The Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Multiemployer Pension Plan Amendment Act of 1980 (MPPAA), imposes withdrawal liability against an employer for its proportionate share of a multiemployer pension fund’s unfunded vested benefits when the employer withdraws from the fund. For this purpose, “employer” is defined to mean all trades or businesses that are under common control. Private equity funds have taken the position that they do not constitute trades or businesses, but are merely passive investors in their portfolio companies. As a corollary to this, private equity funds maintain that they may not be held liable for withdrawal liability resulting from a portfolio company’s withdrawal from a multiemployer pension fund. The U.S. Court of Appeals for the First Circuit recently rejected this position, holding that a private equity fund constituted a trade or business.

Sun Capital Advisors, a private equity firm, formed two private equity funds, Sun Fund III and Sun Fund IV. Sun Funds III and IV were limited partnerships overseen by their respective general partners. Through a number of affiliated entities, Sun Fund III acquired 30 percent and Sun Fund IV acquired 70 percent of the outstanding stock in Scott Brass, Inc. (SBI). Sun Fund IV’s general partner arranged for SBI to receive management services from employees of Sun Capital Advisors, who thereafter actively participated in the management and operations of SBI. Sun Fund IV was entitled to an offset against the 2 percent management fee it otherwise would have owed its general partner for any management fees received by the general partner from one of Sun Fund IV’s portfolio companies.

At the time SBI was acquired by the Sun Funds, SBI was a contributing employer to a multiemployer pension fund. SBI subsequently was unable to make contributions to the multiemployer pension fund, triggering withdrawal liability. Involuntary bankruptcy proceedings were brought against SBI shortly thereafter. Following SBI’s withdrawal from the multiemployer pension fund, the pension fund sent a notice and demand for withdrawal liability to SBI and to the Sun Funds. As discussed in our December 2012 newsletter article, the Sun Funds filed suit in federal district court, seeking a declaration that they were not a trade or business, with the district court deciding in favor of the Sun Funds.

In reversing the district court, the First Circuit adopted an “investment plus” test to determine the existence of a trade or business. That test asks 1) whether an entity has made an investment with the principal purpose of making a profit (the “investment prong”), and 2) whether the entity has undertaken sufficient activities with respect to the company it has invested in (the “plus prong”). With the investment prong found to be easily satisfied, the court also found the plus prong satisfied based on the following factors:

  • The extensive management authority granted to Sun Fund IV’s general partner by Sun Fund IV’s partnership agreement and discussed in private placement memorandums.
  • The general partner’s own partnership agreement empowered it to make decisions about hiring, terminating, and compensating agents and employees of the Sun Fund and its portfolio companies.
  • The general partner received a percentage of the total commitments to the Sun Fund and a percentage of the profits as compensation.
  • The purpose of the Sun Fund was to seek out potential portfolio companies in need of extensive intervention with respect to their management and operations, to provide that intervention, and to then sell the companies.
  • The Sun Funds’ controlling stake in SBI placed them and their affiliate entities in the position of being intimately involved in the management and operation of SBI.
  • Through the management agreements arranged by Sun Fund IV’s general partner, Sun Capital Advisor employees became immersed in the management and operation of SBI.
  • Sun Fund IV received a direct economic benefit from the ongoing management of SBI by Sun Fund IV’s general partner through an offset to the two-percent fee it otherwise would owe to its general partner. Although the court disclaimed any one factor being dispositive, the fact that Sun Fund IV received this offset seemed to weigh heavily in favor of it being found to be a trade or business.

It is important to note that the court’s holding was limited to Sun Fund IV. The issue of whether Sun Fund III also constituted a trade or business was remanded to the district court, along with the issue of whether the common control requirement needed to impose withdrawal liability was satisfied.

The First Circuit’s holding raises numerous benefits- and non-benefits-related issues. For example, one benefits-related issue arising from the decision is whether portfolio companies and fund management companies may be required to be viewed as a single employer for purposes of the qualified retirement plan rules relating to plan coverage and nondiscrimination requirements. (Sun Capital Partners III, LP et al. v. New England Teamsters & Trucking Industry Pension Fund)