The US District Court for the District of Massachusetts recently ruled that two private equity funds were trades or businesses and in common control with a bankrupt company, and thereby liable for the multiemployer pension plan withdrawal liability obligations of the bankrupt company. The case, Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund, was heard on remand from the prior appeal to the US Court of Appeals for the First Circuit. The district court rejected the company’s choice of organizational structures based on state law, holding that such choice and state law should not determine whether investment funds that are trades or businesses may be part of the same controlled group of businesses.

Under ERISA and the Internal Revenue Code (the Code), members of the same controlled group have joint and several liability for certain employee benefit liabilities of each group member, including single employer defined benefit plan funding and Pension Benefit Guaranty Corporation (PBGC) premiums, medical plan COBRA obligations, and multiemployer pension plan contribution, withdrawal, and termination liability. The Sun Capital cases involve multiemployer pension plan withdrawal liability. For ERISA and the Code, a controlled group requires an ownership/control threshold (at least 80% for a parent-subsidiary relationship or, for a brother-sister relationship, five or fewer individuals with 80% overall ownership and 50% identical ownership) among trades or business.

Prior to 2007, based on a few IRS rulings, an investment fund was not treated as a trade or business. In 2007, the PBGC issued an opinion letter taking a contrary position, concluding that a private equity fund was a trade or business jointly and severally liable for the unfunded benefit liabilities of one of its portfolio companies. This PBGC opinion letter was judicially endorsed in Sheet Metal Workers National Pension Fund v. Palladium Equity Partners, LLC. Other cases have also held passive investors to be engaged in a trade or business. 

The Sun Capital decisions involve certain private equity funds referred to as “Sun Fund III” and “Sun Fund IV.” The funds owned 30% and 70%, respectively, of an LLC, which owned through a holding company 100% of Scott Brass, Inc. (SBI). SBI was the entity that, upon its bankruptcy, incurred withdrawal liability regarding a multiemployer pension plan. The pension fund demanded withdrawal liability from SBI and also from the Sun Funds, claiming the funds were part of a joint venture under common control. In 2010, the Sun Funds sued in district court, asserting that it was not part of a joint venture and not under common control. The district court’s 2012 decision ruled that the Sun Funds were not trades or businesses and did not address the common control issue. Upon appeal by the pension fund, the First Circuit held that a private equity fund (Sun Fund IV) might be held jointly and severally liable as a “trade or business” for the unfunded pension obligations of its portfolio companies and remanded to the district court for further proceedings to determine (1) whether Sun Fund III LP and Sun Fund III QP, LP are engaged in a “trade or business” and (2) whether Sun Fund III and Sun Fund IV were under “common control.” Upon remand, the district court held that the Sun Fund III was engaged in a trade or business and that the funds were under common control. 

Regarding whether the funds were under common control, the district court also addressed the separate issue of whether to ignore the structure chosen by the private equity fund (i.e., a less than 80% investment by its Fund III and a greater than 20% investment by its related, although not parallel, Fund IV) and to deem a partnership/joint venture to exist among the related funds rather than the entity formed below them. On this issue, the court held that the investments by the related funds in an LLC that owned the operating company subject to pension liabilities were disregarded and instead deemed the funds to have formed a partnership-in-fact with joint and several liability for the portfolio company’s liability. The determination about whether a partnership-in-fact exists is made under principles of federal tax law.

Although it is unclear whether the district court’s holdings will be upheld on appeal and/or in other circuits, the decision raises many questions about organization and liability for private equity funds and other investors.