Private Equity Update: 1st Circuit Reverses Imposition of Pension Plan Withdrawal Liability

The Multiemployer Pension Plan Amendments Act of 1980 ("MPPAA") amended the Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code to make "trade[s] or business[es]" that are under "common control"—which has since been defined by regulation to mean 80% common ownership—jointly and severally liable for each other's withdrawal liability under a multiemployer pension plan.

In the November–December 2013 edition of the Business Restructuring Review, we discussed a groundbreaking ruling by the U.S. Court of Appeals for the First Circuit in Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013). The decision fired a shot across the bow of private equity funds with portfolio companies that are participants in multiemployer pension plans. In Sun Capital, the First Circuit held that a private equity fund was a "trade or business" that could be held jointly and severally liable under ERISA for the pension plan withdrawal liability incurred by one of its portfolio companies.

However, the First Circuit remanded the case to the district court to determine: (i) whether a related private equity fund in that case was also a trade or business under ERISA; and (ii) whether the second prong of the test for imposing joint and several liability under ERISA—i.e., "common control"—had been met with respect to the private equity funds. On remand, the district court concluded in Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 172 F. Supp. 3d 447 (D. Mass. 2016), that the answer to both of these questions was "yes." According to the district court, an implied partnership-in-fact existed between the affiliated private equity funds—thereby satisfying ERISA's common control requirement—even though the funds disclaimed any intent to form such a partnership because, among other things, the funds were not merely passive investors in the portfolio company but actively managed its affairs.

The First Circuit recently reversed the district court's ruling. In Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, 943 F.3d 49 (1st Cir. 2019), petition filed for reh'g en banc, Nos. 16-1376, 19-1002 (1st Cir. Dec. 6, 2019), the court of appeals concluded that: (i) the multi-factored partnership test under relevant federal tax law had not been satisfied; and (ii) there is no indication that Congress intended to impose liability under the circumstances of the case.

Sun Capital

In 2007, two private equity funds of Sun Capital Advisors, Inc.—Sun Capital III and Sun Capital IV (collectively, the "Sun Capital funds")—acquired 30% and 70% stakes, respectively, in Scott Brass, Inc. ("Scott Brass"), a brass and copper manufacturer, through a series of jointly-owned limited-liability-company subsidiaries, including Sun Scott Brass, LLC ("SSB"). The Sun Capital funds are structured as distinct Delaware limited partnerships with different investors and investments as well as separate tax returns, books, records and bank accounts. However, through a series of affiliates, the funds are controlled by the same two men and coordinate to identify, acquire, reorganize and sell portfolio companies. In connection with these activities, the funds become intimately involved in portfolio company operations.

Scott Brass was a participant in a multiemployer pension plan, the New England Teamsters and Trucking Industry Pension Fund ("NETTI"). In the fall of 2008, following a collapse in the price of copper, Scott Brass breached its loan covenants and was unable to obtain sufficient credit to stay in business. The company stopped making pension contributions in October 2008, and an involuntary bankruptcy petition was filed against it the following month 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 district court in Massachusetts, seeking a declaratory judgment that they were not jointly and severally liable for the withdrawal liability. The district court granted summary judgment in favor of the funds. Among other things, the court reasoned that, since the funds were "passive" and had no employees or offices, neither was a "trade or business" under section 1301(b)(1) of ERISA. NETTI appealed to the First Circuit.

Construing section 1301(b)(1) of ERISA, the First Circuit conducted a fact-specific "investment plus" approach and ruled that one of the funds—Sun Capital IV—was a trade or business within the meaning of the provision. The court predicated its ruling on factual findings that: (i) Sun Capital IV was actively involved in the management of Scott Brass and had the ability to control the company's board of directors; and (ii) Sun Capital IV received an economic benefit that an ordinary passive investor would not have derived in the form of an offset against fees it otherwise would have had to pay to its general partner.

