On March 28, 2016, the District Court of Massachusetts held that two private equity funds managed by Sun  Capital  (the  “Sun  Funds”)  were  jointly  and  severally  liable  for  the  multiemployer  pension withdrawal liabilities of one of the Sun Funds’ portfolio companies, Scott Brass Inc. (“Scott Brass”), even though neither fund individually owned a stake in Scott Brass large enough to trigger such liability under the Employee Retirement Income Security Act of 1974 (“ERISA”).

When Scott Brass went bankrupt and defaulted on its withdrawal obligations to a multiemployer pension plan, the plan sued the Sun Funds, asserting that they were jointly and severally liable under the theory that (1) the Sun Funds were engaged in a “trade or business” and (2) were in an ERISA “controlled group” with Scott Brass. Traditionally, private equity funds have not been held responsible for the pension funding liabilities of their portfolio companies; however, under the First Circuit’s recently adopted “investment plus” test, an otherwise passive investment can rise to the level of a trade or business for ERISA controlled group purposes if coupled with certain additional activities. The First Circuit has not established a specific standard to determine which additional activities constitute the requisite “plus” but, in a prior appeal involving the Sun Funds, it emphasized that the receipt of a management fee offset for management services performed for Scott Brass was an economic benefit beyond what a true passive investor would receive.

Following the First Circuit’s  lead, the district court held that, when coupled with the Sun Funds’ management activities at Scott Brass, the benefit received from management fee offsets was sufficient to find that both Sun Funds were engaged in a trade or business under the First Circuit’s “investment plus” test. The court then turned to the controlled group analysis. Rather than follow a “traditional” controlled group analysis, which focuses on corporate formalities like entity structure, the court reasoned that the Multiemployer Pension Plan Amendments Act, which amended ERISA in 1980, “allows for, and may in certain circumstances require, the disregard of such formalities,” and thus asked whether the Sun Funds’ investment in Scott Brass could be deemed a “partnership-in-fact,” regardless of the fact that the Sun Funds had formed an LLC for the Scott Brass investment that formalized and documented the fact that Sun Funds were separate partnerships. Ultimately, after considering numerous factors (including the Sun Funds’ co-investments in five other companies through the same organizational structure and the joint activities they engaged in before the co- investing), the court determined that the Sun Funds’ investment in Scott Brass was indeed a partnership-in-fact, whose interests could be aggregated for purposes of the ERISA controlled group analysis. As such, the court concluded the Sun Funds were jointly and severally liable for the pension withdrawal liabilities of Scott Brass.

The Sun Capital decision is currently pending appeal in the First Circuit. Until the decision is finally resolved on appeal, private equity firms across the U.S. should tread carefully when using affiliated funds to achieve a combined ownership stake of 80% or more in a portfolio company with significant pension liabilities, even if each individual fund holds only a minority share (one of the Sun Funds owned only 30% of Scott Brass), especially where management fee offsets are involved.