Sun Capital: PE Funds Face Increased ERISA Exposure
In a decision with significant implications for private equity funds and their investors, the U.S. District Court for the District of Massachusetts held in Sun Capital1 that two Sun Capital Advisors private equity funds were jointly and severally liable under Title IV of ERISA2 for multiemployer pension plan withdrawal liability incurred by a bankrupt portfolio company that was jointly owned by the funds. Based on the novel (and troubling) rationale that a “partnership in fact” existed between the funds, the court reached this conclusion despite neither fund separately owning a sufficient percentage of the portfolio company to be exposed to joint and several liability under Title IV’s controlled group rules.
Controlled Group Liability
Under Title IV of ERISA, all members of a controlled group are jointly and severally liable for certain liabilities, including multiemployer pension plan withdrawal liability and defined benefit plan termination liability. For an entity, such as a private equity fund, to be part of a controlled group, the entity must be both a “trade or business,” and under “common control” with at least one other entity. In general, “common control” means an 80% or more ownership link. Historically, private equity funds have taken the position that they are not “trades or businesses” based on law developed under the tax code. In addition, it has been common for funds to structure portfolio company investments to avoid the 80% ownership threshold in any event.
The Sun Capital Decision
Sun Capital is a long running litigation involving a multiemployer pension plan’s attempt to collect withdrawal liability from two Sun Capital sponsored private equity funds that was incurred by a bankrupt portfolio company that was indirectly owned 70%/30% by the two funds. At an earlier stage of the litigation, the First Circuit Court of Appeals ruled that one of the two funds was a “trade or business” and remanded the case to the District Court to determine whether the second fund was a trade or business and whether either of the funds were under “common control” with the portfolio company. Please see our previous advisory, Appeals Court Decision Raises Controlled Group Pension Liability Concerns for the Private Equity Industry, for more on this topic.
On remand, the District Court recently found that (i) the second fund also was a “trade or business” under the standard adopted by the First Circuit, and (ii) despite the fact that the two funds’ actual, indirect ownership was split 70/30%, the co-investment by the two funds amounted to a “partnership in fact” under common law that was liable (along with its general partners, the funds) for the withdrawal liability because it indirectly owned 100% of the portfolio company.
The District Court’s recent decision is disturbing and marks a significant change in the law. It upsets longstanding strategies used by funds and other investors to insulate themselves from ERISA liabilities -- particularly the common strategy of allocating investments among a sponsor’s funds so that no fund owns more than 80% of the portfolio company. It also highlights the importance of identifying, and taking into account, potential ERISA controlled group liabilities in decision-making with respect to both future and existing investments. The ultimate reach of Sun Capital remains to be seen.