Although this case almost certainly will be appealed, there are several takeaways to consider while we await further guidance: 

  • The first test for ERISA liability – the “trade or business” test based on the investment-plus standard – will most likely apply to a private equity fund if the fund is formed as a limited partnership, if the fund’s general partner has its own capital commitment to the fund, if the general partner is owed a management fee that can be offset by portfolio company fees received in connection with its investments (either currently or as a carryforward against future periods), and if the private equity fund derives economic benefits from portfolio company investments more than an ordinary, passive investor.
    • Other, non-traditional investment vehicles (such as those formed by “fundless” or “independent” sponsors) where the person or entity driving the investment decision derives economic benefits from portfolio company investments more than an ordinary, passive investor may similarly be considered a “trade or business” for purposes of ERISA liability. The more these non-traditional vehicles look and operate like private equity funds as a result of their active management of the portfolio company, the ability to earn a management fee, and the ability to obtain other benefits above and beyond return on its equity investment, the greater is the risk of tripping the “trade or business” prong of the test.
  • The second test for ERISA liability – the 80% common control test – cannot be avoided simply by having two or more affiliated private equity funds structure their ownership in an investment vehicle such that no individual fund’s ownership exceeds 80%. 
    • Private equity funds that share a general partner or have an agreement or history of investing together in a fixed proportion will likely meet this second prong if their ownership in a portfolio company exceeds 80% in the aggregate (as is typical with “parallel funds”).
    • Private equity funds with different general partners and independent investment portfolios may nonetheless be deemed to be acting under “common control” when the investment decisions of those funds are formally or informally made by the same group or substantially the same group of senior fund managers (as is typical with a fund and its “successor” fund that share in investment opportunities while the first fund’s investment period is still active).
    • Investors who have a “partnership-in-fact” (which is a very fact-intensive analysis) that each own individually less than 80% of a portfolio company, but collectively own more than 80% of such portfolio company, will likely meet the second-prong of the test. While courts will review the written agreements between or among the investors to find evidence of whether the investors have a partnership to act jointly, courts will also review the history of the parties’ actions inside and outside of the particular company investment to determine if the investors have a pattern of taking coordinated actions, acting jointly or otherwise synchronizing themselves smoothly for the benefit of the investor group.
    • Note that shares held by employees, which are typically subject to vesting or rights of first refusal, are not considered outstanding for purposes of the common control analysis. Therefore, if an operating company is owned 70% by a trade or business and 30% by management whose shares are subject to substantial restrictions, the trade or business will be deemed to own 100% of the operating company.
  • Structuring an acquisition in a manner such that unaffiliated third-party investors (with no history of coordination with the private equity fund sponsor) hold greater than 20% of a portfolio company, where the third-party investors have the ability to make their own independent decisions with respect to that investment, should allow the private equity fund sponsor (and the unaffiliated third party) to avoid ERISA liability. This may provide a significant opportunity for private equity funds or other investors who are willing to make minority investments in portfolio companies alongside a private equity fund sponsor. Fund sponsors should also consider whether the co-investors should participate directly in the portfolio company rather than through an aggregator special-purpose vehicle that is sponsor-managed.