The First Circuit remanded the case to the district court to determine whether: (i) Sun Capital III was also a trade or business within the meaning of section 1301(b)(1); and (ii) ERISA's common control requirement had been satisfied for the Sun Capital funds.

The District Court's Ruling on Remand

As an initial matter, the Sun Capital funds represented that the facts on which the First Circuit relied in determining whether Sun Capital IV was a trade or business were inaccurate because they pertained to Sun Capital III rather than Sun Capital IV. As a consequence, the district court examined whether: (i) in light of this confusion of the facts, the First Circuit's ruling concerning Sun Capital IV was clearly erroneous; (ii) Sun Capital III was a trade or business; and (iii) the Sun Capital funds were under common control.

The district court began its analysis of whether Sun Capital III was a trade or business within the meaning of section 1301(b)(1) by considering whether Sun Capital III derived an economic benefit from its activities. From 2005 through 2012, the court explained, the fees that Sun Capital III owed to its general partner had been reduced by the amount which Scott Brass had paid to Sun Capital III's general partner. On this basis, the court concluded that Sun Capital III qualified as a trade or business within the meaning of section 1301(b)(1) of ERISA.

In support of its contention that the Sun Capital funds were under "common control," NETTI argued that: (i) Sun Capital III and Sun Capital IV formed a partnership or joint venture; (ii) the partnership or joint venture was engaged in a trade or business; and (iii) the partnership or joint venture was the indirect parent of Scott Brass. The Sun Capital funds countered that, because they intentionally invested in Scott Brass through SSB, rather than directly, the district court was obligated to respect organizational formalities.

The district court rejected the Sun Capital funds' argument. The question of organizational liability, the court explained, must reflect the economic realities of the business entities that were created for the acquisition. According to the court: (a) the Sun Capital funds intentionally engaged in conduct supporting the existence of a partnership or joint venture that owned Scott Brass; (b) the funds were intimately involved in managing and operating Scott Brass; and (c) SSB was created as an attempt to limit withdrawal liability, not as a truly independent entity.

The district court also concluded, examining the Sun Capital funds' pre-acquisition activities and the manner in which the acquisition of Scott Brass was structured, that a partnership-in-fact existed sufficient 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 within the meaning of section 1301(b)(1) of ERISA. The court found, among other things, that the partnership-in-fact was involved in the active management of Scott Brass, controlled the company's board through a joint effort, and engaged in activities which were intended to generate compensation that an ordinary, passive investor would not have derived.

The First Circuit's Ruling

A three-judge panel of the First Circuit reversed the district court's ruling regarding the "common control" element of withdrawal liability under ERISA but declined to address whether the Sun Capital funds operated as a "trade or business." Notably, the First Circuit prefaced its discussion by acknowledging the tension between competing policy concerns:

If the MPPAA imposes such withdrawal liability, [the Pension Benefit Guaranty Corporation ("PBGC")] states it assumes [NETTI] intends to look to the private equity funds, including their general partners and their limited partners, to pay the liability. The issues raised involve conflicting policy choices for Congress or PBGC to make. On one hand, imposing liability would likely disincentivize much-needed private investment in underperforming companies with unfunded pension liabilities. This chilling effect could, in turn, worsen the financial position of multiemployer pension plans. On the other hand, if the MPPAA does not impose liability and the Pension Fund becomes insolvent, then PBGC likely will pay some of the liability, and the pensioned workers (with 30 years of service) will receive a maximum of $12,870 annually.

The First Circuit explained that, under ERISA, as amended by the MPPAA, the issue of liability depends on whether, despite being structured as distinct business entities, the funds operated as an implied partnership-in-fact that constituted a control group. The court further noted that, although regulations adopted in 1996 by the PBGC state that entities are under common control if they are members of a "parent-subsidiary group of trades or businesses under common control" (see 26 C.F.R. § 1.414(c)-2(b); 29 C.F.R. §§ 4001.2 and 4001.3(a)), the PBBC has not provided any additional guidance on "how to determine common control specifically in the MPPAA context."

