuits, the court's decision increases a private equity fund's potential exposure to ERISA liabilities incurred by its portfolio companies. The risk that the decision creates for private equity funds will require additional care in structuring and managing their portfolios going forward.

Background and Procedural History

In Sun Capital, two private equity funds (Sun Fund III and Sun Fund IV) invested in a manufacturing company in 2006 through an affiliated subsidiary and subsequently held 30% and 70% indirect ownership interests, respectively, in the manufacturing company. Two years after the investment, the manufacturing company filed for protection under chapter 11 of the Bankruptcy Code, triggering a withdrawal from the New England Teamsters and Trucking Industry Pension Fund (the pension plan), with a resulting withdrawal liability in the amount of $4.5 million. In pursuing a claim against the bankrupt company, the pension plan also asserted liability against the two Sun Funds, arguing that they were a joint venture or partnership under common control with the bankrupt company and thus jointly and severally liable for the bankrupt company's withdrawal liability.

In response to the pension plan's action, the private equity funds filed for a declaratory judgment in the U.S. District Court for the District of Massachusetts, claiming, among other things, that they were not "employers" under ERISA (and thus not liable for the bankrupt company's withdrawal liability) because they were neither (1) "trades or businesses" nor (2) under "common control" with the bankrupt company. The district court agreed, finding that the private equity funds were mere passive investors in the portfolio company and, therefore, were not "trades or businesses" under common control with it. Accordingly, the district court held that the funds were not jointly and severally liable for any withdrawal liability the bankrupt company owed the pension plan.

In deciding this issue, the district court refused to follow a 2007 opinion letter from the Pension Benefit Guaranty Corporation (PBGC) that found a private equity fund that owned a 96% interest in a portfolio company to be a trade or business under common control with the portfolio company and thus liable for any underfunding when the portfolio company's single-employer pension plan was terminated. In addition, the district court held that—even though each private equity fund structured its ownership stake in the portfolio company to be less than 80%, in part to minimize exposure to potential future withdrawal liability—these steps did not subject either fund to liability under ERISA's "evade or avoid" provisions.

The First Circuit Decision

"Trade or Business"

The First Circuit reversed the district court's conclusion that the private equity funds were mere passive investors. Instead, the court found that, at least where a passive investment in an entity might defeat the imposition of withdrawal liability, the court should look at whether some form of an "investment plus" approach would be appropriate when applying the concept of "trade or business" under ERISA. Under such an approach, the court concluded that at least one of the private equity funds actively and regularly exercised control over the bankrupt company. According to the court, this was sufficient to find that one of the funds—Sun Fund IV—was a "trade or business" and could thus be jointly and severally liable for the bankrupt company's withdrawal liability if it were part of a "controlled group" with the bankrupt company. The court remanded to the district court for further factual development on the issue of whether the private equity funds were under "common control" with the bankrupt company.

When applying its "investor plus" approach, however, the court did not provide any definitive guidelines to determine when a private equity fund transforms itself from a mere passive investor into an "investor plus." Instead, the court identified a number of factors that may tip the scales. At one end of the scale, the court noted that a mere investment to seek a profit will not turn the investment into a trade or business. Rather, various factors, including the following, may expose a fund to potential ERISA pension liability owed by a portfolio company:

  • Descriptions in Investment Offerings: According to the court, various limited partnership agreements and private placement memos touted the active involvement that the two private equity funds would have in the management and operation of the portfolio company and noted that the general partner in each fund had "exclusive and wide-ranging management authority."
  • General Partner Duties: The court found that the general partners were given extensive roles in hiring, terminating, and compensating employees and agents of the funds and the portfolio companies.
  • Management Role: In light of the stated purpose of the funds to find potential targets ripe for transformation, the court stated that the funds played a significant role in the restructuring and operation of the target companies so that those companies could be later sold at profit.
  • Economic Benefits: The court determined that at least one of the funds—Sun Fund IV—derived a direct economic benefit that a typical passive investor would not receive. Specifically, the court concluded that the portfolio company's payments to the fund's general partner were offset by the fees the fund itself was required to pay its general partner.

Based on the "sum" of these factors, the court concluded that Sun Fund IV reached "investor plus" status and was a "trade or business" under ERISA. The court remanded the issue of whether Sun Fund III met this test because the record did not contain information as to whether Sun Fund III had received any similar direct economic benefits. The court's focus on this last factor—and its remand for further factual development on Sun Fund III—suggests that the court may have given this factor significantly greater weight in its analysis than the other factors identified (and, indeed, that it may have found this factor dispositive).

