On July 24, 2013 the First Circuit Court of Appeals, applying an “investment plus” test, concluded that a Sun Capital private equity investment fund was engaged in a “trade or business” for purposes of determining whether the fund could be jointly and severally liable under ERISA for the unfunded pension withdrawal liability of the portfolio company.1 Two Sun Capital investment funds, conveniently named Sun Capital Partners III, LP (“Fund III”) and Sun Capital Partners IV, LP, (“Fund IV”) (the “Sun Funds”) collectively owned 100 percent of Scott Brass, Inc. (“SBI”); Fund III held 30 percent and Fund IV held 70 percent of the ownership interests. The investment was not successful and SBI withdrew from its multiemployer pension plan and a bankruptcy ensued. The Teamsters Pension Fund (“TPF”) contended that Funds III and IV were liable for SBI’s unfunded pension obligations as entities engaged in a “trade or business” and under “common control” with SBI. In order for an entity, such as one or both of the Sun Funds to be liable for SBI’s withdrawal liability, the entity must satisfy a two-part “controlled group” test; it must be both a “trade or business” and be under “common control” with SBI. For a parent-subsidiary group to be under “common control,” the parent must have an 80 percent interest in the subsidiary, and the TPF contended that Funds III and IV had entered into a joint venture that was under common control with SBI because the two Funds, together, owned 100 percent of SBI.
The court’s opinion addressed the “trade or business” requirement with respect to Fund IV, but remanded the case for a determination of whether the required common control existed and whether Fund III was a trade or business. The court stated that a mere investment to make a profit, without more, does not itself make an investor a trade or business, but declined to set forth general guidelines regarding what constituted “plus” in an investment plus analysis. However, applying a very fact specific approach, the court concluded that Fund IV was more than a passive investor and was a “trade or business” for purposes of pension liability.2
The Sun Funds’ limited partnership agreements and private placement memos explained that the Funds were actively involved in the management and operation of their portfolio companies and the general partners were empowered to make decisions about hiring, terminating and compensating agents and employees of the portfolio companies.3 The memos discussed strategic plans to improve margins, accelerate sales growth, implement or modify information systems and improve control functions. Frequent meetings to discuss operations, competition, new products and personnel, along with check signing authority for portfolio companies were mentioned. Two of the three directors at SBI were Sun Capital employees and Sun Capital provided management and consulting services to SBI. The partnership agreements granted authority to the general partner to provide management services to portfolio companies and gave a limited partnership committee power to make determinations about hiring, terminating and compensating employees of the portfolio companies. In addition, with respect to Fund IV, the court found that the fund’s active involvement in management provided a direct economic benefit to Fund IV that an ordinary passive investor would not derive: Fees paid by SBI to Fund IV’s general partner were offset against fees that Fund IV would otherwise pay to that general partner. Based on these findings, the court determined that Fund IV was engaged in a “trade or business” for purposes of pension liability.4
The court declined to hold the Sun Funds liable under 29 U.S.C. 1392(c) which states “[i]f a principal purpose of any transaction is to evade or avoid liability under this part, this part shall be applied (and liability shall be determined and collected) without regard to such transaction.” (emphasis added). TPF contended that Sun Funds violated this provision by splitting ownership 70 percent/30 percent between them. Disregarding the agreement to divide the ownership of SBI would not result in Fund IV owning 100 percent of SBI and the court refused to speculate regarding a transaction that never occurred since Fund IV never owned 100 percent of SBI, notwithstanding the fact that Fund IV had executed a letter of intent contemplating a purchase of 100 percent of SBI. The court recognized the distinction between a letter of intent and a binding agreement and ruled that Fund IV had not violated 29 U.S.C. 1392(c).
This case underscores the potential liability of private equity investment funds that derive direct economic benefits from the active management of portfolio companies which have unfunded pension liabilities. Lenders to private equity investment funds may also want to evaluate this potential risk in connection with any financing of the funds.