In the absence of any such guidance from the PBGC and because PBGC's common control regulations must be consistent with U.S. Treasury regulations, which incorporate federal tax law's definition of "partnership," the First Circuit stated that the question "turns on an application of the multifactored partnership test in Luna v. Commissioner, 42 T.C. 1067 (1964)."

In Luna, the U.S. Tax Court adopted the following factors to determine whether a partnership exists:

  1. "The agreement of the parties and their conduct in executing its terms";
  2. "the contributions, if any, which each party has made to the venture";
  3. "the parties' control over income and capital and the right of each to make withdrawals";
  4. "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";
  5. "whether business was conducted in the joint names of the parties";
  6. "whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers";
  7. "whether separate books of account were maintained for the venture"; and
  8. "whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise."

Sun Capital, 2019 WL 6243370, at *6 (quoting Luna, 42 T.C. at 1077-78).

The First Circuit rejected the Sun Capital funds' argument that these factors do not apply because they organized a limited liability company—SSB—to operate Scott Brass. According to the court, "[m]erely using the corporate form of a limited liability corporation cannot alone preclude courts [from] recognizing the existence of partnership in fact."

The First Circuit explained that some of the Luna factors indicated the existence of a partnership between the funds, including: (i) the funds' collective efforts to find potential portfolio companies that needed "extensive intervention" in management and operations; and (ii) control of both funds by the same two individuals and the pooling of their resources in relying on an affiliate to identify, acquire and manage portfolio companies, to structure acquisitions and to provide other services.

However, the First Circuit concluded that most of the Luna factors supported a finding that no partnership-in-fact existed between the Sun Capital funds. Among other things, the court noted that: (i) the funds expressly disclaimed any sort of partnership; (ii) the funds did not have the same limited partners (for the most part), filed separate tax returns and had separate books, records and bank accounts; (iii) the funds did not "invest in the same companies at a fixed or even variable ratio, which also shows some independence in activity and structure"; and (iv) the creation of SSB to acquire Scott Brass "shows an intent not to form a partnership."

Finally, the First Circuit again emphasized that competing policy considerations complicated the analysis:

[W]e are reluctant to impose withdrawal liability on these private investors because we lack a firm indication of congressional intent to do so and any further formal guidance from PBGC. Two of ERISA and the MPPAA's principal aims—to ensure the viability of existing pension funds and to encourage the private sector to invest in, or assume control of, struggling companies with pension plans—are in considerable tension here.


Given its conclusion that the Sun Capital funds were not under common control, the First Circuit declined to address whether the funds were a trade or business for purposes of withdrawal liability under ERISA.


On December 6, 2019, NETTI filed a petition for rehearing en banc of the First Circuit's ruling. According to the petition, the First Circuit decision: (i) contrary to every other federal circuit court of appeals that has addressed the issue, failed to apply the U.S. Supreme Court's holding in Commissioner v. Culbertson, 337 U.S. 733 (1949), which uses a "totality of the circumstances approach" to determine whether a partnership exists, and instead applied the test in Luna, a tax court case that limits the analysis to a list of eight factors to make that determination; and (ii) relies upon a misstatement of the purpose of ERISA and the MPPAA as related to the private equity industry.

The First Circuit's recent Sun Capital decision was a successful and clearly helpful result to the private equity community. It reveals at least one appellate court's reluctance to aggressively apply equitable theories of liability—like federal tax law's de facto partnership doctrine—to expand multiemployer pension liability to private equity funds, especially in the absence of clear congressional intent to do so. Even with the Sun Capital result, however, because private equity funds are likely to continue to be treated as trades or businesses for purposes of ERISA's control group rules, it is particularly important for funds to evaluate their ownership structure practices in connection with portfolio companies that contribute to multiemployer plans. The ruling highlights the importance of maintaining structural formalities as a way to minimize a private equity sponsor's potential exposure in connection with portfolio company contingent liabilities.

A version of this article was previously published in Lexis Practice Advisor. It has been reprinted here with permission.
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