In Reversal, First Circuit Holds Sun Capital Private Equity Funds Not Liable for Withdrawal Liability of Portfolio Company | Practical Law

In Reversal, First Circuit Holds Sun Capital Private Equity Funds Not Liable for Withdrawal Liability of Portfolio Company | Practical Law

In Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, the US Court of Appeals for the First Circuit held that two private equity funds that each owned less than 80% of a portfolio company were not jointly and severally liable for the bankrupt company's withdrawal liability because the two funds did not form a partnership-in-fact that was in common control with the portfolio company under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Multiemployer Pension Plan Amendments Act of 1980 (MPPAA).

In Reversal, First Circuit Holds Sun Capital Private Equity Funds Not Liable for Withdrawal Liability of Portfolio Company

by Practical Law Employee Benefits & Executive Compensation
Published on 26 Nov 2019 • USA (National/Federal)
In Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, the US Court of Appeals for the First Circuit held that two private equity funds that each owned less than 80% of a portfolio company were not jointly and severally liable for the bankrupt company's withdrawal liability because the two funds did not form a partnership-in-fact that was in common control with the portfolio company under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Multiemployer Pension Plan Amendments Act of 1980 (MPPAA).
In Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, the US Court of Appeals for the First Circuit held that two private equity funds that each owned less than 80% of a portfolio company were not jointly and severally liable for the company's withdrawal liability to a multiemployer pension plan because the two funds did not form a partnership-in-fact that was in common control with the portfolio company under ERISA, as amended by the Multiemployer Pension Plan Amendments Act of 1980 (MPPAA) (Nos. 16-137619-1002, (1st Cir. Nov. 22, 2019)).
Specifically, the First Circuit held that:
  • Under the partnership test in Luna v. Commissioner, the two funds did not create an implied partnership-in-fact that constituted a control group (42 T.C. 1067 (1964)).
  • Congress did not firmly indicate an intent to impose withdrawal liability in this situation.

Background

Sun Capital Advisors, Inc. (SCAI) sponsors two private equity funds, Sun Capital Partners III, LP (Sun Fund III) and Sun Capital Partners IV, LP (Sun Fund IV) (together, the Sun Funds), that invest in underperforming companies. SCAI provides capital to the Sun Funds and, through related entities, takes an active role in the management of the Sun Funds' portfolio companies.
In 2007, the Sun Funds purchased Scott Brass, Inc. (SBI), a closely-held corporation that contributed to the New England Teamsters and Trucking Industry Pension Fund (the TPF). The general partner of Sun Fund IV, through a subsidiary, contracted with SCAI to provide management and consulting services to SBI. At the time the Sun Funds purchased SBI, they established Sun Scott Brass, LLC as the vehicle for investing in SBI.
In October 2008, due to its poor business performance, SBI stopped contributing to the TPF, which made it liable for its proportionate share of the TPF's unfunded vested benefits. An involuntary Chapter 11 bankruptcy proceeding was brought against SBI in November 2008.
In December 2008, the TPF demanded that SBI pay its estimated withdrawal liability of $4.5 million. The TPF also demanded this amount from the Sun Funds, asserting that they were part of a joint venture or partnership under common control with SBI, and were therefore jointly and severally liable for the entire amount of SBI's withdrawal liability under ERISA.
In response, the Sun Funds sought a declaratory judgment from the US District Court for the District of Massachusetts providing that they were not subject to withdrawal liability under the MPPAA, which resulted in the following court decisions:
  • In October 2012, the district court held that the Sun Funds were not a trade or business under MPPAA and did not reach the issue of common control.
  • In July 2013, the First Circuit held on appeal that Sun Fund IV was a trade or business and remanded to the district court to determine if Sun Fund III was a trade or business and whether the two funds were under common control with SBI.
  • In March 2016, the district court held that Sun Funds III and IV were trades or businesses and also were a partnership-in-fact under common control with SBI (see Legal Update, District Court Holds that Private Equity Funds Were a Trade or Business in Common Control with Portfolio Companies).
Sun Capital appealed the district court's grant of summary judgment in favor of the New England Teamsters and Trucking Industry Pension Fund.

Outcome

On November 22, 2019, the First Circuit issued its decision in this case, focusing on the issue of common control. The First Circuit did not address any other issue, such as the trade or business issue.

