August 1, 2013
For the first time, a federal court of appeals has ruled that two private equity funds are “trades or businesses” that could be liable for the multiemployer pension plan withdrawal liability of one of their portfolio companies. Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund, U.S. App. LEXIS 15190 (1st Cir. July 24, 2013). The ruling reverses a district court decision favorable to the funds and is a wake-up call for private equity funds whose portfolios include companies that contribute to multiemployer plans or sponsor single-employer pension plans with substantial unfunded benefit liabilities. This article discusses the case and key considerations for funds when investing in such companies.
Scott Brass, Inc., a portfolio company of Sun Capital Partners III, LP and Sun Capital Partners IV, LP (the Sun Funds), was a contributing employer to the New England Teamsters & Trucking Industry Pension Fund (the Teamsters Plan), a multiemployer plan. Like most multiemployer plans today, the Teamsters Plan was not fully funded, and under ERISA, as amended by the Multiemployer Pension Plan Amendments Act of 1980, an employer withdrawing from the plan is liable for the employer’s share of the plan’s unfunded vested benefits.
Moreover, under ERISA all trades or businesses under common control (the controlled group) are jointly and severally liable for certain pension benefit obligations of any employer in the controlled group, including multiemployer plan withdrawal liabilities, unfunded pension benefit liabilities of single-employer plans, minimum funding obligations and Pension Benefit Guaranty Corporation (PBGC) premiums. However, the term “trade or business” is not defined in ERISA or the Internal Revenue Code (Code), nor in PBGC or Treasury regulations, and has not been given a definitive, uniform definition by the United States Supreme Court.
In recent years multiemployer plans have aggressively litigated against alleged controlled-group members to recover withdrawal liability payments that the contributing employer was unable to make. In Board of Trustees, Sheet Metal Workers Nat’l Pension Fund v. Palladium Equity Partners, LLC, 722 F. Supp. 2d 854 (E.D. Mich. 2010), the district court relied on a 2007 PBGC Appeals Board decision to find that a private equity fund could be liable for unpaid withdrawal liability as a trade or business controlled-group member or alter ego of the contributing employer.
When Scott Brass withdrew from the Teamsters Plan and filed for bankruptcy, the plan demanded that the Sun Funds pay Scott Brass’ $4.5 million withdrawal liability. The Sun Funds sued for a declaratory judgment that they were not responsible for the withdrawal liability because:
The district court ruled in the Sun Funds’ favor. It rejected the analysis of the 2007 PBGC decision and instead relied on two Supreme Court tax cases (Higgins v. Comm’r, 312 U.S. 212 (1941) and Whipple v. Comm’r, 373 U.S. 193 (1963)) and found the Sun Funds were not trades or businesses.
The First Circuit’s Decision
On appeal, the First Circuit determined that the district court erred in applying Higgins and Whipple and followed the PBGC’s analysis of the controlled-group issue. Acknowledging that its decision was “very fact-specific,” the First Circuit concluded that the Sun Funds are trades or businesses based on the following factors:
The First Circuit distinguished the Higgins and Whipple cases because those cases interpreted “trade or business” for purposes of determining whether the taxpayer properly deducted certain expenses and did not consider what “trade or business” meant for purposes of controlled-group withdrawal liability.
The Court of Appeals held that activities of related Sun Fund entities could be attributed to the Sun Funds because “the general partner of Sun Fund IV, in providing management services to [Scott Brass], was acting as an agent of the Fund” under Delaware partnership law and under Sun Fund partnership agreements that authorized the Sun Funds’ general partners to provide management services to portfolio companies and hire, terminate and compensate agents and employees of the Sun Funds and their portfolio companies.
The 2007 PBGC decision on which the First Circuit relied applied the following two-part test to determine whether an organization was a trade or business:
In its decision, the PBGC found that the private equity fund was a trade or business due to:
This “investment plus” standard was followed not only by the First Circuit in Sun Capital, but also previously by the district court in Palladium Equity Partners.
The First Circuit decided only the “trade or business” issue in the case; whether “common control” exists between the Sun Funds and Scott Brass will be determined on remand to the district court.
Key Considerations for Private Equity Funds in General
Private equity funds should note the following when considering investment in companies that sponsor defined benefit pension plans or contribute to multiemployer plans:
Sun Capital ’s holding may also affect the tax qualification of retirement plans sponsored by the portfolio companies owned by a private equity fund. For example, assume that Fund F owns 80 percent or more of Portfolio Companies A, B and C, and that each of those companies sponsors a qualified retirement plan.
Most, if not all, private equity funds have to date not considered themselves as trades or businesses and have therefore not considered Section
At some point, the Internal Revenue Service may issue guidance for testing qualified plans in light of Sun Capital, particularly if other courts of appeals reach similar results.
Special Issues for Private Equity Funds Having Significant Benefit Plan Investors
The First Circuit noted in its decision that the Sun Funds were
One exception to the general rule is where the entity (such as a private equity fund) is a VCOC. 29 C.F.R. Section 2510.3-101(d). Private-equity funds having investors who are ERISA benefit plans sometimes structure themselves as VCOCs in order to avoid the DOL regulation. The requirements under the regulation for an entity to be a VCOC include the following:
Accordingly, in order for a private equity fund benefit to retain its VCOC status, so that the managers of the fund would not be considered ERISA fiduciaries of its benefit-plan investors, the fund has to take an active role in the management of one or more of its portfolio companies. Doing so, however, makes it more likely that the fund would be considered a trade or business. Although the Sun Capital court expressly rejected the Teamsters Fund’s argument that a VCOC is necessarily a trade or business, active involvement in the management and operation of Scott Brass was a significant factor in the court’s determination that the Sun Funds were trades or businesses.
For further information, please contact any of the authors, Taylor Wedge French, James P. McElligott, Jr., Larry R.Goldstein, Jeffrey R. Capwell, Steven D. Kittrell and G. William Tysse, or any other member of the McGuireWoods employee benefits team.