On March 28, 2016, the U.S. District Court for the District of Massachusetts found that two private equity funds sponsored by the same advisor were jointly liable for withdrawal liability incurred by one of their portfolio companies. Sun Capital Partners III, LP and Sun Capital Partners IV, LP, each sponsored by Sun Capital Advisors (“SCA”), purchased an interest in a company called Scott Brass. Scott Brass later went out of business, and a multiemployer pension plan to which Scott Brass had contributed sought to assess withdrawal liability on Sun Fund III (the 30% owner of Scott Brass) and Sun Fund IV (the 70% owner of Scott Brass). Please see our previous Client Memorandum, “First Circuit Concludes Private Equity Fund Can  Be Liable for Pension Obligations of  Portfolio Companies,”1 for a more in-depth discussion of the facts and the related decision of the U.S. Court of Appeals for the First Circuit.

Following the First Circuit’s decision, the district court was tasked with answering two questions: (1) whether Sun Fund III was engaged in a “trade or business” for ERISA purposes and (2) whether the Sun Funds were under “common control” with Scott Brass. The district court found that:

  • Applying the First Circuit’s so-called “investment plus” test, Sun Fund III was engaged in a trade or business for ERISA purposes. The limited partnership agreements of both Sun Fund III and Sun Fund IV contained management fee offset provisions. The facts presented to the First Circuit suggested that Fund IV’s limited partners benefitted from a fee offset, which was the basis on which the “investment plus” test was met for Fund IV. The record was less clear regarding Fund III. Following the First Circuit’s decision, SCA clarified that Sun Fund III’s limited partners did benefit from the offset during the period in question, but asserted that Sun Fund IV’s limited partners did not (because SCA waived the fees for unrelated reasons). The district court held that the mere potential to benefit from the fee offset in future years by means of fee offset carryforwards was sufficient to meet the “investment plus” test.
  • The Sun Funds were under common control with Scott Brass, despite the fact that neither Sun Fund alone owned 80% of Scott Brass. The court took two steps to reach this conclusion:
    • First, purporting to rely on applicable federal income tax guidance, the court imagined that Sun Fund III and Sun Fund IV formed a “partnership-in-fact” to invest in the LLC that ultimately owned Scott Brass. The court reached this conclusion despite the corporate form of the Sun Funds’ investment and the fact that all co-investment agreements between the Sun Funds disclaimed any intent to form a partnership or joint venture. The district court cited the primary goal of ERISA and the Multiemployer Pension Plan Amendments Act as the protection of employees’ benefits, and noted the tension between that goal and the use of a bright-line ownership test to determine common control. The court noted that all of the Sun Funds, although formally independent entities with separate owners, tax returns, financial statements, reports to partners, and bank accounts, and largely non-overlapping investors and investments, ultimately made their investment decisions under the direction of the co- CEOs of SCA. The district court also noted that between 2005 and 2008, the Sun Funds co- invested in five other companies, each time using the same investment structure, and the record did not show any “meaningful evidence of actual independence in their relevant co- investments.”
    • Second, the court concluded that the deemed partnership formed by the Sun Funds was engaged in a trade or business. In reaching this conclusion, the court specifically declined to attribute the actions of its partners (the Sun Funds) to the deemed partnership, but it did conclude that those activities had to be taken into account in determining the purpose and scope of the deemed partnership. The district court found that, like the individual Sun Funds, (i) the deemed partnership’s purpose was to make a profit and generate compensation that a passive investor would not derive (i.e., through the potential to benefit from fee offsets) and (ii) the deemed partnership was involved in the active management of Scott Brass, thus meeting the “investment plus” test.

In light of Sun Capital, private equity sponsors should continue to be diligent in considering investments in portfolio companies that sponsor significant defined benefit pension plans or contribute to multiemployer pension plans, and should consider any such potential liabilities when making representations in credit agreements and purchase and sale agreements.