On March 28, 2016, a federal district court in Massachusetts held that two private equity funds were jointly and severally liable for withdrawal liability under the Employee Retirement Income Security Act (“ERISA”) with respect to a bankrupt portfolio company’s multiemployer (union) pension plan in Sun Capital Partners III, LP v. New England Teamsters & Truckers Industry Pension Fund.1 In light of this decision, private equity funds will want to pay more attention to any potential ERISA obligations when considering whether to invest in a portfolio company. While the decision in Sun Capital focused on multiemployer pension plan withdrawal liability, the impact of a private equity fund being included as a member of a portfolio company’s ERISA controlled group could subject the private equity fund to other potential liabilities for the company’s ERISA plans, including underfunded single employer pension plans and welfare plan excise taxes, and could impact the application of qualified plan nondiscrimination and coverage requirements.

Overview of Facts and 2013 First Circuit Ruling

The case involves two private equity funds, Sun Fund III (“Sun III”) and Sun Fund IV (“Sun IV” and together with Sun III, the “Sun Funds”) that owned 30% and 70%, respectively, of a portfolio company, Sun Scott Brass, LLC. Sun Scott Brass, LLC owned Scott Brass Holding Corp, which in turn owned Scott Brass, Inc. (“SBI”). The general partners of the Sun Funds received management fees from the Sun Funds. However, the fees paid by SBI to the Sun Funds for management services “offset” the management fees that the funds otherwise were obligated to pay the general partners.

SBI was a party to the New England Teamsters and Trucking Industry Pension Fund, a multiemployer (union) pension plan (“Pension Fund”), to which SBI was obligated to make pension contributions for its union employees. When SBI went into bankruptcy, it triggered a withdrawal liability under ERISA to the Pension Fund. The Pension Fund claimed the Sun Funds were jointly and severally liable for the withdrawal liability as members of SBI’s ERISA controlled group. For purposes of withdrawal liability, ERISA provides that all employees of trades or businesses (whether or not incorporated) that are under common control are treated as employed by a single employer and all such trades and businesses as a single employer.2 In the case of a parent-subsidiary group, such as in Sun Capital, “common control” basically means a group of trades or businesses that are 80% or more owned by a common parent.3

The district court’s ruling was the result of a remand by the U.S. First Circuit Court of Appeals in its 2013 Sun Capital decision.4 In its opinion, the First Circuit explained that in order to impose ERISA withdrawal liability on an organization other than the organization that is obligated to the pension plan a two-prong test must be satisfied: (1) the organization must be under “common control” with the obligated organization; and (2) the organization must be a trade or business.5 The First Circuit held that Sun IV was a trade or business under an “investment plus” theory based on the applicable facts. In support of its finding, the First Circuit noted that, among other facts, the Sun Funds were actively involved in the management and operation of SBI, the management agreements gave the general partners exclusive and wide-ranging management authority and control of SBI such that the funds and their affiliated entities were in a position to be intimately involved in the management and operation of SBI, and the Sun Funds placed two of the three director positions at SBI, thus giving the funds control of the SBI board. However, the First Circuit remanded the case back to district court to determine whether Sun III was a trade or business and whether the Sun Funds are under common control with SBI.

District Court Finds the Sun Funds are in a “Partnership-in-Fact”

The district court, applying the First Circuit’s “investment plus” approach and reviewing the structure of the ownership arrangements, found both Sun III and Sun IV were in fact “trades or businesses” (recall that the First Circuit had already made this determination with respect to Sun IV). Among the facts that were important to the district court’s finding: (1) the purpose of the Sun Funds to seek out potential portfolio companies that are in need of extensive intervention with respect to their management and operations; (2) the funds were active managers of SBI; and (3) the management fee offsets provided an “economic benefit” to the Sun Funds.

The court next turned to the common control prong. On the surface, neither of the Sun Funds individually owns 80% of SBI’s holding company and thus without more there is no common control by either fund of SBI. However, the court found that there was a deemed “partnership-in-fact” between Sun III and Sun IV. In support of its finding of the existence of this new partnership, the court noted that the Sun Funds were set-up to avoid 80% control of SBI (with the 30%/70% split) and “the choice to organize Sun Scott Brass, LLC, so as to permit each of the Sun Funds coinvesting to remain under 80 percent ownership, is likewise a choice that shows an identity of interest and unity of decision-making between the [Sun] Funds rather than independence and mere incidental contractual coordination.”6

The court then found this deemed partnership-in-fact was a trade or business for essentially the same reasons each of the Sun Funds were found to be a trade or business. Since the deemed partnership-in-fact is itself a trade or business that owns 100% of SBI, the court concluded that the Sun Funds, as partners in this partnership-in-fact, are jointly and severally liability for the SBI withdrawal liability to the Pension Fund.

The partnership-in-fact concept is new and novel and, as we submit, controversial. This concept is not found in the ERISA controlled group rules. The partnership-in-fact concept has only been considered once before this context by another district court, but the case settled before any determination of the partnership issue was made.7 It is unclear whether any appellate court will adopt the deemed partnership-in-fact theory when read against the ERISA controlled group rules. The Sun Funds filed an appeal of the district court’s ruling to the First Circuit on April 8, 2016. Thus, the First Circuit will have the opportunity to consider whether to uphold the partnership-in-fact concept.


So, what can we glean from this latest Sun Capital ruling?

First, if a private equity fund (or with its “related funds”) will own more than 80% of a portfolio company, the fund will want to do more extensive due diligence related to potential ERISA-related liabilities, particularly when the portfolio company maintains a pension plan or is obligated to contribute to a multiemployer pension plan. The fund will also want to consider more extensive representations and indemnities in the transaction agreements. It is also important to note that the ERISA controlled group concept is not limited to just ERISA Title IV liability, such as multiemployer withdrawal liability or liability for underfunding in a terminated single employer pension plan. A private equity fund in the same position as the Sun Funds could have potential liabilities related to other ERISA plans that are maintained by its portfolio companies, including potential excise taxes for failure to comply with employer-mandates under the Patient Protection Affordable Care Act or COBRA. Any entities within the ERISA controlled group are also considered a single employer for purposes of non-discrimination testing and other requirements related to 401(k) and other qualified retirement plans.

Second, a private equity fund’s portfolio company will need to pay close attention to the standard representations and covenants in the typical credit agreement, as these provisions almost always extend to ERISA controlled group liabilities.

Third, a private equity fund should review the facts of the Sun Capital structure and consider whether it can use an alternative structure. Of particular note, both the First Circuit and district court appear to place substantial emphasis on the economic benefit to the Sun Funds from the management fee/offset structure.