United States: Private Equity Funds Held Liable For Unfunded Pension Obligations Of Their Portfolio Company

Following the U.S. District Court for the District of Massachusetts' March 28, 2016 decision in Sun Capital Partners III LP v. New England Teamsters and Trucking Industry Pension Fund, private equity (PE) firms need to be aware of how they may form "controlled groups," and thereby share employee benefits liabilities, including pension obligations, with their portfolio companies.

Background

Two Sun Capital funds (Fund III and Fund IV) held indirect interests in Scott Brass, Inc. (SBI). SBI entered bankruptcy and defaulted on its withdrawal obligations to a multiemployer pension plan. The plan filed suit against Fund III and Fund IV, alleging that they were jointly and severally liable for the unpaid pension withdrawal liability. In 2012, the District Court found that the funds were not liable because they were not engaged in a trade or business. The plan then appealed. In its 2013 decision, the First Circuit indicated that two conditions must be satisfied in order to impose withdrawal liability on a third-party organization: (1) the third-party organization must be under common control with the obligated organization and (2) the third-party organization must be a trade or business. The First Circuit then held that Fund IV was engaged in a trade or business and, as such, would be jointly and severally liable for SBI's unfunded pension liabilities if it was found to be in the same controlled group as SBI. The First Circuit remanded the case to the District Court to determine whether Fund III was engaged in a trade or business and whether Fund III and Fund IV were part of the same controlled group with SBI.

Trade or Business

Using the "investment-plus" test in the First Circuit's opinion, the District Court held that Fund III was engaged in a trade or business because the sum of its investment in SBI plus its other activities amounted to a greater role than would be played by a passive investor. In particular, Fund III received an economic benefit in the form of an offset against the management fees it would otherwise have paid to the general partner for managing the investment in SBI.

Partnership-in Fact

The District Court also held that Fund III and Fund IV formed a partnership-in-fact and thereby were in a controlled group with SBI. The controlled group rules ordinarily require a controlling interest of at least 80% ownership. Fund III's interest in SBI was 30% and Fund IV's interest was 70%, meaning that neither fund alone met the 80% threshold. Thus, unless their ownership could be aggregated, Fund III and Fund IV would not be liable for SBI's withdrawal liability, a fact which the funds acknowledged was an important consideration in dividing the ownership among multiple funds. However, the District Court found that Fund III and Fund IV formed a "partnership-in-fact" and together held a 100% interest in SBI, meaning that Fund III and Fund IV were in the same controlled group of companies as SBI. Therefore, Fund III and Fund IV were jointly and severally liable for SBI's withdrawal liability.

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