The First Circuit recently ruled in Sun Capital Partners III, LP v. New England Teamsters & Trucking Ind. Pension Fund that two investment funds controlled by private equity firm Sun Capital were not part of a “controlled group” with a former portfolio company, Scott Brass, Inc. (“Scott Brass”), and therefore not liable for Scott Brass’s withdrawal liability from a multi-employer pension plan. While this decision ends the decade-long attempt by the New England Teamsters pension fund to hold the Sun Capital funds liable, the opinion is not a repudiation of the principle that private equity funds may constitute a “controlled group” for purposes of pension plan withdrawal liability. Rather, it signals that each case will have to be evaluated on its own facts. So, while the ruling is good news for Sun Capital, the message for investors is that they need to be mindful of pension plan withdrawal liability in structuring private equity acquisitions.
The liability of the members of a “controlled group” for withdrawal from a multi-employer pension plan is governed by the Multiemployer Pension Plan Amendments Act of 1980 (“MPPAA”). Under the MPPAA, the potential liability of the two Sun Capital funds depended on whether they had created an implied partnership-in-fact that constituted a control group for purposes of ERISA. When an employer withdraws from a multi-employer plan, it must pay its proportionate share of the plan’s unfunded vested benefits. To prevent evasion of withdrawal liability, the MPPAA imposes joint and several withdrawal liability, not only on the withdrawing employer, but also on all entities (1) under “common control” with the obligated organization, and (2) that qualify as engaging in “trade or business.”
In 2007, two private equity funds sponsored by Sun Capital Advisors, Inc. — Sun Capital III and Sun Capital IV — acquired 30% and 70%, respectively, of Scott Brass, a brass and copper manufacturer that was a participant in a multi-employer pension plan, the New England Teamsters and Trucking Industry Pension Fund (“NETTI”). Scott Brass stopped making pension contributions in October 2008. In the fall of 2008, an involuntary bankruptcy petition was filed against Scott Brass in the District of Rhode Island. In December 2008, NETTI demanded that Scott Brass pay more than $4.5 million in withdrawal liability and it also demanded payment from the Sun Capital funds. The funds sued NETTI in federal court in Massachusetts, seeking a ruling that they were not liable for the withdrawal liability. The district court granted summary judgment in favor of the funds, ruling that because the funds were passive investors and had no employees or offices, neither was a “trade or business” for purposes of the ERISA provisions governing withdrawal liability. NETTI appealed to the First Circuit.
First Circuit 2013 Ruling
Construing § 1301(b)(1) of ERISA, the First Circuit conducted a fact-specific “investment plus” approach and ruled that Sun Capital IV was a trade or business. The court based its ruling on findings that: (i) Sun Capital IV was actively involved in the management of Scott Brass and controlled its board of directors; and (ii) Sun Capital IV received an economic benefit which an ordinary passive investor would not have derived in the form of an offset against fees it had to pay to its general partner. The First Circuit remanded the case to the district court to determine whether Sun Capital III was also a trade or business and whether ERISA’s common control requirement had been satisfied.
District Ruling on Remand
The Sun Capital funds argued that the First Circuit had gotten its facts wrong in determining that Sun Capital IV was a trade or business because the factors the First Circuit relied on pertained to Sun Capital III rather than Sun Capital IV. The district court then examined whether: (a) the First Circuit’s ruling was clearly erroneous; (b) Sun Capital III was a trade or business; and (c) the Sun Capital funds were under common control. The district court analyzed whether Sun Capital III was a trade or business by considering whether it derived an economic benefit from its ownership interest in Scott Brass. From 2005 through 2012, the court explained, the fees that Sun Capital III owed to its general partner had been reduced by the amount that Scott Brass paid to Sun Capital III’s general partner. Because the fee offset was different from ordinary investment income, the district court concluded that Sun Capital III qualified as a trade or business.
NETTI argued that the Sun Capital funds were under common control because: (a) Sun Capital III and Sun Capital IV formed a partnership that was engaged in a trade or business; and (b) the partnership was the indirect parent of Scott Brass. The Sun Capital funds countered that because they intentionally structured their investment in Scott Brass through intermediary entities, rather than directly, the district court was obligated to respect organizational formalities and not find them to have formed a partnership.
The district court analyzed whether a partnership in fact existed using the factors listed in Luna v. Commissioner. The analysis, the court explained, was not dependent on the legal structure used, but must reflect the economic realities of the acquisition. According to the district court: (a) the Sun Capital funds engaged in conduct supporting the existence of a partnership; (b) the Sun Capital funds were directly involved in managing Scott Brass; and (c) the intermediary entities were created as an attempt to limit withdrawal liability, not as truly independent entities. After analyzing the Luna factors, the district court concluded that there was sufficient evidence of a partnership-in-fact to aggregate the funds’ interests and place them under common control with Scott Brass. Finally, the district court determined that this partnership-in-fact was a trade or business for ERISA purposes.
2019 First Circuit Appeal
The Sun Capital funds appealed to the First Circuit, which reversed and entered summary judgment for the funds. The First Circuit concluded that although there was clear evidence that the funds had acted together to manage Scott Brass, the weight of the evidence did not establish a partnership-in-fact under the Luna factors. Looking to the eight-factor Luna test, the First Circuit concluded that the district court had applied Luna incorrectly, finding that most of the Luna factors pointed away from the establishment of a partnership-in-fact.
Although the First Circuit acknowledged that the Sun Capital funds were actively involved in the management of Scott Brass, the First Circuit pointed to the following facts in deciding that there was no partnership: (a) each fund kept its own books and records, (b) each fund filed separate tax returns, (c) the funds did not invest in lockstep in the same transactions and in the same amounts or percentages, (d) while there was some overlap of investors between the funds, the majority of the investors in each fund were unique; (e) the Scott Brass business was not conducted in the joint name of the parties, and (f) the funds disclaimed any intention of acting as a partnership. In the absence of an implied partnership, neither fund was liable for Scott Brass’s withdrawal liability to the multiemployer pension plan because neither fund otherwise directly or indirectly owned 80% of Scott Brass.
Lessons From Sun Capital
The most important conclusions from the Sun Capital saga are that private equity funds may be found to engage in a “trade or business” for pension withdrawal purposes, and that two or more funds may be deemed to be under common control or have formed a partnership-in-law. Private equity sponsors should structure investments so that no single fund acquires more than 80% of any single portfolio company. If private equity sponsors want to use related funds to complete an acquisition, they need to give consideration to how they structure an investment to stay within the principles identified in the Sun Capital decision. Finally, the Sun Capital cases should remind investors that in evaluating investment targets, they need to carefully consider potential withdrawal liability for any multi-employer pension plans.
For more information on this alert or other restructuring & bankruptcy matters please contact:
 Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, Case 19-1002, First Cir., November 22, 2019.
 29 U.S.C. § 1301(b)(1).
 Luna v. Commissioner, 42 T.C. 1067, 1077-78 (1964).
 The Luna 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 coproprietor, 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.