In the most recent installment of the Sun Capital1 line of cases, the U.S. District Court for the District of Massachusetts (on remand from the First Circuit) held that two Sun Capital private equity funds were jointly and severally liable under the Employee Retirement Income Security Act (ERISA) for a bankrupt portfolio company's $4.5M multiemployer pension plan withdrawal liability. Under ERISA and the U.S. Internal Revenue Code, each member of a controlled group (which includes a corporation’s subsidiaries, parent and other subsidiaries of the parent that are a "trade or business" provided that an 80% ownership threshold is met) is jointly and severally responsible for various pension-related liabilities.
Although neither fund owned the requisite 80% interest on its own (SCP-IV held 70% and SCP-III and SCP-IIIQ held 30% in the aggregate) and the funds' organizational documents expressly disclaimed any intent to form a partnership or joint venture, the U.S. District Court found that the funds had formed a partnership under federal common law that controlled the bankrupt portfolio company. The District Court’s finding of a "partnership-in-fact" was based on the funds' joint investigation and action prior to investment, their co-investment activities, the lack of disagreement between the funds with respect to the management of the portfolio company and their joint efforts to control the portfolio company through Sun Capital Advisors. Since the activities of the funds went beyond passive investment (e.g., the funds had the ability to place employees of Sun Capital Advisors as board members, and benefited from management fee offset carry forwards that were not available to passive investors), they were engaged in a "trade or business" under the "investment plus" standard. Accordingly, the funds were held to be a part of a controlled group with the portfolio company.2
What You Need To Know
- The ruling establishes that a private equity fund can be engaged in a trade or business and be subject to controlled group liability under ERISA if either on its own, or together with other related funds, it owns at least 80% of a portfolio company. The Court looked beyond the funds' organizational formalities, largely non-overlapping sets of limited partners, and largely non-overlapping portfolio companies to find a partnership-in-fact that controlled the portfolio company. If the decision is upheld on appeal or followed by courts in other circuits, private equity funds will need to reassess the current market practice for structuring investments in portfolio companies that contribute to multiemployer pension plans or sponsor defined benefit pension plans.
- Private equity funds acquiring U.S. entities should conduct thorough due diligence of single employer and multi-employer pension liabilities and consider appropriate seller indemnifications or purchase price adjustments.
1 Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund (Sun Capital).
2 For full analysis of the Sun Capital line of cases, please see our March 7, 2014 bulletin, U.S. Supreme Court Declines to Review Liability Decision here.
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