The First Circuit recently found that private equity funds structured as partnerships or LLCs may be engaged in a “trade or business” for purposes of ERISA pension liability, overruling a 2012 decision of the U.S. District Court for the District of Massachusetts. Sun Capital Partners III, LP, et al. v. New England Teamsters and Trucking Industry Pension Fund, 1st Cir., No. 12- 2312 (July 24, 2013). By so holding, the First Circuit has revived concerns of the private equity industry regarding exposure to the pension liabilities of their portfolio companies by rejecting a common first-line defense to pension liability: that the funds are not in a trade or business.

Controlled Group’s Joint and Several Liabilities

A recurring concern in the private equity industry is whether private equity funds structured as partnerships or LLCs and their various portfolio companies constitute a single “controlled group” for purposes of ERISA. A controlled group is commonly thought of as a family of related entities, generally occurring where one “parent” trade or business owns at least 80% of one or more other trades or businesses. Under ERISA, members of a common controlled group are jointly and severally liable for the pension liabilities of every other member of the controlled group. If a private equity fund and its portfolio companies were to constitute a controlled group, then a pension obligation at one portfolio company could create significant liability exposure for the private equity fund itself and potentially some of its other portfolio companies.

The first defense against controlled group liability traditionally has been that the fund is not engaged in a “trade or business.” Without a common trade or business, there is no controlled group implicating the fund or its portfolio companies. This first defense went relatively unquestioned until 2007 when the Pension Benefit Guaranty Corporation (“PBGC”) issued an opinion of dubious authority stating that private equity funds were, in fact, trades or businesses under an “investment plus” test (“2007 PBGC Opinion”). Appeals Board Opinion, Pension Benefit Guaranty Corporation (September 26, 2007).

Facts and Analysis of Case

In 2007, two private equity funds sponsored by Sun Capital Advisors, together acquired a 100% ownership interest in Scott Brass Holding Corporation. Ownership was split between the two limited partnerships, Sun Fund IV (70% interest) and Sun Fund III (30% interest). Two years later, Scott Brass entered into bankruptcy and withdrew from the New England Teamsters and Trucking Industry Pension Fund (“Pension Fund”). The Pension Fund subsequently demanded more than $4.5 million from Scott Brass as its share of the withdrawal liability. The Pension Fund sought the same amount from Sun Funds IV and III under the theory that they were jointly and severally liable for Scott Brass’s withdrawal liability. In 2012, the District Court for Massachusetts ruled in favor of the private equity funds, agreeing that the funds were not trades or businesses.

Unlike the District Court, the First Circuit granted limited deference to the 2007 PBGC Opinion by following its “investment plus” test for determining whether a private equity fund is a trade or business. The investment plus tests asks: “(1) whether the private equity fund was engaged in an activity with the primary purpose of income or profit and (2) whether it conducted that activity with continuity and regularity.” Instead of setting forth general guidelines for what constitutes the “plus” in the investment plus test, the First Circuit simply took a very “factspecific approach” where none of the facts alone is dispositive. The First Circuit considered factors such as the partnership agreements and private placement memos detailing how the Sun Funds are actively involved in the management and operations of the companies in which they invest and that the Sun Funds sought out companies in need of extensive intervention. The First Circuit also noted that Sun Fund IV received “an offset against the management fees it otherwise would have paid its general partner from managing the investment” in the portfolio company, which a passive investor would not receive. Notably, the First Circuit did not address that the general partner is in a trade or business of managing the Pension Fund. Based on those factors, among others, the First Circuit found that Sun Fund IV was a trade or business for purposes of ERISA. However, the First Circuit did not make a ruling with respect to Sun Fund III because it did not have evidence as to whether Sun Fund III received any benefit from an offset of fees, and remanded to the District Court the question of whether Sun Fund III constituted a trade or business and whether there was “common control” creating a controlled group among the Sun Funds and Scott Brass.

Splitting Investments Among Different Funds is Not a Transaction Designed to “Evade or Avoid” Liability

Even if a fund is found to be a trade or business, it generally will not be in a controlled group with its portfolio company where the fund holds less than an 80% interest in such company. In fact, many private equity acquisitions consist of one fund acquiring less than 80% and one or more other entities acquiring the remaining interests. The other investors may be independent co-investors or may be a related fund, as was the case with Sun Fund III and Sun Fund IV.

The Pension Fund argued to the First Circuit that the Sun Funds collectively remain liable because they acquired Scott Brass in a manner to avoid the pension liabilities. Under the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”), “if a principal purpose of any transaction is to evade or avoid liability under this part, this part shall be applied…without regard to such transaction.” The Pension Fund argued that because the Sun Funds purposely structured their investments to avoid the 80% controlled group threshold, the Sun Funds were avoiding or evading liability. The First Circuit ruled against the Pension Fund because that provision of the MPPAA (Section 4212 of ERISA) requires the court to analyze potential liability “…without regards to such transaction.” Essentially, the Pension Fund argued to have the First Circuit create a “fictitious transaction” where a single Sun Fund made a 100% investment in Scott Brass. The plain language of the MPPAA indicates that a court is to “put the parties in the same situation as if the offending transaction never occurred.” Accordingly, the First Circuit found that if one disregarded the transaction, neither Sun Fund held any stake in Scott Brass, much less an interest that exceeded 80%. Therefore, no liability could be imposed under that provision of the MPPAA.


By holding that private equity funds may be trades or businesses depending on various “investment plus” factors, the First Circuit has increased the potential risk that private equity funds may be liable for certain portfolio company pension liabilities. This is particularly true where a single fund acquires a controlling interest (at least 80%) in a company that has either defined benefit or multiemployer union pension plan liabilities. It is not clear what implication the First Circuit’s holding will have for federal income taxes, where the term “trade or business” is used in various provisions with important implications to private equity funds and their investors.