On March 28 2016 the US District Court for the District of Massachusetts concluded that two private equity funds with the same sponsor, investing together in a distressed portfolio company, can be held liable for pension liabilities incurred by the company under the Employee Retirement Income Security Act 1974 (ERISA), even where the ownership interest in the company of each of the funds, when viewed separately, would have been insufficient to reach that result. The district court's decision rests on a finding that the two funds – based on their coordinated actions in making and managing the investment – entered into a 'partnership-in-fact' or deemed partnership, and that this deemed partnership was part of a controlled group with the company.(1)
Under ERISA, "trades or businesses" under "common control" are jointly and severally liable for multi-employer pension plan withdrawal liabilities incurred by other members of the controlled group. Generally entities are under common control if, among other tests, they are linked by an 80% ownership interest. The two funds managed by Sun Capital held respectively 70% and 30% of the limited liability company through which the portfolio company was acquired, so neither fund's stake was sufficient to meet this test. However the court held that the two funds had formed a partnership or joint venture to hold their investment – notwithstanding the funds' express disavowal of intent to form such a partnership – and treated the deemed partnership (without explicit analysis) as a general partnership, despite the funds' decision to form a limited liability vehicle.
In reaching its conclusion with respect to common control, the court looked to the smooth coordination in fund investments, control of the funds by the same general partners and the similarities in fund governing instruments and fund operations. These factors were found to indicate a lack of "actual independence" in the funds' investment decisions. The court's conclusion that a separate deemed partnership sat between the limited liability company and the funds – coupled with its determination that the deemed partnership was itself engaged in a trade or business – enabled the court to pierce the limited liability shield and hold the funds liable for the deemed partnership's liabilities, specifically its controlled group liability for the pension obligations of the portfolio company.
While the reach of this decision remains to be seen, private equity sponsors should consider reviewing their fund structures and investing practices with counsel, to determine the extent to which they may share features that this decision found indicative of a partnership-in-fact or of being engaged in a common trade or business with a portfolio company.
Sun Capital filed a notice of appeal in the First Circuit on April 4 2016.
For further information on this topic please contact William Jewett or Connor Kortje at Ropes & Gray LLP by telephone (+1 617 951 7000) or email (firstname.lastname@example.org or email@example.com). The Ropes & Gray website can be accessed at www.ropesgray.com.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.