Deference to PBGC Opinions

The First Circuit also addressed the degree of deference it should give to the 2007 PBGC appeals letter that first applied an "investment plus" approach to private equity funds. The PBGC appeared in the Sun Capital case as an amicus curiae to defend its 2007 opinion and argued that the letter was entitled to substantial deference because the PBGC was interpreting a statutory term—"trade or business"—that was included in its own regulations.

The court rejected this assertion, finding that the PBGC regulations merely parroted ERISA's statutory language. Because the PBGC had made no effort actually to define the term by regulation, subject to administrative notice and comment, the court held that no deference was due to PBGC's subsequent interpretive guidance in the 2007 letter beyond its own intrinsic power to persuade. In addition, the court stated that greater deference was not appropriate where a party (e.g., the private equity funds) may face significant liability for conduct that took place when the party lacked "fair notice of the interpretation at issue."

Evade or Avoid

Finally, the district court had found that the structure of the funds' overall ownership interest in the portfolio company was not designed to evade or avoid liability under ERISA. The First Circuit affirmed on appeal but on different grounds.

The pension plan had claimed that the 70%/30% ownership interests in the portfolio company were designed to circumvent the 80% parent-subsidiary common control requirement under ERISA. The pension plan argued that withdrawal liability should attach to the private equity funds under ERISA's "evade or avoid" provisions, even if they were not part of the controlled group as a result of falling below the 80% ownership threshold, because (1) a principal purpose of the ownership structure was to avoid unfunded pension liability that would possibly be triggered if any entity owned 80% or more of the portfolio company and (2) discovery documents revealed that the funds had divided the ownership as they did, in part, to minimize exposure to potential unfunded pension liability.

The court rejected this argument, holding that the remedy the pension plan sought was not available under the statute. Specifically, ERISA's "evade or avoid" provisions allow a court to ignore a transaction where a principal purpose of the transaction is to evade or avoid pension liability. The court concluded that this provision would only allow the court to put the parties in the same situation as if the transaction had not taken place but would not allow the court to take the additional step of creating new terms or even a new transaction that did not previously exist in order to impose liability. Given that the division of ownership between Sun Fund III and Sun Fund IV had occurred before the acquisition of the portfolio company was complete, simply ignoring that transaction would not provide the pension plan any relief because neither Sun Fund III nor Sun Fund IV would have held any stake in the portfolio company under a literal reading of the statute.


While currently controlling only in the First Circuit, the Sun Capital decision will have a significant effect on the means by which well-managed private equity funds acquire, manage, and turn around the portfolio companies in which they invest going forward. Among other things, private equity funds will be encouraged to pay close attention to the degree to which they play active roles in portfolio company management; make greater use of structural solutions, such as blocker entities; and observe closely the niceties of corporate governance and corporate form. Failure to do so may increase the exposure of private equity funds, not only to the potential withdrawal liability of their portfolio companies but also to the liability of those companies for contributions to single-employer pension plans and for underfunding of those plans when they terminate.

The Sun Capital decision, however, does have some good news for private equity funds. As the court held, structuring an initial transaction so that no single owner will hold an 80% or greater stake in a portfolio company with potential unfunded pension liabilities will not expose a fund to evade-or-avoid liability under ERISA. Nonetheless, going forward, private equity funds should take steps to minimize their exposure for pension obligations incurred by potential and current portfolio companies. These steps should include the following:

  • Conducting thorough due diligence into any potential employee benefits liability of a target company, including withdrawal liability or underfunded single-employer pension liability
  • Examining with care whether any particular fund should invest in a portfolio company with substantial unfunded pension liability, and, if so, considering structuring the initial transaction to avoid 80% ownership by any single fund
  • Managing and structuring the initial transaction to ensure that the private equity funds appear as passive investors and will not be deemed to be engaging in management activities or other activities that would elevate the funds to "investor plus" status
  • In particular, paying close attention to any general partner's duties, how such partners are compensated, and, most importantly, whether the fund receives any direct economic benefits at the expense of the portfolio company other than those that a passive investor would receive

[1]. See Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 12-2312, 2013 WL 3814984 (1st Cir. July 24, 2013), available here. The Sun Funds filed a petition for rehearing on August 7, 2013.


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.

© Morgan Lewis | Attorney Advertising

Written by:

Morgan Lewis

Morgan Lewis on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.