The most recent decision in the ongoing Sun Capital saga provides no relief from pension withdrawal liability for private equity funds. The federal district court for the District of Massachusetts recently reaffirmed its 2016 ruling that two private equity funds were responsible for the unfunded pension liabilities of a bankrupt portfolio company. Consequently, private equity funds should continue to carefully evaluate investments in companies with pension liabilities.
The District Court’s Most Recent Opinion
As we have written before, the case concerns whether a private equity fund may be subject to a portfolio company’s multiemployer pension withdrawal liability under the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”). The case has broader implications, though, because the court focused its analysis on whether the private equity fund and the portfolio company were part of the same “controlled group,” and that term has significance across ERISA and the Internal Revenue Code. For example, if a private equity fund is part of the same controlled group as its portfolio companies, the fund and the portfolio companies may have joint and several liability for unfunded single-employer pension liabilities, as well as multiemployer plan withdrawal liability. In addition, small portfolio companies that are part of larger controlled groups may not take advantage of special provisions for small employers under ERISA and the Code, such as exemption from the employer mandate to provide health insurance coverage under the Affordable Care Act.
In this most recent decision, Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, No. 10-10921-DPW, 2018 WL 6169366 (D. Mass. Nov. 26, 2018), the court took the opportunity to reconsider its previous ruling on the merits and held that no modification of the reasoning in its prior decision was necessary. Like the First Circuit in its 2013 opinion in the case, the district court lamented the lack of regulatory guidance or Congressional action on the question of whether a private equity fund can be held liable for the pension liability of its portfolio company. Because of the lack of guidance, the court stated that private equity investors must take into account the risk that private equity funds may incur pension liabilities, characterizing an expectation of avoiding such liabilities a “risky gambit.”
The District Court’s Previous Decision
In the prior decision, Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, 172 F. Supp. 3d 447 (D. Mass. 2016), the district court held that two private equity funds were engaged in a trade or business and were under common control, and therefore were responsible under the MPPAA for a bankrupt portfolio company’s withdrawal liability to a multiemployer pension plan.
Trade or Business Analysis
The district court applied the First Circuit’s “investment plus” analysis in considering whether one of the private equity funds engaged in a trade or business. No single factor is dispositive in an “investment plus” analysis, and relevant facts include the general partners’ and private equity firm’s active management of the portfolio company, the provision of personnel to the company, and the control of the company’s board by employees of the private equity firm. However, the deciding factor for the First Circuit was that one of the funds received an economic benefit from the portfolio company’s payment of management fees to the general partner. These fees offset amounts the fund owed its general partner, and the court held that this benefit was something more than the benefit an ordinary investor would have received. The First Circuit therefore held that the fund receiving this benefit engaged in a trade or business and remanded to the district court the question of whether the other fund received a similar offset of management fees. The district court held that the other fund did receive such offsets and therefore also engaged in a trade or business.
Common Control Analysis
On remand from the First Circuit, the district court also held that the funds were under common control because a partnership-in-fact existed between them, even though they had not entered into any formal partnership agreement. The funds had split their investment in the portfolio company 70% and 30%, in part so that neither fund would own more than 80% of the portfolio company and would therefore not be under common control with it under the provisions of ERISA and the Code. Although the First Circuit held that this structuring of the investment was not a transaction to “evade or avoid liability” under the MPPAA, the district court held that the funds’ “conscious decision to split their ownership stake 70/30” demonstrated that a partnership existed between them. The court also looked past the LLC the funds had created for purposes of investing in the portfolio company, holding that the LLC was “better understood as a vehicle for the coordination of the two Sun Funds—and an attempt to limit liability—than as a truly independent entity.”
The court went on to hold that the partnership-in-fact between the funds also engaged in a trade or business because the private equity firm actively managed the portfolio company. The First Circuit had focused its “trade or business” analysis on the economic benefit to the funds from the payments the portfolio company made to the general partner. The district court held, though, that the partnership-in-fact did not need to receive an economic benefit in addition to the economic benefit each fund received for the partnership to also be engaged in a trade or business. The partnership’s activities allowed the funds to each receive an economic benefit, so the partnership between the funds, like the funds themselves, engaged in a trade or business.
Conclusion, For Now
In light of the district court’s recent reaffirmation of its prior decision, private equity funds and their investors should continue to be aware of the potential for liability based on a fund’s investments in portfolio companies with multiemployer or unfunded single-employer pension obligations. In evaluating this risk, funds and investors should consider the extent of the management activities the private equity firm and the fund’s general partner undertake with respect to the portfolio company. Investors should particularly consider whether the fund will receive offsets for any management fees a portfolio company pays to the general partner. Under the First Circuit’s reasoning, as implemented and reaffirmed by the district court, these types of fees may raise a red flag. We suspect that the First Circuit focused on these fees because of the appearance that these amounts are effectively being transferred from the portfolio company to the fund, possibly at the expense of a portfolio company’s pension obligations. This focus may shift, though, on appeal back to the First Circuit, and private investment funds and their advisors will want to continue to follow this case closely.