Common Control

In Luna v. Commissioner, the Tax Court provided a list of factors to help determine whether a partnership exists:
  • The agreement of the parties and their conduct in executing its terms.
  • The contributions, if any, which each party has made to the venture.
  • The parties' control over income and capital and the right of each to make withdrawals.
  • Whether each party was a principal and co-proprietor, 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.
  • Whether business was conducted in the joint names of the parties.
  • Whether the parties filed federal partnership returns or otherwise represented that they were joint venturers.
  • Whether separate books of account were maintained for the venture.
  • Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
(42 T.C. 1067, 1077-78 (1964).)
As the First Circuit explained, if the Sun Funds formed a partnership-in-fact under the Luna test, then under the MPPAA common control regulations the Sun Funds are jointly and severally liable for the debts of the partnership, including withdrawal liability under MPPAA, if the separate trade or business test is also met. For more information on controlled group rules, see Practice Note, Controlled Group and Affiliated Service Group Rules.
The district court applied the Luna factors to this case and held that a partnership-in-fact existed among the Sun Funds. The First Circuit, however, concluded that consideration of all of the Luna factors shows that the Sun Funds did not form a partnership-in-fact to assert common control over SBI.
The First Circuit acknowledged that there is evidence that the Sun Funds exercised mutual control and assumed mutual responsibilities over SBI:
  • The Sun Funds filled two of SBI's three director positions with SCAI employees, which allowed SCAI to control SBI.
  • According to the First Circuit, the Funds' efforts to pool resources and expertise in SCAI, which is used to acquire, manage, and provide consulting and employees to portfolio companies, is evidence tending to show a partnership.
  • The Sun Funds did not disagree over how to operate Sun Scott Brass, LLC (SSB-LLC), which the two Funds created for the purpose of investing in SBI. The Funds' management of SSB-LLC also is evidence of a partnership.
However, the following facts demonstrate that, under most of the Luna factors, a partnership-in-fact did not exist:
  • The Sun Funds did not intend to join together in the conduct of the enterprise beyond their coordination within SSB-LLC.
  • The Sun Funds expressly disclaimed the existence of a partnership, which counts against the first, fifth, and sixth Luna factors.
  • Most of the entities or persons who were limited partners in Sun Fund IV were not limited partners in Sun Fund III.
  • The Sun Funds filed separate tax returns, kept separate books, and maintained separate bank accounts.
  • The Sun Funds did not invest in the same companies at a fixed or even variable ratio, which, according to the First Circuit, shows some independence in activity and structure.
  • The creation of SSB-LLC, which was used to acquire SBI, shows an intent not to form a partnership (although the First Circuit did not give this factor the same weight as the Funds did). Specifically, forming an LLC:
    • prevented the Sun Funds from conducting their business in their joint names (Luna factor five); and
    • limited the manner in which the Funds could exercise mutual control over and assume mutual responsibilities for managing SBI (Luna factor eight).
  • The entities involved in this case formally organized themselves as limited liability business organizations under state law at virtually all levels, which distinguishes this case from previous withdrawal liability cases in which courts have found that the parties formed partnerships-in-fact that were under common control (such as Connors v. Ryan's Coal Co., Inc., 923 F.2d 1461 (11th Cir. 1991)), which often involved individuals such as married couples that fractionalized already-existing businesses, rather than entities pursuing investments in different businesses.
The First Circuit also explained that it did not find congressional intent to impose withdrawal liability on private investors in this situation, nor is there any further formal guidance from the Pension Benefit Guaranty Corporation (PBGC) addressing this.
The First Circuit reversed the district court's entry of summary judgment for the Pension Fund and remanded with directions to enter summary judgment for the Sun Funds.

Practical Implications

As the First Circuit mentioned, the facts of this case created tension between two goals of ERISA and the MPPAA: to protect the financial well-being of existing multiemployer plans and to encourage the private sector to invest in struggling companies that sponsor multiemployer plans. While the decision is binding only in the First Circuit, private equity funds should take note of the First Circuit's latest Sun Capital decision, which reverses the district court's ruling and affirms that the use of an investment structure that is commonly used by private equity funds may allow those funds to avoid withdrawal liability of portfolio companies, depending on the facts.