A recent ruling of the US District Court in Massachusetts held that private equity funds were not trades or businesses that could be held liable for pension withdrawal liability incurred by a portfolio company in which they had a substantial investment. The case, Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, No. 10-10921-DPW, 2012 WL 5197117 (D. Mass. Oct. 18, 2012), rejected a 2007 ruling of the Pension Benefit Guaranty Corporation (PBGC) that a private equity fund was liable for the funding shortfall of its portfolio company’s defined benefit plan. The Sun Capital case is also at variance with Board of Trustees, Sheet Metal Workers’ National Pension Fund v. Palladium Equity Partners, LLC, 722 F.Supp. 2d 854 (E.D. Mich. 2010), a 2010 Michigan district court decision that found the PBGC ruling persuasive.

The Sun Capital case provides some comfort to private equity funds about their exposure to the pension funding liabilities of their portfolio companies. It is, however, currently the only case rejecting the PBGC ruling and is on appeal. The Palladium Equity Partners case, the PBGC ruling referenced below and the Sun Capital case reflect the unsettled status of these issues. The PBGC may continue to assert liability against private equity funds until the matter is finally determined. Advance planning for investment in portfolio companies should be undertaken to ensure that any pension plan liability is identified and properly addressed.


The Sun Capital opinion addressed the issue of whether a private equity firm is engaged in a "trade or business" for purposes of the controlled group rules of the Employee Retirement Income Security Act (ERISA). Generally, two or more trades or businesses under common control are jointly and severally liable for pension plan funding obligations and multiemployer plan withdrawal liability. Common control includes a parent-subsidiary relationship where the parent owns 80 percent or more (by vote or value) of the subsidiary. Thus, a private equity fund that is found to be engaging in a trade or business with a portfolio company of which its ownership interest is 80 percent or more could be liable for the pension funding liabilities of the portfolio company.

PBGC Ruling

Practitioners had historically believed that a private investment fund was generally not a "trade or business" for purposes of the controlled group rules because of the established tax principle that investment activities in and of themselves do not constitute carrying on a "trade or business."

Commissioner v. Groetzinger, 480 U.S. 23 (1987); Whipple v. Commissioner, 373 U.S. 193 (1963). In 2007, however, the PBGC issued an opinion imposing the underfunded pension liability of a portfolio company on a private equity fund with more than 80 percent ownership, determining that the investment activities of the private equity fund constituted a trade or business with the portfolio company. The PBGC concluded that the private equity fund was not a passive investor because its agent, the general partner of the private equity fund, was actively involved in the business activity of its portfolio company and exercised control over its management.

Palladium Case

The PBGC opinion was later endorsed by a 2010 decision of a US district court in Michigan involving a fact pattern similar to Sun Capital. In Board of Trustees, Sheet Metal Workers’ National Pension Fund v. Palladium Equity Partners, LLC, a motion for summary judgment by the three defendant private equity funds was rejected. Although none of the three funds individually owned 80 percent of the portfolio company, they owned more than 80 percent in the aggregate and shared a general partner. The court found persuasive the reasoning of the PBGC ruling that a private equity fund could constitute a trade or business and that a conclusion could be reached that the three funds constituted one partnership linked by 80 percent ownership to the portfolio companies.

Sun Capital Case

In Sun Capital, two private equity funds, Sun Fund III and Sun Fund IV, acquired a manufacturing company and obtained a 30 percent and 70 percent ownership interest, respectively, in the portfolio company. A few years after the acquisition, the portfolio company withdrew from a multiemployer pension plan and filed for bankruptcy protection. The pension fund asserted a claim against the portfolio company for withdrawal liability in the amount of US$4.5 million and claimed that the two private equity funds were trades or businesses under common control with the bankrupt portfolio company and were thus jointly and severally liable for its withdrawal liability.

The private equity funds then sought a declaratory judgment that they could not be liable for the bankrupt company’s pension withdrawal liability as they were neither a "trade or business" nor under common control with the bankrupt company. The District Court of Massachusetts granted summary judgment in favor of the funds.

The District Court refused to grant deference to the PBGC ruling stating that the PBGC had "misunderstood the law of agency" and "misread Supreme Court precedent." The court noted that the Sun Funds did not engage in a trade or business as:

  • the Sun Funds did not have ". . . any employees, own any office space, or make or sell any goods,"
  • the Sun Funds’ investments in the portfolio company occurred only once and were passive, and
  • although the Sun Funds did elect the directors of the portfolio company, this was solely in their capacity as shareholder.

The court also disagreed with the multiemployer pension fund’s argument that the Sun Funds should be responsible for the withdrawal liability because a principal purpose of splitting the ownership of the portfolio company by 70 percent/30 percent was to avoid the controlled group rules and thus the withdrawal liability. ERISA requires that a transaction must be disregarded if its principal purpose is to evade or avoid withdrawal liability. The District Court found that this rule was designed to cover "essentially fraudulent maneuvers lacking in economic substance by employer-sellers, and not by outside investors." The court also reasoned that, at the time of their investment, the Sun Funds did not expect withdrawal liability and that there is no objection to structuring a transaction to mitigate potential exposure as opposed to avoiding a current ERISA liability.