In Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, a U.S. district court in Massachusetts held that investment funds managed by private equity firm Sun Capital Advisors, Inc. (“Sun Capital”) were not liable for a portfolio company’s withdrawal liability with respect to a multiemployer pension plan. The court rejected as unpersuasive a 2007 Pension Benefit Guaranty Corporation (“PBGC”) Appeals Board finding that a private equity fund was a “trade or business” under common control with its portfolio company and therefore was liable for the funding shortfall of the company’s terminated defined benefit plan. The Sun Capital decision, which is on appeal to the First Circuit, strengthens the argument that private equity funds are not liable for the multiemployer and defined benefit pension plan liabilities of their portfolio companies.
The Employee Retirement Income Security Act of 1974 (“ERISA”) imposes joint and several liability for various liabilities, including withdrawal liability under a multiemployer pension plan, on each “trade or business” under common control with the employer sponsoring the pension plan. The PBGC has interpreted this aspect of ERISA broadly. In 2007, the PBGC Appeals Board ruled that a private equity fund was a trade or business and was therefore liable to the PBGC for the funding shortfall of its portfolio company’s terminated defined benefit plan. (The fund had acknowledged that it was under common control with the portfolio company.)
In Board of Trustees, Sheet Metal Workers’ National Pension Fund v. Palladium Equity Partners, LLC, a 2010 case with a fact pattern similar to that of Sun Capital, a U.S. district court in Michigan rejected the defendant private equity investment funds’ motion for summary judgment. In finding that the facts could support a conclusion that the private equity funds were engaged in a trade or business, the court cited the 2007 PBGC Appeals Board decision and stated that it found the PBGC’s reasoning persuasive. The court also found that the facts could support a conclusion that the three investment funds, none of which had a controlling interest in the portfolio company, should be treated as a single entity for purposes of the common control test.
In 2006, two of Sun Capital’s investment funds (the “Sun Funds”) acquired Scott Brass, Inc. (“Scott Brass”), a manufacturing company, through Sun Scott Brass, LLC, a limited liability company that was treated as a partnership for federal tax purposes. The ownership of Sun Scott Brass, LLC was split 70 percent / 30 percent between the Sun Funds. In 2008, Scott Brass withdrew from the New England Teamsters and Trucking Industry Pension Fund (the “Pension Fund”) shortly before entering bankruptcy proceedings. The Pension Fund then sought to recover approximately $4.5 million in withdrawal liability from the Sun Funds.
Joint and Several Liability Claims
“Trade or Business” Status
In Sun Capital, the Pension Fund’s primary claim was that the Sun Funds were trades or businesses under common control with Scott Brass and therefore were jointly and severally liable under ERISA for Scott Brass’s withdrawal liability. The court held that each Sun Fund was a passive investor rather than a “trade or business.” In finding that neither of the Sun Funds engaged in activity sufficient to constitute a “trade or business,” the court cited the following factors:
- The Sun Funds did not have any employees, own any office space, or make or sell any goods;
- Each of the Sun Funds had made a single investment; and
- The tax returns for each of the Sun Funds listed only investment income in the form of dividends and capital gains.
In analyzing the extent of the Sun Funds’ management and oversight activities, the court refused to impute to the Sun Funds the activities of either their management companies or general partners. The court found that the Sun Funds’ election of board members of Scott Brass was not an example of active management because it was undertaken in the funds’ capacity as shareholders. The court also found that, because the management and consulting fees received by the general partners were paid through a contractual arrangement that did not involve the Sun Funds, they could not be characterized as non-investment income to the Sun Funds.
The court declared the 2007 PBGC Appeals Board opinion letter unpersuasive and therefore not entitled to deference. The court found that the Appeals Board had incorrectly attributed to the investment fund the activity of the investment fund’s general partner and had misinterpreted Supreme Court precedent regarding the “trade or business” status of investment activity. The court disagreed with the Appeals Board’s finding that the holdings in Higgins v. Commissioner and Whipple v. Commissioner that investing is not a trade or business are limited to individual investors. The court also disagreed with the Appeals Board’s conclusion that the “continuity and regularity” prong of the test established by Commissioner v. Groetzinger can be satisfied based solely on the size or profitability of an investment. (The Groetzinger court found that a taxpayer, to be engaged in a “trade or business,” must be involved in an activity with “continuity and regularity” and must engage in the activity for the primary purpose of income or profit.)
Because it had found that the Sun Funds were not trades or businesses, the court did not address whether the Sun Funds and Scott Brass were under common control.
Treatment as Partnership or Corporation
The Pension Fund also argued that the Sun Funds were jointly and severally liable for Scott Brass’s withdrawal liability as partners of Sun Scott Brass, LLC. The court rejected this argument, finding that it was proper to treat Sun Scott Brass, LLC as a limited liability company (the liabilities of which did not extend to its partners) for corporate liability purposes despite the fact it was treated as a partnership for federal tax purposes.
“Evade or Avoid” Withdrawal Liability Claim
The Pension Fund also contended that the Sun Funds were liable for Scott Brass’s withdrawal liability under ERISA Section 4212(c), which provides that “[i]f a principal purpose of any transaction is to evade or avoid [withdrawal liability], this part shall be applied (and liability shall be determined and collected) without regard to such transaction.” The Pension Fund argued that the Sun Funds decision to divide the ownership of Scott Brass using a 70 percent / 30 percent structure had a “principal purpose” of “evading or avoiding” withdrawal liability. After reviewing the legislative history and analyzing the wording of ERISA Section 4212(c), the court concluded that the provision was intended to apply to employer-sellers, not outside investors such as the Sun Funds. The court also found that, even if the provision could be applied to the Sun Funds’ acquisition of Scott Brass, the only available remedy for a violation of ERISA Section 4212(c) is to ignore the transaction in determining liability, which would have meant holding the original (and now bankrupt) owner of Scott Brass liable, not the Sun Funds.
Having found that the Sun Funds could not be held liable for Scott Brass’s withdrawal liability under ERISA or as partners of Sun Scott Brass, LLC, the court granted the Sun Funds’ motion for summary judgment.
The Sun Capital decision strengthens the argument that private equity funds are not liable for the multiemployer and defined benefit pension liabilities of their portfolio companies. The law is far from settled, however. Private equity firms should continue to evaluate targets’ pension plan liabilities and, when investing in companies with such liabilities, should (if possible) use a structure in which the investment funds are passive investment vehicles none of which controls 80 percent or more of the target company.