Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund

It’s Part 2 of one of the most important withdrawal liability cases in a decade…

Executive Summary In 2013, the First Circuit issued the highly publicized decision in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund (“Sun Capital I”), holding that a private equity fund that engages in activities beyond “passive investment” could be considered a “trade or business” and, thus, may be considered part of a controlled group that is jointly and severally liable for withdrawal liability of its portfolio company. [CR&B News Nov. 2013]

On March 28, 2016, the other shoe dropped when the United States District Court for the District of Massachusetts decided Part 2 of the same dispute (“Sun Capital II”). 2016 BL 95418. The court held that two Sun Capital Funds were jointly liable for $4.5 million in withdrawal liability of their portfolio company, Scott Brass, Inc. (“SBI”), reasoning that, although neither owned the requisite 80 percent of SBI, the two related equity funds were a “partnership-in-fact” under federal law that owned all of SBI.

Factual Background SBI incurred $4.5 million in withdrawal liability to the New England Teamsters & Trucking Industry Pension Fund (the “Pension Fund”) when it entered bankruptcy and ceased contributions to the Pension Fund. At the time of its bankruptcy, SBI was ultimately owned by two private equity funds (the “Sun Capital Funds”) through a blocker LLC: Sun Capital Partners III, L.P. owned 30 percent and Sun Capital Partners IV, L.P. owned 70 percent. The Pension Fund alleged that the Sun Capital Funds were responsible for SBI’s withdrawal liability.

Trade or Business under Common Control For purposes of withdrawal liability, ERISA defines the “employer” that is liable for such amounts to include not only the entity directly obligated to make contributions to the fund, but also any “trades or businesses (whether or not incorporated)” that are under “common control” with the contributing entity. As relevant to this case, businesses are considered under common control if a parent organization owns (directly or through a series of organizations) at least 80 percent of each organization in the chain.

In 2013, the First Circuit in Sun Capital I addressed the question of whether a private equity fund could be considered a “trade or business” for this purpose. Sun Capital I held that, while passive investment alone is insufficient to constitute a trade or business, “investment plus” may make an investor a trade or business. After engaging in a detailed facts and circumstances analysis, the First Circuit held that at least one of the Sun Capital Funds constituted a trade or business because its involvement with SBI exceeded mere passive investment.

The case was then remanded to the U.S. District Court for the District of Massachusetts to determine whether, among other things, in light of this analysis on the trade or business issue, the Sun Capital Funds had the requisite ownership to be considered part of a controlled group with SBI. The court answered “yes” in Sun Capital II.

The District Court’s Holding The District Court first determined that the other Sun Capital Fund – the one not ruled on in Sun Capital I – was also a trade or business applying the same test. It then moved on to hold that – notwithstanding disclaimers in the agreement governing the LLC formed to acquire SBI – the two Sun Capital Funds together constituted a “partnership-in-fact” under federal law, such that their ownership in SBI should be aggregated, making their ownership 100 percent and sufficient to be part of SBI’s controlled group. Although the two Sun Capital Funds are formally structured as completely distinct legal entities, the District Court noted that ERISA permitted disregard of organizational formalities and engaged in a detailed facts and circumstances analysis of the Sun Capital Funds’ joint activities. It found that the two acted in concert in taking most significant actions relating to the investment in and management of SBI and, thus, were a “partnership-in-fact” based on lack of “meaningful evidence of actual independence.” Accordingly, the two Funds’ ownership percentages in SBI were aggregated, and the Funds are jointly liable for SBI’s withdrawal liability.

Implications of the Decision This case is of critical importance to the private equity and venture capital community, as well as other “passive” investors and business owners. While most such entities currently (consistent with IRS regulations) apply a more “black and white” mathematical test to determine their controlled group status, this case portends a more nebulous facts and circumstances analysis. Investors, particularly those that co-invest with related persons, should carefully consider their structure and operations in light of this decision. Although the decision relates to withdrawal liability for multiemployer plans, the court’s analysis would apply similarly to underfunded single-employer defined benefit plan liability and, potentially, other ERISA liabilities of a portfolio company.