Private equity fund sponsors can breathe a sigh of relief last week as the First Circuit Court of Appeals, reversing a district court finding, held that two separate private equity funds sharing a general partner (Sun Capital Partners III and Sun Capital Partners IV) were not jointly and severally liable under the Employee Retirement Income Security Act of 1974, as amended (ERISA) for the multiemployer pension withdrawal liability of a portfolio company in which both funds invested. Sun Capital Partners v. New England Teamsters & Trucking Industry Pension Fund.
ERISA imposes joint and several liability on each member of a company’s controlled group for certain liabilities, including multiemployer pension plan withdrawal liabilities of the contributing employer. Generally, a company’s “controlled group” includes the company, its subsidiaries and each “trade or business” that owns at least 80% of or more of the company, through a parent-subsidiary or brother-sister relationship.
Previously, the First Circuit held that a private equity fund qualified as a “trade or business” (see our prior alert here). In 2016, the U.S. District Court for Massachusetts held that the Sun Capital Funds were part of the same controlled group as Scott Brass Inc., the contributing employer, notwithstanding that neither Fund owned the requisite 80% of the portfolio company. The district court held that by co-investing in Scott Brass, the Funds formed a “partnership in fact” that owned 100% of Scott Brass. (see our prior alert here).
The First Circuit Decision
The First Circuit reversed the district court, finding that the Funds did not create a “partnership in fact” and, thus, were not jointly and severally liable for the withdrawal liability. In reaching its decision, the First Circuit applied the same multi-factor test for identifying federal tax partnerships outlined in Luna v. Commissioner, 42 T.C. 1067 (1964) as the district court. While certain of the factors, such as the same two people were in control of the Funds’ general partners, the Funds pooling of resources and expertise to identify, acquire, sell, and manage portfolio companies, and the Funds’ conduct in managing the LLC, supported finding a de facto partnership, most of the factors did not. Among the factors cited by the First Circuit in its decision not to find a “partnership in fact” were the Funds’ express intent not to form a partnership, lack of parallel investments, the fact that the Funds maintained separate records and bank accounts and filed separate tax returns, and significantly different investors in each Fund. The court also found that, although not dispositive, the creation of an LLC by the Funds through which the Funds would acquire the portfolio company demonstrated an intent not to form a partnership because the formation of the LLC “both prevented the Funds from conducting their business in their ‘joint names’ and limited the manner in which they could exercise mutual control over and assume mutual responsibilities” for managing the portfolio company.
Implications for Private Equity Sponsors
While this decision is welcome news to private equity sponsors, it does not alter the First Circuit’s earlier decision that the a private equity fund could engage in a “trade or business” and, if the requisite 80% ownership existed, could be considered to be in the same controlled group as its portfolio companies. Moreover, this decision is not binding on courts outside of the First Circuit (namely, Maine, Massachusetts, New Hampshire, Puerto Rico and Rhode Island) and it remains to be seen whether the PBGC and/or Congress will undertake to issue guidance or legislation on this subject. Private equity funds should carefully consider the structure when investing in portfolio companies that participate in multiemployer pension plans and defined benefit pension plans.
 Sun Capital Partners III indirectly owned 30% of Sun Scott Brass, LLC and Sun Capital Partners IV owned 70% of Sun Scott Brass, LLC, which in turn owned 100% of the portfolio company.