​​1st Cir. Sun Capital Case

(ERISA Liability of Private Equity Sponsor for Portfolio's Plans)

NOTE:2019 Decision - $3.5 Million Judgement.

See generally: ERISA Controlled Group Home Page

2019.NOV.19 UPDATE:

  • The First Circuit issued decided, in Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 943 F.3d 49, 51, that two investment funds established by a private equity firm were not liable for a portfolio company's withdrawal liabilities owed to a union pension plan. The First Circuit held that the funds were not under “common control” with the portfolio company, since neither separately owned 80% or more of the stock of the portfolio company, and based upon the facts and circumstances, the funds had not formed a de facto partnership to acquire and own the stock.

 2016.April     Unprecedented Private Equity Court Decision Collapses Related Funds Triggering ERISA Withdrawal Liability for Portfolio Company’s Union Pension Obligations.  In the latest opinion issued in the Sun Capital litigation, the U.S. District Court for the District of Massachusetts just held two non-parallel private equity funds jointly and severally liable for a $4.5 million ERISA multiemployer plan withdrawal liability claim. This will be startling to funds and ERISA mavens alike, because the funds were intentionally structured to own only 70 percent and 30 percent, respectively, of the portfolio company, and thereby never trigger the 80 percent ownership level that triggers controlled group liability under ERISA. The court disregarded the funds’ actual ownership structure and in what some might say was an ends-justifies-the-means analysis, held that the funds had formed a “partnership-in-fact.” Consequently, each fund was jointly and severally liable for their portfolio company’s withdrawal liability.  Continued in PDF.

2013.July.24  Private Equity Alert re 1st Circuit's Sun Capital Decision: 
                    Consider ERISA Pension Liability Risks from Portfolio Plans
On July 24th, the First Circuit issued a decision that should concern private equity funds because it breaks new ground in articulating when these funds could be held liable to a multiemployer (union) pension plan for a portfolio company’s withdrawal liability. The Sun Capital[1] decision has two immediate implications for PE funds. First, they should evaluate their exposure to ERISA pension liability risks for any portfolio company as to which the PE fund is an 80% or more owner. Second, they should consider structuring future investments in a manner that keeps each fund’s ownership below 80% of any portfolio company with ERISA defined benefit or multiemployer pension plans (because the PE fund could potentially be held liable for those obligations under ERISA). 

Regarding this 80% consideration, the First Circuit’s decision affirmed that Sun Capital’s PE funds could not be held liable for withdrawal liability under ERISA’s “evade or avoid” provision. The issue arose because, in anticipation of purchasing the portfolio company that later gave rise to $4.5 million withdrawal liability, the two Sun Capital funds divided their ownership 70%-30%. They split ownership in this way in order to avoid becoming part of the portfolio company’s controlled group (as to which ERISA triggers joint and several liability at an 80% or more ownership level).[2] The First Circuit declined to impose ERISA liability based on that investment structure because the predicate for judicial relief -- disregarding the 70/30 split in ownership -- would require that the court “create a transaction that never occurred – a purchase by Sun Fund IV of a 100% stake in [the portfolio company]” (page 43 of slip opinion).

Despite obtaining dismissal of ERISA claims based on their split investment in the portfolio company, the two Sun Capital funds nevertheless faced potential ERISA liability if they were shown to be both (1) operating trades or businesses, and (2) under common control, which would warrant treating the funds as  the combined owner of 100% of the portfolio company.[3]  Regarding whether the PE funds were a trade or business for ERISA purposes, the First Circuit’s decision endorses -- for the first time at the federal circuit court level – an “investment-plus” standard that the PBGC enunciated in a 2007 appeals letter.  The court nevertheless declined “to set forth general guidelines for what the ‘plus’ is,” and instead merely observed that it is “a very fact-specific approach” (page 24 of slip opinion).

In applying the investment-plus standard to the two funds created by Sun Capital Advisors, the First Circuit focused on their organizational documents, which identified the purpose of the funds as involving “extensive intervention with respect to [the] management and operations” of portfolio companies. That the funds acted through their general partner did not shake them free of ERISA liability, because Delaware agency law and the relevant partnership agreements made it clear to the court that the general partner’s management services were both within its scope of authority and provided “on behalf of and for the benefit of the Sun Funds” (page 38 of slip opinion).  The court also considered the direct economic benefit that the 70% fund received through an arrangement that reduced the fees payable to its general partner by an amount equal to the fees that the general partner received from the portfolio company.

The foregoing led the First Circuit to conclude that the 70% fund was indeed a trade or business for ERISA purposes, and to remand the case for further proceedings to determine –
(1) whether the facts relating to the second (30%) Sun Capital fund establish it as a trade or business based on the court’s investment-plus standard, and 
(2) “the issue of common control” (between the two Sun Capital funds). 

PE funds should likewise consider their exposure to being treated as trades or businesses for ERISA purposes, and to being insulated from ERISA pension liability through owning less than 80% of a portfolio company.  For new as well as existing investments, thoughtful adjustments to ownership structures and management operations may mitigate  the exposure of PE funds to the ERISA pension liabilities attributable to their portfolio companies.

[1] Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund, 1st Cir. , 724 F.3rd 129 (7/24/2013).

[2] Two district court decisions reached opposite conclusions before the First Circuit reversed one in Sun Capital - resulting in adoption of the PBGC's "investment-plus" standard in both the First Circuit and by the ED Michigan court.

[3] “Common control” for ERISA purposes involves a complex test, and generally results if the same five or fewer persons own 50% or more of two companies, based on taking into account each person’s minimum  percentage ownership in either company.