What you need to know:

The US Court of Appeals for the First Circuit has held that a private equity fund can be a “trade or business,” allowing the fund under certain circumstances to be liable under ERISA for the unfunded pension liabilities of a portfolio company.

What you need to do:

Fund sponsors should immediately view existing and potential portfolio companies that sponsor single-employer defined benefit pension plans, or contribute to multiemployer pension plans for unionized employees, with heightened scrutiny and discuss the risks associated with such investments and strategies for limiting potential liability with their advisors.


On July 24, in Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, the US Court of Appeals for the First Circuit became the first federal appellate court to consider whether a private equity fund can be liable under ERISA for the unfunded pension liabilities of a portfolio company.

The First Circuit, reversing a widely reported federal district court decision, determined that the general partner of Sun Capital Partners IV, LP, was sufficiently involved in the management of a 70%-owned portfolio company to make the fund a “trade or business” for purposes of Title IV of ERISA. Therefore, the fund was potentially liable for the multiemployer pension plan withdrawal liability of the portfolio company, Scott Brass. The First Circuit left several related questions for the District Court to decide, including whether a related fund, Sun Capital Partners III, LP, which owned the remaining 30% of Scott Brass, was a trade or business and whether either or both of the funds were under “common control” with Scott Brass. The First Circuit avoided creating a bright-line test to determine whether a private equity fund is a trade or business for purposes of ERISA and stressed that any determination would depend upon the facts and circumstances of the fund’s structure and operation.


When Scott Brass filed for bankruptcy, the Teamsters multiemployer pension plan assessed $4.5 million in so-called “withdrawal liability” against the portfolio company and then sought payment from the Sun Capital funds under the theory that the fund and the portfolio company could be held jointly and severally liable for the plan’s underfunding. Under Title IV of ERISA a private equity fund can be liable for the pension plan obligations of a portfolio company if:

  • the fund is a “trade or business,” and
  • the fund and the portfolio company are under “common control.”

In Sun Capital, the First Circuit considered only whether the fund was a trade or business and remanded the issue of common control to the District Court. In considering whether the fund was a trade or business, the First Circuit used an “investment plus” test derived from a 2007 PBGC Appeals Board decision, which found that a private equity fund’s involvement in the management and operation of a portfolio company made it a “trade or business” rather than a mere passive investor. The First Circuit focused in particular on the fact that under the terms of the fund’s organizing documents management fees owed by the fund to the fund’s general partner were to be reduced to the extent of any management fees paid by the portfolio company to an affiliated management company that was a wholly owned subsidiary of the general partner. The First Circuit did not address the inherent conflict of its ruling with the need for private equity funds to acquire and exercise management rights over portfolio companies for purposes of satisfying the venture capital operating company requirements under ERISA’s plan asset rules to preclude fund managers from becoming ERISA fiduciaries of pension plan investors of their funds.

The Court’s analysis notably rejects prior guidance, including decisions by the Supreme Court of the United States, on the meaning of “trade or business” for other tax purposes under the Internal Revenue Code. Title IV of ERISA cross-references a particular section of the Code (which has not been the subject of any prior federal court decision) on which private equity funds have relied in taking the position that they are not engaged in a trade or business for purposes of Title IV. If a private equity fund can be characterized as a trade or business under ERISA, and the portfolio companies can be deemed to be under common control through the fund, then the implications may extend beyond the liability of the fund. For instance, if portfolio companies can be connected via a chain of ownership passing through the fund, each portfolio company may be held liable for the pension liabilities of any other. Under certain circumstances, this liability can follow a company even after it has left the fund’s controlled group, potentially making the sale of a portfolio company more difficult and/or leading to more difficult negotiations regarding indemnification obligations of the selling group.

When feasible, private equity funds should consider splitting ownership interest in a portfolio company among two or more funds with no fund holding 80% or more of the voting power or value (profits or capital interests in the case of a LLC or partnership) and each with a different general partner. The First Circuit ruled that such a division of ownership was not an attempt to “evade or avoid” Title IV liability.

Note that if a private equity fund owns more than 50% of the voting power or value (or capital or profits interests) of a portfolio company, then special rules under ERISA which attribute or exclude interests would apply. So, for example, if one fund has an option to purchase the other fund’s interest in a portfolio company, the first fund will be deemed to own the second fund’s interest for “controlled group liability” purposes under ERISA. Similarly, certain equity interests held by management of a portfolio company may be ignored under the special exclusion rules of ERISA, which also has the effect of increasing the ownership interest of private equity funds. In cases where company management retains or acquires a significant ownership interest in the company, actual ownership of slightly more than 50% of a portfolio company by the fund can be deemed to be an 80% or more ownership interest, thereby opening the door to potential controlled group liability.

Even if separate private equity funds are used, care needs to be taken in the operation of such funds. For example, a stronger case for preserving the separate status under ERISA of two private equity funds within a family of funds can be made if the two funds were created at different points in time (rather than, as is typical, the simultaneous establishment of a main fund and a parallel fund for offshore investors) and other steps are taken that cause the funds to not be viewed as acting as a joint venture or partnership with respect to their investments. The independent legal status of separate funds, general partners and management companies can become blurred if the principals reach out directly to intervene in the activities of a portfolio company without observing those entities’ separate formalities. A “club deal” with unrelated private equity funds should provide a strong defense.

Finally, note that even private equity funds that are unlikely to acquire interests in companies with direct pension plan liability still need to consider the impact of the pension liabilities of acquisition targets that are members of a controlled group with pension liability resulting from the target’s affiliates, as well as for purposes of COBRA, nondiscrimination testing of 401(k) and profit-sharing plans, and provisions in portfolio company credit agreements regarding ERISA affiliates.