Private Equity

On July 24, 2013, the U.S. Court of Appeals for the First Circuit decided a case of first impression regarding whether a private equity fund could be liable to a multiemployer pension fund for the withdrawal liability of a bankrupt portfolio company. In Sun Capital Partners III, et al. v. New England Teamsters & Trucking Ind. Pension Fund, the court held that a private equity fund could be so liable on a controlled group theory of liability if common control is established and if the private equity fund is a trade or business. The court rejected an argument that the subject fund merely was a passive investor. Instead, the court concluded that an affiliated management company’s active involvement in the management of the portfolio company, among other things, supported a conclusion that the private equity fund was engaged in a trade or business for purposes of establishing withdrawal liability.

Withdrawal liability refers to a statutory scheme enacted by Congress that was intended to create a disincentive for employers to withdraw from multiemployer pension plans and also to provide a means for recouping a pension fund’s unfunded liabilities. The statute is known as the Multiemployer Pension Plan Amendment Act of 1980 (“MPPAA”), 29 U.S.C. § 1381 et seq. The MPPAA requires employers withdrawing from a multiemployer plan to pay their proportionate share of vested but unfunded benefits. Unfunded benefits exist when the value of the vested benefits is greater than the plan’s assets. A withdrawing employer generally refers to an employer that permanently ceases its obligations to contribute or permanently ceases covered operations under the plan.

The MPPAA provides that “all employees of trades or businesses (whether or not incorporated) which are under common control shall be treated as employed by a single employer and all such trades and businesses as a single employer.” 29 U.S.C. § 1301(b)(1). Common control generally requires an 80% ownership interest. For example, if a parent trade or business owns 80% or more of a subsidiary trade or business, these entities would constitute a controlled group and would be treated as a single employer. The MPPAA imposes withdrawal liability jointly and severally on all trades and businesses in a controlled group with the withdrawing employer.

Regulations have not been adopted to define “trades or businesses” in the withdrawal liability context. Generally, a mere passive investment will defeat pension withdrawal liability. However, in interpreting the meaning of “trades or businesses,” courts have held that even unrelated but commonly owned rental properties must be included in a controlled group. See, e.g., Central States Se. & Sw. Pension Fund v. Messina Prods, LLC, 706 F.3d 874, 877 (7th Cir. 2013). Thus, an analysis of whether an entity should be included in a controlled group may turn on whether the entity is deemed to be a trade or business under the MPPAA.

In Sun Capital, the court applied a test it referred to as the “investment plus” test to conclude that one of the funds in question operated as a trade or business. The court declined to set forth specific guidelines for what constitutes the “plus” in this test. The court described that the “investment plus” analysis is a “very fact specific approach” that takes into account a

Specifically, the court noted that the equity funds along with an affiliated management company were “actively involved in the management and operation of the companies in which they invest.” Indeed, the fund agreements stated that a “principal purpose” of each fund entity was the “manag[ement] and supervisi[on] of its investments.” In addition, the affiliated entities “were empowered through partnership agreements to make decisions about hiring, terminating, and compensating agents and employees of the [equity funds] and their portfolio companies.” The court further observed that the purpose of the equity funds generally was to seek out potential portfolio companies that were in need of extensive intervention with respect to management and operations, to provide such intervention, and then to sell the companies for a profit. The court reasoned that the active involvement in management provided a direct benefit to the equity funds that an ordinary passive investor would not derive. Accordingly, the court held that the sum of these factors satisfied the “plus” in the “investment plus” test.

The two equity funds in the Sun Capital case shared ownership of the bankrupt portfolio company, one owning 70% and the other owning 30%. It would appear that splitting ownership such that neither of the equity funds owns 80% or more of the portfolio company could avoid the common control threshold. Even if a private equity fund is deemed to be a trade or business, it would not be responsible for a portfolio company’s withdrawal liability if there is no common control. However, the court remanded to the district court the issue of whether splitting ownership between related entities is enough to defeat common control. Thus, this issue will need to be further developed by the courts and for now it remains an open question.