Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013), which we reported on in our August 7, 2013 client alert, the District Court for the District of Massachusetts issued its decision (available here) addressing two questions posed to it on remand from the First Circuit. The district court’s conclusions have potentially far-reaching implications for private equity funds investing in portfolio companies that sponsor or contribute to underfunded pension plans.


When an employer withdraws from an underfunded multiemployer pension plan, the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) requires the employer to pay into the plan a proportionate share of the plan’s underfunding. This can occur, for example, when an employer bargains out of its obligation to contribute to the plan, transfers covered workers to another employer in an M&A transaction, or simply reduces its covered workforce substantially. All “trades or businesses” that are under “common control” with the employer are treated as parts of a single employer for this purpose and thus are jointly and severally responsible for this liability. The First Circuit’s 2013 decision involved a portfolio company, Scott Bass, Inc. (“SBI”), which incurred a withdrawal liability when it withdrew from the New England Teamsters & Trucking Industry Pension Plan. A private equity fund (“Sun Capital IV”) indirectly owned 70% of SBI, and a related private equity fund (“Sun Capital III”) indirectly owned 30% of SBI. The issue was whether they were trades or businesses under common control with SBI and thus were jointly and severally responsible for that liability. The First Circuit ruled that Sun Capital IV was not a mere passive investor in SBI, but rather constituted a trade or business and therefore could be aggregated with SBI if common control could be shown. It remanded the case to the district court to resolve two questions: (1) whether Sun Capital III also was engaged in a trade or business and (2) whether Sun Capital IV and Sun Capital III (together, the “Sun Funds”) were under common control with SBI.

Trade or Business Analysis of Sun Fund III:

In considering whether Sun Capital III was a trade or business, the district court employed the same “investment plus” approach adopted by the First Circuit in its earlier decision, which asks whether an investing entity’s actions involve more than just “passive investment” and takes a very fact-specific approach, considering a number of factors, with no one factor being dispositive. The factors cited included statements made by the fund about its ability to actively participate in making management and operating improvements in SBI, its ability to appoint a majority of members to SBI’s board of directors, the provision of management and consulting services to SBI by an affiliate of Sun Capital, and whether Sun Capital’s involvement in the management of SBI provided an “economic benefit” to the fund that a passive investor would not receive. The district court observed that many of the “plus” factors which led the First Circuit to determine that Sun Capital IV was engaged in trade and business applied to Sun Capital III as well. The only factor that was unclear, which the First Circuit appeared to consider important and specifically directed the district court to examine, was whether Sun Capital III’s involvement in the management of SBI provided an “economic benefit” to the fund that a passive investor would not receive, by virtue of the fact that Sun Capital III could offset management fees payable to its general partner by the amount of management fees SBI paid the general partner. After examining the record, the district court concluded that it did. The court rejected the Sun Funds’ argument that the offsets for some years were carried forward to later years (because the general partner had waived its management fees for those years in exchange for reduced capital contributions to Sun Capital III) and therefore the offsets did not directly benefit Sun Fund III. Accordingly, the court held that Sun Capital III, like Sun Capital IV, engaged in more than mere passive investment in SBI and therefore was a trade or business.

Common Control Analysis of Sun Fund III and Sun Fund IV:

The district court next addressed the second question, namely whether Sun Capital IV and Sun Capital III were under common control with SBI. Generally, in order for an organization to be under common control with another organization under ERISA, one organization must have at least an 80% ownership interest in the other. The Sun Funds argued that since Sun Capital IV indirectly owned only 70% of SBI while Sun Capital III indirectly owned only 30% of SBI, neither of the entities was under common control with SBI and, accordingly, they could not be responsible for SBI’s withdrawal liability. However, the district court concluded that the Sun Funds had combined to create a partnership-in-fact with respect to their investment in SBI, and the partnership-in-fact was a trade or business that owned 100% of SBI. Citing decisions from the tax area, the court pointed to a number of factors supporting the existence of a partnership-in-fact, including that the Sun Funds had identical language in their partnership agreements and operated similarly; co-invested in five other companies using the same organizational structure; acted jointly in deciding to co-invest; and consciously decided to split ownership of SBI 70%-30% in order to jointly allocate responsibility and remain under the 80% threshold generally required for common control. In addition, it concluded that the record offered no convincing evidence that the Sun Funds operated independently with respect to their joint investments, and showed only “smooth coordination” lacking any disagreement between the funds over how to operate. The court also acknowledged that the two funds were not “parallel funds” – funds investing together in fixed proportions and often sharing the same general partner – but explained that not all parallel funds are partnerships and not all non-parallel funds are not partnerships, and that conduct, rather than organizational formalities, determines questions of partnership.

Impact of the District Court’s Decision:

It is not yet known whether the district court’s decision will be appealed. It also is too early to know whether this decision will be adopted in other circuits. However, if the decision is not reversed and the analysis is adopted by other circuits, private equity funds could be looked to as responsible for their portfolio companies’ withdrawal liabilities in a much wider range of circumstances than was previously understood. The same analysis could be applied to single-employer defined benefit pension plan liability, which is imposed on all members of a controlled group when an underfunded single-employer plan is terminated with the PBGC's permission on account of the group's financial distress or involuntarily by the PBGC in order to limit its own liability.

The funds that could face the most risk would be those that invest in portfolio companies with potential withdrawal liabilities, either by themselves, or with others with whom they coordinate their activities, at a combined level of 80% or higher, are involved through their general partners, employees or managers in the management of those portfolio companies, and receive “economic benefits” that passive investors would not receive. Not only would the funds in these situations be at risk, but so would any other portfolio companies owned by the funds at an 80% or higher level. Therefore private equity funds investing in portfolio companies should consider the potential ERISA controlled group implications that could arise as a result of Sun Capital, including risk allocation considerations when negotiating definitive purchase and sale agreements.

In addition, although Sun Capital dealt only with the application of the common control rules under the pension underfunding rules in ERISA, the same common control rules apply to the rest of ERISA and to many tax rules relating to employee benefits, including the rules for determining whether a retirement plan is tax-qualified. If a court or the IRS took the same approach as the First Circuit in Sun Capital under those rules, 401(k) and other tax-qualified retirement plans maintained by every portfolio company in which a fund owned an 80% or more interest would have to be aggregated to determine whether the plans satisfied applicable nondiscrimination and other requirements. It also is possible that the IRS or a court could regard Sun Capital as supporting a conclusion that an investment fund (particularly one with a management fee offset such as the one here) is engaged in a trade or business for purposes of determining the taxability of foreign and tax-exempt investors under the rules pertaining to “effectively connected income (ECI)” and “unrelated business taxable income (UBTI),” respectively. We will watch these developments closely and report on any additional significant developments.