Private Investment Funds Not Liable for Portfolio Company's Pension Withdrawal Liability

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  • The U.S. Court of Appeals for the First Circuit held that two Sun Capital private equity investment funds (Sun Capital Funds) were not liable for the withdrawal liability of a portfolio company based on a partnership-in-fact analysis.
  • In the First Circuit's November 2019 holding, the court said the Sun Capital Funds were not jointly and severally liable for their portfolio company's pension debt because the Sun Capital Funds did not constitute a controlled group. The First Circuit thereby overruled the District Court's 2016 holding that the Sun Capital Funds had created an implied partnership-in-fact for purposes of withdrawal liability.
  • Despite the First Circuit's holding that there was no implied "partnership-in fact" between the Sun Capital Funds, the existing Sun Capital "Trade or Business" analysis remains intact.

The U.S. Court of Appeals for the First Circuit has held in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund that two Sun Capital Funds were not under common control with Scott Brass Inc., their portfolio company (SBI), an entity in which the Sun Capital Funds collectively owned 100 percent (but in which neither Fund owned at least 80 percent).1 As a result, the Sun Capital Funds2 were deemed not liable for SBI's $4.5 million withdrawal liability to the New England Teamsters & Trucking Industry Pension Fund's multiemployer pension plan (the Pension Plan). The key holding by the court in its November 2019 decision was that the Sun Capital Funds had not formed a partnership-in-fact in acquiring and operating the SBI.

Background

Over the past decade, the Sun Capital Funds, two private equity funds, have been battling the Pension Plan about whether the Sun Capital Funds should be liable to the Pension Plan for SBI's withdrawal liability arising from SBI's withdrawal from the Pension Plan. The Pension Plan initially sued the Sun Capital Funds in 2010 for SBI's unpaid withdrawal liability after SBI filed for bankruptcy and withdrew from participation in the Pension Plan.

The Employee Retirement Income Security Act of 1974, as amended (ERISA), imposes joint and several liability on plan sponsors and each member of their "controlled groups" for certain defined benefit pension plan liabilities, including multiemployer plan withdrawal liability. Congress enacted the Multiemployer Pension Plan Amendment Act of 1980 (MPPAA) to ensure defined pension benefit plans remain viable, dissuade employers from withdrawing from multiemployer plans and enable pension funds to recoup unfunded liabilities. If the First Circuit had deemed the Sun Capital Funds to be in the same "controlled group" with SBI, the Sun Capital Funds would have been jointly and severally liable for the withdrawal liability of the partnership under the common control regulations.

An entity is typically under "common control" with another entity if each entity is in a trade or business and the entities are considered to be in a "parent-subsidiary" or "brother-sister" relationship, which generally exists where one entity owns 80 percent or more of the other entity. The Sun Capital Funds owned 30 percent and 70 percent, respectively, of SBI. In the 2016 Sun Capital case, the U.S. District Court for the District of Massachusetts had significantly expanded the "common control" test by supplementing it with a facts-and circumstances partnership-in-fact analysis. Under that test, the District Court found that the two Sun Capital Funds were under "common control" with the portfolio company and therefore liable for SBI's debt. (For a more detailed analysis on this discussion, see Holland & Knight's previous alert, "Pension Plan Withdrawal Liability Imposed on Investor Private Equity Funds," April 14, 2016.) The District Court also found that the Sun Capital Funds were in a trade or business due to their respective management activities with respect to their portfolio companies.

First Circuit Decision

The First Circuit stated in its decision last month that, while the Sun Capital Funds' limited partnership agreements expressly disclaimed any partnership or joint venture, there was evidence that even before incorporating, the Sun Capital Funds acted together in seeking out potential portfolio companies that would require extensive intervention with respect to management and operations. Furthermore, together the Sun Capital Funds developed restructuring and operating plans for target companies before actually acquiring them through limited liability companies (LLCs). Nonetheless, applying an analysis including federal statutory and common laws regarding partnerships, the First Circuit ultimately held that the factors point away from common control, including finding that there was sufficient evidence that the Sun Capital Funds did not "intend" to join together "in the present conduct of the enterprise" and noting that the Sun Capital Funds' express disclaimer of any sort of partnership between them counts against a partnership finding.

Other factors the First Circuit cited as support for the conclusion of no partnership in fact include that: 1) while there was overlap between the limited partners between the Sun Capital Funds, most of the limited partners were not shared between both Sun Capital Funds; 2) the Sun Funds filed separate tax returns, kept separate books and maintained separate bank accounts; and 3) the Sun Capital Funds did not invest in the same companies at a fixed or even variable ratio, which also showed independence in activity and structure. While the First Circuit rejected the Sun Capital Funds' argument that the formation of a limited liability partnership through which to acquire SBI was evidence against an intent to form a partnership, the court agreed that the formation of an LLC both prevented the Sun Capital Funds from conducting their business in their "joint names" and limited the manner in which they could exercise mutual control over and assume mutual responsibilities for managing SBI.

In its final statement, the First Circuit indicated its reluctance to impose withdrawal liability on private investors, citing no indication of congressional intent to impose such liability and recognizing the conflicting aims of ensuring viability of pension funds and encouraging private sector investment. The court did not address other legal issues in the case in making its determination, leaving the prior decision relating to the private equity funds acting as a "trade or business" to be addressed another day.

Takeaways and Considerations

Although the decision would appear to be a victory for private equity funds, it should continue to serve as a caution sign with guidelines for structuring management arrangements as to what practices may put funds at risk of being viewed as a partnership. Furthermore, in light of the standing "trade or business" analysis provided in the District Court's 2016 Sun Capital decision, private equity funds seeking to avoid portfolio liability should continue to monitor their level of involvement in managing portfolio companies. Finally, multiemployer pension plans continue to operate with substantial underfunding liabilities. Private equity funds should carefully assess risks relating to unfunded multiemployer pension liabilities3 and other compliance requirements that impose liabilities beyond the immediate investor and onto controlled group members at the time of investment.


Notes

1 943 F. 3d 49 (1st Cir. 2019).

2 Sun Capital III LP (with Sun Capital III QP LP) and Sun Capital IV LP.

3 Controlled group liability also applies to underfunded single employer pension plans.

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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