The Private Equity Practice has been getting an increasing number of calls related to the decision made earlier this spring (Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, 2016 US Dist. LEXIS 40254 (D. Mass. Mar. 28, 2016)). Because this decision can greatly impact how a private equity firm (in Massachusetts) structures and manages its portfolio companies, we have provided a brief redux of the case below. As always, please contact your Mintz Levin business and legal counselors with any questions. We discussed this case in an earlier post available here.
A Massachusetts district court found two private equity funds, Sun Capital Partners III, LP (Sun Fund III) and Sun Capital Partners IV LP (Sun Fund IV), collectively the Sun Funds, jointly and severally liable for a portfolio entity’s share of the unfunded vested benefits of a pension fund.
In 2007, the Sun Funds, which are managed by Sun Capital Advisors, Inc., acquired indirect 30% and 70% ownership interests, respectively, in Scott Brass, Inc. (SBI), which was committed to a multi-employer pension fund.
In 2008, SBI filed for bankruptcy and subsequently stopped making payments to the pension fund, thereby incurring withdrawal liability for its share of the pension’s unfunded vested benefits under the multiemployer pension rules of the Employee Retirement Income Security Act of 1974 (ERISA). However, SBI could not meet its withdrawal liability, and so the pension fund wanted the Sun Funds held jointly and severally liable for SBI’s liability. Under ERISA and based on 414(c) of the Tax Code, other entities that are related to the employer, SBI in this case, may be liable if the entity is engaged in a trade or business and is under common control with the employer, which is when the entity owns at least 80% of the employer.
The Sun Funds argued they did not incur withdrawal liability because neither fund had engaged in a trade or business with SBI. The Funds were merely investors in SBI. Furthermore, neither fund was under common control with SBI since neither fund owned at least 80% of SBI’s stock.
However, the district court held that the Sun Funds were not passive investors in SBI and actively oversaw the operations of SBI and controlled its board of directors. As a result, both funds had engaged in a trade or business.
Relying on the “investment plus” standard used earlier by the First Circuit, in this case to determine whether an investor was engaged in a trade or business in regards to withdrawal liability, the district court held that the Sun Funds met the “investment plus” test. Each Sun Fund benefited from the informal joint venture they engaged in to manage SBI in ways that normal investors would not (SBI had agreed to pay a portion of the annual management fee that the Sun Funds were liable to their general partner for based on limited partnership agreements).
The court did acknowledge that the Sun Funds were “non-parallel” funds, had few sets of limited partners and portfolio investments in common, and filed separate financial statements and tax returns. Nevertheless, the court still found that even though neither Sun Fund independently owned 80% of SBI, the Sun Funds were effectively managing SBI in partnership and consequently indirectly owned 100% of SBI, which constitutes common control.
Prior to this ruling, private equity funds have not been classified as engaging in a trade or business. This now may be changing. This case has the potential to impact the value of portfolio companies with, and the price of future deals involving, unfunded pension liabilities. One case does not make a trend of course. At a minimum, there is now a greater premium on identifying controlled groups (under rules that can be ghastly in their complexity), and assessing the funded status of pension funds. At bottom, this precedent setting case could have a major impact on the structure selected by private equity firms in managing portfolio companies, as private equity funds often use the ownership and management structure employed by the Sun Funds.