Previously, we wrote about the First Circuit decision that a private equity fund constituted a “trade or business” under ERISA as amended by the Multeimployer Pension Plan Amendments Act (“MPPAA”). That dry description is actually very significant since it would mean that private equity funds and their other portfolio companies could be responsible for withdrawal liability, potentially in the millions of dollars, when a portfolio company withdraws from a multiemployer plan. Based on a recent District Court case in that same dispute, it may be even harder for private equity funds and their portfolio companies to escape liability, which could have implications for those companies and the companies that buy them.

By way of background, multiemployer pension plans are pension plans into which (as the name implies) many employers contribute pursuant to collective bargaining agreements. If a multiemployer plan is underfunded, and an employer withdraws, the plan is allowed to assess liability on that employer pursuant to a formula to help make up the underfunding. As we detailed previously, MPPAA imposes liability on any “trade or business” that is under “common control” with the withdrawing employer.
In prior iterations of this case, Sun Capital Partners had alleged that none of the three investing funds (Sun Fund IV, Sun Fund III, and Sun Fund III QP) was a trade or business since each was merely a passive investor. The First Circuit rejected this approach and applied an “investment plus” analysis (without giving much in the way of a standard) to Sun Fund IV based on certain economic benefits it received in connection with the management of the portfolio company by its affiliated advisors that were different from benefits a merely passive investor would usually receive. However, it remanded the case back to the District Court to determine if the other funds were also trades or businesses.

It turned out that the facts on which the First Circuit relied were twisted around and it was actually Sun Fund III and Sun Fund III QP that received economic benefits. However, that turned out not to matter to the District Court.

As noted above, most of the analysis by the courts had been focused on the “trade or business” prong, but the District Court, on remand, also examined whether the Sun Funds were under “common control.” On its face, based on corporate formalities, the answer was no. Sun Fund IV owned 70% of the ultimate parent of the withdrawing company and the other two funds together owned 30%. None of them owned the requisite 80% necessary to be treated as a parent entity under the “common control” test. The Sun Funds actually admitted that they kept their ownership percentage below 80% specifically to avoid withdrawal liability.

However, looking at actions of the Sun Funds, the Court concluded that the Sun Funds had formed a partnership-in-fact. The Court found that the Sun Funds created an ultimate parent LLC to invest in the withdrawing company and, prior to investment, engaged in joint activity leading to the two funds’ decision to coinvest. These actions were sufficient, under the Court’s analysis, to form a partnership-in-fact. The fact that their organizing documents disclaimed any intent to form a partnership was not sufficient to overcome the Court’s view of the existence of the partnership. Further, given the First Circuit’s conclusion that an “investment plus” test should apply, it was easy for the District Court to conclude that the partnership was a “trade or business.”

The distinction is important because, as partners in a partnership invested in a withdrawing company, each Sun Fund would be liable for its proportionate share of the liability. This is because the partnership itself would be under “common control” with the withdrawing company (as a parent) and its liability would pass through to its partners.

Private equity funds should examine this decision closely. While this dispute may not be over, this precedent casts significant doubt on the long-standing position of private equity funds that they are not liable for the withdrawal liability of their underlying portfolio companies.

Acquirers of portfolio companies from private equity funds should also take note. If the funds are under common control with their portfolio companies, then under the applicable ERISA and tax rules, those portfolio companies could also be considered under common control with one another. This would mean a withdrawal liability in Portfolio Company A, for example, could be assessed against Portfolio Company B and Portfolio Company C. Depending on the structure of any sale of Portfolio Company B or C, that liability could follow the sold portfolio company to its new owner.