On November 22, 2019, the United States Court of Appeals for the First Circuit held that two separate private equity funds managed by the same general partner/management firm were not liable for the pension fund withdrawal liability of their bankrupt portfolio company. At issue in Scott Brass was whether those two funds -- and potentially their investors -- were part of the debtor’s control group when it withdrew from the multiemployer pension fund, such that the funds would be jointly liable for the withdrawal liability of the debtor. By holding that the funds were not partners-in-fact when they jointly invested in the LLC that ultimately controlled the debtor, the First Circuit provided clarity and helpful guidance for sponsors who invest in companies with significant multi-employer pension liability.
Sun Capital Partners III, LP (“Sun Fund III”) and Sun Capital Partners IV, LP (“Sun Fund IV” and together with Sun Fund III, the “Funds”) were established by Sun Capital Advisors, Inc. (“SCAI”), a private equity firm. The Funds formed and financed subsidiary LLCs through which they acquired and controlled portfolio companies, including Scott Brass, Inc. (“SBI”), a brass manufacturing company. As part of their acquisition of SBI, the Funds formed and financed Sun Scott Brass, LLC (“SSB-LLC”), which was owned 30% by Sun Fund III and 70% by Sun Fund IV. While the Funds jointly owned SBI, it filed for bankruptcy and subsequently withdrew from a multiemployer pension fund (the “Pension Fund”), incurring withdrawal liability.
The issue of the Funds’ potential withdrawal liability is governed by the Multiemployer Pension Plan Amendments Act of 1980 (the “MPPAA”). Congress enacted the MPPAA in order to ensure that defined benefit plans remain viable, dissuade employers from withdrawing from multiemployer plans, and enable a pension fund to recoup any unfunded liabilities. To prevent evasion of the payment of withdrawal liability, the MPPAA imposes joint and several liability not only on the withdrawing employers, but also on all entities that (1) are under “common control” with the obligated organization and (2) qualify as engaging in “trade or business.”
The District Court held that there was an implied partnership-in-fact between the Funds which constituted a control group. Specifically, the District Court determined that the Funds had formed a partnership-in-fact sitting on top of SSB-LLC, which partnership-in-fact owned 100% of SBI through SSB-LLC. Therefore, the District Court concluded that the Funds met the “common control” test utilized in MPPAA law. Because it also found that the partnership-in-fact engaged in “trade or business” in its operation of SBI, the District Court held the Funds jointly and severally liable for SBI’s withdrawal liability. The Funds appealed.
The Court of Appeals framed the inquiry as follows: if the Funds formed a partnership-in-fact, then under the common control regulations they are jointly and severally liable for the debts of the partnership, including MPPAA withdrawal liability, provided the separate trade or business test also is met. The Court of Appeals considered whether the Funds formed a partnership-in-fact to acquire and operate SBI through SSB-LLC in light of the multifactored partnership test from a Tax Court case, Luna v. Commissioner. These factors are:
- The agreement of the parties and their conduct in executing its terms;
- The contributions, if any, which each party has made to the venture;
- The parties’ control over income and capital and the right of each to make withdrawals;
- Whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income;
- Whether business was conducted in the joint names of the parties;
- Whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers;
- Whether separate books of account were maintained for the venture; and
- Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
The Court of Appeals first discussed the Luna factors demonstrating that a partnership-in-fact existed. It noted that the Funds, through SCAI, developed restructuring and operating plans for target companies before actually acquiring them through LLCs, which is some evidence of the Funds exercising mutual control and assuming mutual responsibilities. The Court of Appeals also noted that the overlapping control by principals of the sponsor over the Funds and over SBI also provided some evidence of a partnership-in-fact. Finally, the Court of Appeals found the pooling of resources and expertise in SCAI was additional evidence tending to show a partnership between the Funds.
The Court of Appeals next discussed the Luna factors weighing against recognition of a partnership-in-fact. The Funds each were established as distinct limited partnerships with primarily different investors and investments, and expressly disclaimed in their respective limited partnership agreements any partnership or joint venture with each other. The Court of Appeals reasoned these facts weighed against a partnership finding as to several of the Luna factors. The Funds also maintained distinct tax returns, financial books and bank accounts. Moreover, the formation of an LLC prevented the Funds from conducting business in their “joint names” and limited their ability to exercise mutual control and assume mutual responsibilities for managing SBI.
Based on its analysis and application of the Luna factors, the Court of Appeals reversed the District Court’s decision which held the Funds jointly and severally liable for SBI’s withdrawal liability. Having decided the issue of common control, the Court of Appeals did not reach the question of whether the Funds engaged in trade or business such that they would be liable for the withdrawal liability.
The Court of Appeals noted that the incorporation of SSB-LLC did not, in and of itself, preclude recognizing a partnership-in-fact between the Funds; that said, it did implicate many Luna factors and weighed against recognition of the Funds as partners-in-fact. Moreover, the Court of Appeals distinguished this case, where the entities formally organized themselves as limited liability business organizations under state law at virtually all levels, from cases where such organization did not exist and the parties were found to have formed a partnership-in-fact.
The Court of Appeals stated its reluctance to impose withdrawal liability on the Funds, as private investors, because it lacked a firm indication of Congressional intent to do so, and it also lacked any formal guidance from the PBGC. In its analysis, the Court of Appeals highlighted the inherent conflicting policy choices at issue. On the one hand, Congress’s imposition of withdrawal liability on commonly controlled group members can have the beneficial effect of delaying or preventing pension plans from becoming insolvent and preventing reductions in pension benefits. On the other hand, imposing liability likely would disincentivize much-needed private investments in underperforming companies with unfunded multi-employer pension liabilities, which, in turn, would put more strain on the financial position of multiemployer pension plans. We will stay tuned to see if the PBGC takes this an opportunity to provide such guidance.