In a decision published on November 22, 2019, the First Circuit reversed a district court's prior decision and held two Sun Capital private equity funds were not liable for the withdrawal liability incurred when a jointly-owned portfolio company declared bankruptcy and withdrew from a union pension fund. Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 16-1376, 2019 WL 6243370 (1st Cir. Nov. 22, 2019).
The case arose after a brass manufacturing company, Scott Brass, Inc. (SBI), filed for bankruptcy following the decline of copper prices. In connection with the bankruptcy, SBI withdrew from a multiemployer pension plan, incurring $4.5 million in withdrawal liability. At the time of bankruptcy, SBI was a portfolio company owned by a holding company that itself was jointly owned by two private equity funds, Sun Capital Partners III, LP (Sun Fund III) and Sun Capital Partners IV, LP (Sun Fund IV and collectively, the Sun Funds). The Sun Funds were sponsored and managed by a private equity firm, Sun Capital Advisors, Inc. The multiemployer pension plan assessed withdrawal liability against both SBI and the Sun Funds on the grounds that the Sun Funds were a partnership exercising common control over SBI.
Under ERISA, as amended by the Multiemployer Pension Plan Amendments Act of 1980, when an employer exits a multiemployer pension plan, the plan may assess withdrawal liability on the employer for the employer's share of unfunded vested benefits. ERISA provides that when "trades or businesses" are under "common control," they are treated as a single employer. It follows then that trades or businesses under common control are jointly and severally responsible for any withdrawal liability incurred by one of the trades or businesses. With respect to "common control" for purposes of withdrawal liability, the Pension Benefit Guaranty Corporation (PBGC) adopted regulations that generally mirror IRS controlled group regulations: common control exists if there is individual or aggregated ownership of at least 80%.
In 2013 and 2016, the District Court of Massachusetts found that the Sun Funds were not only "trades or businesses," but also a partnership-in-fact (i.e., a partnership under common law) acting under "common control" with SBI. Sun Fund III and Sun Fund IV had individual investment stakes in the portfolio company of only 70% and 30%, respectively, so the strict common control ownership threshold was not met. However, the critical partnership-in-fact finding meant those individual ownership stakes were nevertheless aggregated for determining common control. Narrowly, those rulings meant the Sun Funds were jointly and severally liable for SBI's withdrawal liability. More broadly, those rulings threatened the fundamental way private equity funds are established, funded and operated.
Because the First Circuit had previously ruled that Sun Fund III was a trade or business (and on remand, the lower court found the same for Sun Fund IV), the outstanding issue on appeal was whether the Sun Funds had indeed formed a partnership-in-fact that caused the Sun Funds' individual ownership stakes in SBI to be aggregated. In the absence of formal guidance from the PBGC on determining when separate entities are considered to be a partnership-in-fact, the First Circuit turned to the partnership factors articulated in an old tax court case, Luna v. Commissioner1 for its analysis. Those factors are:
- The agreement of the parties and their conduct in executing its terms;
- The contributions, if any, which each party has made to the venture;
- The parties' control over income and capital and the right of each to make withdrawals;
- Whether each party was a principal and co-proprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income;
- Whether business was conducted in the joint names of the parties;
- Whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers;
- Whether separate books of account were maintained for the venture; and
- Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
Applying these Luna factors, the First Circuit noted that some facts supported a partnership-in-fact between the Sun Funds. For instance, the Sun Funds together scouted potential portfolio companies, and essentially the same two individuals ran both the Sun Funds. However, the First Circuit found facts supporting the opposite finding more compelling. That is, the Sun Funds expressly disclaimed any sort of partnership with each other in their respective limited partnership agreements and each was created as a separate LLC; they filed separate tax returns and maintained separate books and bank accounts; most of the 230 limited partners in Sun Fund IV were not also limited partners in Sun Fund III; and the Sun Funds did not invest in parallel in the same portfolio companies.
In the end, the First Circuit recognized conflicting policy goals—on the one hand, the need "to ensure the viability of existing pension funds", and on the other hand, the need "to encourage the private sector to invest in, or assume control of, struggling companies with pension plans[.]" The court also stated it was reluctant to impose withdrawal liability on the Sun Funds when there was neither clear congressional intent to do so nor formal guidance from the PBGC.
While this is certainly a positive outcome for private equity funds, the First Circuit's decision was very narrow and fact specific—the court did not reverse the district court's earlier decision that the Sun Funds were "trades or businesses," and the court noted that it did not "reach other arguments that might have been available to the parties." This suggests that had the facts been different, the court could have ruled the other way. For more information please also see our blog post and Labor & Employment, Corporate, and Real Estate Legal Update.
1. 42 T.C. 1067 (1964).
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