On March 28, 2016, in the latest of a series of decisions, in Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Indus. Pension Fund,1 the United States District Court for the District of Massachusetts issued a decision adverse to private equity funds that invest in companies with commitments to multiemployer pension funds. The decision imposed withdrawal liability on two Sun Capital funds that the District Court found to be trades or businesses under common control with their bankrupt portfolio company. With respect to characterizing a private equity fund as a trade or business, the District Court followed an earlier ruling by the United States Court of Appeals for the First Circuit2 that a private equity fund will be a trade or business if it sufficiently operates and manages the portfolio company or is otherwise advantaged by it.

With respect to common control, the two funds together owned indirectly all of the stock of the portfolio company. Although the two funds were formally separate, with neither fund owning enough of the portfolio company to be considered in control of it, the District Court held that the two funds were a "partnership-in-fact." Thus, the two funds were jointly liable for $4.5 million of withdrawal liability owed to a Teamsters pension fund.

Background

The Sun Capital case derives from the bankruptcy of Scott Brass, Inc. ("SBI"), which is a portfolio company of the two private equity funds ("Fund III" and "Fund IV"). SBI defaulted on its withdrawal obligations to the New England Teamsters & Trucking Industry Pension Fund, a multiemployer pension plan. The funds sought declaratory judgment that they were not liable for the payment of withdrawal liability. The defendant counter-claimed that the funds were jointly and severally liable under the Multiemployer Pension Plan Amendments Act ("MPPAA")3 because they were engaged in a trade or business under common control with SBI. In its original decision, the District Court granted summary judgment to the funds on the ground that they were passive investors, rather than trades or businesses.4

The First Circuit reversed the District Court's original ruling in favor of the funds. The First Circuit held that an otherwise passive investment by a fund would be a trade or business if the fund sufficiently operates, manages and is otherwise advantaged by the portfolio company. According to the First Circuit, some form of "investment plus" approach is appropriate when evaluating the trade or business prong. The court declined to set general guidelines for what satisfies the "investment plus" standard and instead adopted a fact-specific approach, taking into account a number of factors with no one factor being dispositive.

Applying this approach, the First Circuit concluded that Fund IV met the trade or business requirement but that the record was insufficiently developed to decide the status of Fund III. The court's conclusion as to Fund IV was based on the court's determination that management fees that SBI paid to a Sun Capital management company would offset fees that Fund IV otherwise would have owed to its general partner. The court was uncertain whether Fund III received such an offset. On remand, the District Court was charged with answering two questions: (1) whether Fund III was engaged in a "trade or business" and (2) whether the two funds were under common control with SBI.

Engaged in "Trade or Business"

With respect to the question of trade or business, the District Court found that Fund III was entitled to the same type of offset to which Fund IV was entitled. In addition, the District Court reevaluated this factor of offset in light of the fact that the general partner of Fund IV had waived its right to fees currently due from Fund IV, and thus Fund IV had no present benefit from its right to offset the general partner's fee by the management fees paid by SBI. Although Fund IV could carry forward the right of offset, that right of carry-forward would be of no future benefit if the general partner continued to waive its right to fees from Fund IV.

The court concluded that the funds' right to generate offset carry-forwards created an economic benefit to the funds even though it was of uncertain value. The possibility of future value from the right of offset was considered sufficient to satisfy the "investment plus" test articulated by the First Circuit, and thus the funds met the trade or business test.

Under "Common Control"

With respect to the question of common control, the District Court concluded that the funds were under common control with SBI. Under the Pension Benefit Guaranty Corporation's regulations, two or more trades or businesses are under common control if they are members of a "parent-subsidiary" group.5 To constitute a parent-subsidiary group, the parent in the chain must control 80% of the subsidiary. Each fund's interest in the indirect owner of SBI (Sun Scott Brass, LLC) fell below the 80% threshold, with one fund owning 70% and the other owning 30%.

The District Court found that prior to forming Sun Scott Brass, LLC, the two funds decided to co-invest and made a conscious decision to split their ownership stake 70/30 in the LLC. The District Court focused on the funds' "top-down decisions to allocate responsibility jointly." This unity in decision-making between the funds indicated that they had formed a "partnership-in-fact" even though the two funds had no formal partnership arrangement. The District Court concluded that the statute contemplated disregarding business entity formalities meant to prevent responsible parties from having withdrawal liability.

Private Equity Considerations

This most recent Sun Capital decision strikes a blow to the structuring of investments to avoid the 80% rule. Private equity funds must be extremely careful when investing in companies with multiemployer pension liabilities and take a hard look at these potential liabilities before making an investment.

Footnotes

1 Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, NO. 10-10921-DPW, 2016 U.S. Dist. LEXIS 40254 (D. Mass. Mar. 28, 2016).

2 Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013).

3 29 U.S.C. § 1301(b)(1).

4 Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, 903 F. Supp. 2d 107 (D. Mass. 2012).

5 26 C.F.R. § 1.414(c)-2.

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