Reversing a lower court decision, the First Circuit recently held1 that two private equity funds did not create an implied partnership-in-fact constituting a controlled group, and therefore, the funds could not be held liable for their bankrupt portfolio company’s multi-million dollar multiemployer pension plan withdrawal liability. In reaching this decision, the court acknowledged a tension between, on the one hand, maximizing recovery under ERISA’s controlled group liability principles and, on the other, construing the reach of the MPPAA2 broadly in a way that was not clearly consistent with statutory intent and that may discourage private investment in troubled companies with unfunded pension liabilities. Albeit limited in scope, this ruling provides helpful guidance for funds navigating issues of potential exposure for pension obligations at portfolio companies.
Why Should We Care About Sun Capital v. New England Teamsters?
ERISA imposes joint and several liability related to pension plan obligations to entities conducting a “trade or business” and that are “under common control”, including those deemed affiliated with a withdrawing employer from a multiemployer pension plan. “Common control” generally requires 80% common ownership, determined based on principles of the Internal Revenue Code of 1986, as amended. At issue in Sun Capital v. New England Teamsters was whether two private equity funds, which owned 70% and 30%, respectively, of a portfolio company through a jointly formed limited liability company, were members of the portfolio company’s controlled group for purposes of the MPPAA. If so, then the funds could be held jointly and severally liable for the portfolio company’s liability arising from the portfolio company’s bankruptcy and withdrawal from the multiemployer pension plan in which such company previously participated.
Both the lower court and the First Circuit agreed that whether there was a “partnership-in-fact” among the funds would be a critical component of such funds’ liability, and also agreed that whether such “partnership-in-fact” existed should be determined based on the well-established test articulated in the 1964 Luna decision.3 But, unlike the lower court, the First Circuit found that the Sun Capital funds, each of which owned less than 80% of the portfolio company, were not a partnership-in-fact constituting a controlled group with the portfolio company, taking into account all of the facts and circumstances of such funds, including their structure, operations and intent. As such, the Sun Capital funds were not jointly and severally liable for the portfolio company’s withdrawal liability.
While Sun Capital v. New England Teamsters is generally not binding on other circuits and therefore is of somewhat limited application, the application of the Luna factors to the Sun Capital fund structure can be instructive to private equity funds considering how to structure future investments to avoid potential withdrawal liability.
What Key Factors Drove the Decision?
In Luna, the tax court articulated eight factors relevant to a finding that a partnership exists for U.S. federal income tax purposes:
(i) the agreement of the parties and their conduct in executing its terms; (ii) the contributions, if any, which each party has made to the venture; (iii) the parties’ control over income and capital and the right of each to make withdrawals; (iv) whether each party was a principal and coproprietor, 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; (v) whether business was conducted in the joint names of the parties; (vi) whether the parties filed Federal partnership tax returns or otherwise represented that they were joint venturers; (vii) whether separate books of account were maintained for the venture; and (viii) whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
Essentially, whether a partnership exists for these purposes is based on the facts and circumstances (looking to the substance of the enterprise and its activities rather than accepting the form of the arrangements as determinative). A court will look to whether, on balance, the relevant entities are structured, and conduct their operations, in a way indicating shared purpose as a partnership. Because Federal income tax principles bear on the control analysis under the MPPAA, these same factors informed the Sun Capital v. New England Teamsters decision.
Like many private equity fund groups, the Sun Capital funds had overlap in a number of areas, and these overlaps led the lower court to determine, based on the Luna factors, that a partnership-in-fact existed. The First Circuit acknowledged that the structure presented some factors that favored a finding of partnership-in-fact (and therefore controlled group liability for withdrawal liability) – principally that:
- The same two men controlled the Sun Capital funds’ general partners and “essentially ran things” for both the two Sun Capital funds and the portfolio company, and
- The Sun Capital funds pooled resources to identify, acquire, and manage portfolio companies.
On the other hand, the First Circuit noted factors inconsistent with the common enterprise principles of a partnership-in-fact, including that:
- The Sun Capital funds lacked an intent to form a partnership (here, the need to create an LLC to invest collectively was not dispositive, but certainly helped),
- The Sun Capital funds expressly disclaimed any partnership or joint venture,
- The Sun Capital funds maintained separate bookkeeping accounts, filed separate tax returns, and maintained separate bank accounts,
- The Sun Capital funds did not invest in parallel at a fixed or variable rate, and
- The Sun Capital funds had minimal overlap in limited partners.
On balance, the court concluded that there was insufficient support for treating the funds as implied partners for purposes of the MPPAA.
What Are the Implications of This Decision for Private Equity Funds?
While the First Circuit ruling is a welcome outcome for private equity sponsors, it is important to remember that the findings were highly fact specific. This decision constitutes the opinion of a single court, and it is unclear that a different court would have balanced the Luna factors in the same way. That said, the decision provides valuable insight, and suggests that funds may want to consider the following questions in developing their investment structure:
- Will multiple investment funds hold a single portfolio company investment?
- Can a new entity be established to administer the joint investment?
- Do the private equity sponsors maintain common control over the multiple investment funds?
- Can day-to-day corporate and financial practices operate separately amongst the multiple investment funds?
- Are the ultimate decision makers in the private equity fund the same in each investment fund?
The more separation between the investment funds, the stronger the case against linking such funds as a partnership. Nevertheless, private equity funds that acquire a controlling interest in portfolio companies that contribute to multiemployer pension funds should maintain caution, since the right facts could still lead to a determination that the fund is responsible for the portfolio company’s unpaid pension liabilities.
1 Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 16-1376 (1st Cir. 2019), referred to above as Sun Capital v. New England Teamsters.
2 The Multiemployer Pension Plan Amendments Act of 1980.
3 Luna v. Commissioner, 42 T.C. 1067 (1964). The district court, as well as an earlier decision by the First Circuit, also established that the Sun Capital funds were engaged in a “trade or business.” That finding was left undisturbed in the present decision. See Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 172 F. Supp. 3d 447, 466–67 (D. Mass. 2016).
Sidley Austin LLPはクライアントおよびその他関係者へのサービスの一環として本情報を教育上の目的に限定して提供します。本情報をリーガルアドバイスとして解釈または依拠したり、弁護士・顧客間の関係を結ぶために使用することはできません。
弁護士広告 - ニューヨーク州弁護士会規則の遵守のための当法律事務所の本店所在地は、Sidley Austin LLP ニューヨーク：787 Seventh Avenue, New York, NY 10019 (+212 839 5300)、シカゴ：One South Dearborn, Chicago, IL 60603、(+312 853 7000)、ワシントン：1501 K Street, N.W., Washington, D.C. 20005 (+202 736 8000)です。