First Circuit Reverses Lower Court Ruling that Private Equity Funds are Liable for a Portfolio Company’s Pension Liability
On November 22, 2019, the U.S. First Circuit Court of Appeals reversed a district court’s finding that Sun Capital Partners III and Sun Capital Partners IV (collectively, the “Funds”) formed a “partnership-in-fact” in connection with the Funds’ investment in a bankrupt portfolio company (Scott Brass) that incurred pension plan withdrawal liability. Our prior review of the district court’s ruling is available on our blog here.
ERISA imposes joint and several liability on each member of a controlled group for certain liabilities, including pension plan withdrawal liabilities. A “controlled group” includes trades or businesses that are under common control, which typically means 80% common ownership. Notwithstanding the fact that Sun Capital Partners III and Sun Capital Partners IV owned 30% and 70% of Scott Brass, respectively, the district court previously determined that by the Funds’ co-investment in the portfolio company, the two formed a “partnership-in-fact” that owned 100% of Scott Brass and was, therefore, in Scott Brass’s controlled group.
On appeal, the First Circuit disagreed with the district court. Utilizing a multi-factor test for establishing partnership status under federal tax law, the court concluded that most of the factors indicated that a partnership-in-fact had not been created. Among the relevant facts in this case, the court noted that (i) the parties expressly intended not to form a partnership, (ii) the Funds did not always invest in parallel in the same investments, (iii) the Funds did not have identical limited partners, and (iv) each of the Funds maintained separate books, records, and accounts and filed separate tax returns. Further, the court noted the lack of formal guidance from PBGC and the lack of clear congressional intent on this issue.
While the ruling is a positive outcome for private equity funds with respect to the common control issue, the opinion did not address the issue of whether the Funds were a “trade or business.” Under different facts and circumstances than those in this case, there remains a possibility that two or more private equity funds could form a partnership and be in the same controlled group. Thus, private equity sponsors should continue to focus on potential joint and several liability concerns when structuring investments in portfolio companies that participate in defined benefit pension plans.
The First Circuit’s opinion can be found here.