On July 24, 2013, in a case of first impression (Sun Capital Partners III LP vs. New England Teamsters & Trucking Indus. Pension Fund, No.12-2312), the First Circuit held that a private equity fund was a “trade or business” under ERISA as amended by the Multiemployer Pension Plan Amendment Act (“MPPAA”), and thus potentially liable for withdrawal liability incurred by its portfolio company if that company was under common control with the fund.* The court applied an “investment plus” test and found that the private equity fund was not merely a “passive investor” but had sufficient management and operational involvement with its portfolio company so as to make it a trade or business.
Sun Fund IV and Sun Fund III (collectively, the “Sun Funds”) are two funds held by private equity firm Sun Capital Advisors, Inc. Together, the Sun Funds held 100% of the interests of Scott Brass, Inc. and planned to turn around the struggling company within two to five years and sell it. Scott Brass contributed to a multiemployer pension plan. When declining copper prices created a credit crisis about a year and half after its purchase by the Sun Funds, Scott Brass ceased making its required contributions to the pension plan, and was forced into Chapter 11 bankruptcy. Withdrawal liability for Scott Brass was assessed in the amount of $4.5 million, and the pension fund demanded payment from the Sun Funds, which prompted the Sun Funds to seek a declaratory judgment in Massachusetts federal district court that they were not “trades or businesses” under common control with Scott Brass and therefore could not be liable.
The MPPAA imposes liability on an organization other than the organization that is required to contribute to the pension fund only if two conditions are met: the organization must be under common control with the organization required to contribute, and the organization must be a “trade or business.” The district court issued summary judgment in favor of the Sun Funds, finding that they were not “trades or businesses” because they do not have employees or offices and do not report income other than investment income on their tax returns.
There is a dearth of guidance from the Pension Benefit Guaranty Corporation (“PBGC”) on the definition of “trade or business” – so much so that the court lamented, “(w)e express our dismay that the PBGC has not given more and earlier guidance on this ‘trade or business’ ‘ investment plus’ theory to the many parties affected.” No regulations have been issued, and the sole guidance is a 2007 opinion letter in which the PBGC applied a two-part test to determine if a private equity fund is a “trade or business” that could be subject to withdrawal liability. The two elements of the so-called “investment plus” test are whether the fund was engaged in an activity for the primary purpose of making a profit, and whether it conducted the activity with continuity and regularity. The fund that was the subject of the PGBC letter was determined by the PBGC to be a trade or business because the fund had a profit motive and met the continuity and regularity prong due to the size of the fund, the size of its profits and management fees paid to the general partner.
Although the First Circuit found that the PBGC opinion letter was due a limited amount of deference, it essentially disregarded it, employing its own “investment plus” standard in determining whether a private equity fund was a “trade or business.” The court explained that the “plus” portion of the analysis was very fact-dependent, with no one factor being dispositive.
The court noted that the Sun Funds had extensive activity in the management and operation of Scott Brass, Inc., as confirmed in the language of the funds’ partnership agreements (a “principal purpose of the partnership is the management and supervision of its investments”). Employees of Sun Capital Advisors, Inc. “exerted substantial operational and managerial control over Scott Brass,” attending company meetings during which Scott Brass employees were hired and the company’s capital expenditures and possible acquisitions were discussed. Sun Capital Advisors employees were also included in email chains regarding liquidity, revenue growth and potential mergers. Employees of Sun Capital Advisors, Inc. held two of the three director positions at Scott Brass.
Another crucial factor that led the court to conclude that Sun Fund IV was a trade or business was that it was able to offset management fees that it would have otherwise paid its general partner to manage the investment in Scott Brass. This was a “direct economic benefit” to Sun Funds IV that the court noted would not have been available had Sun Fund IV been a passive investor. The court remanded to the district court the question as to whether Sun Fund III was a trade or business due to its inability to determine from the record whether Sun Fund III received an economic benefit from this offset. The court also remanded for a determination as to whether the Sun Funds were under common control with Scott Brass.
The court’s opinion also addressed a policy argument made by the Sun Funds, that Congress never intended this type of result, wherein business owners would be required to “dig into their own pockets” to cover withdrawal liability for a portfolio company. In response, the court wrote, “We recognize that Congress may wish to encourage investment in distressed companies by curtailing the risk to investors in such employers of acquiring ERISA withdrawal liability. If so, Congress has not been explicit, and it may prefer instead to rely on the usual pricing mechanism in the private market for assumption of risk.”
This case serves as an effective admonition to an acquirer that is considering the purchase of 80% or more of the interests in a company which contributes to a multiemployer plan or maintains an underfunded defined benefit plan. Before consummating such a transaction, the acquirer should carefully consider the extent to which other entities in the acquirer’s controlled group might be held liable for any underfunding of the multiemployer or single employer plan.
*The MPPAA requires employers withdrawing from a multiemployer pension fund to contribute a share of the fund’s unfunded but vested pension liability.
Internal citations have been omitted from this article.