Private Equity Investment Funds, Beware!

Background

Scott Brass, Inc. (SB) was a metals manufacturer. Its workforce was represented by the Teamsters and SB contributed to the Teamsters' pension funds. The assets of SB were purchased by Sun Scott Brass, LLC (SSBL), which was formed by Sun Fund III with 30% ownership, and Sun Fund IV (collectively, Sun Funds) with the remaining 70% ownership. Sun Funds were private equity funds created by Sun Capital. Each Sun Fund is a limited partnership that serves as a vehicle for pooling the money of its partners and investing that money. SSBL appointed advisers to help improve SB's efficiency and financial health. In spite of these efforts, SB filed for Chapter 11 bankruptcy in 2008 and incurred withdrawal liability under the MPPAA. The Teamsters' actuary assessed withdrawal liability of approximately $4.5 million.

The Sun Funds sued for a declaratory judgment that they could not be jointly liable for withdrawal liability owed by Scott Brass, Inc. The district court granted the Sun Funds' motion, holding that a private equity fund could not be a “trade or business.” The U.S. Court of Appeals for the First Circuit reversed, finding that a private equity fund could be a trade or business, and remanding the case back to the district court to determine whether the Sun Funds were in fact engaged in “trade or business” and whether they were under “common control” sufficient for liability. A petition for certiorari was denied.

Partnership/Trade or Business

In its decision on remand, the district court noted that no partnership-in-fact based on conventional theories existed between Sun Fund III and Sun Fund IV because the funds had separate tax returns, financial statements, reports to partners, etc. The court found the Sun Funds to be engaged in a “limited partnership” because they were not merely passive investors in SB, but rather engaged in joint management activity in deciding whether to co-invest and on what terms to do so, such as the decision to split their ownership stake 70/30. As stated by the court, “[t]he smooth coordination is indicative of a partnership-in-fact sitting atop the LLC: a site of joining together and forming a community of interest.”

Even where a partnership is deemed to exist, an organization is still not liable under the MPPAA unless it is a “trade or business.” Applying the “investment-plus test,” the court found the limited liability private equity investment funds were a “trade or business.” The Sun Fund's received economic benefit in the form of offset against management fees, without which, the Sun Funds would have had to pay its general partner for managing its investment in SB. This was a benefit that would not otherwise be available to an ordinary, passive investor who did not engage in management activities.

Common Control

Once the court determined that the Sun Funds were a “trade or business,” it then turned its attention to the issue of “common control.” The “common control” provision of the MPPAA pierces the corporate veil, disregarding formal business structures and imposing withdrawal liability even where no economic nexus otherwise exists between the target entity and the withdrawing employer.

The Pension Benefit Guaranty Corporation (PBGC) imposes liability if one organization owns at least 80% of the other. The court noted that this 80% ownership rule “appears to be a roadmap for exactly how to contract around withdrawal liability.”

The Sun Funds conceded that an important reason for dividing the ownership of portfolio companies between multiple funds was to keep ownership by any single entity below 80%. Regardless, the Sun Funds maintained that they adopted the limited liability structure for their risk management of the investment in SB and that the court should respect this corporate organizational formality. Unpersuaded, the court responded that “[t]he question of organizational liability is not answered simply by resort to organizational forms, but must instead reflect the economic realities of the business entities created by the Sun Funds for their acquisition of Scott Brass, Inc. The LLC appears to be better understood as a vehicle for the coordination of the two Sun Funds ' and an attempt to limit liability ' than as a truly independent entity.” Based on this rationale, the district court disregarded the corporate formality of the LLC and aggregated ownership interests between the funds, resulting in the Sun Funds' 100% ownership interest in SSBL.

Conclusion

Ultimately, the district court held that the Sun Funds' partnership was a trade or business in common control with SB, and the Sun Funds were therefore jointly and severally liable for SB's withdrawal liability under ERISA and the MPPAA. The legal implications of Sun Capital are that private equity, venture capital, and other private investment funds should use caution when structuring transactions and in determining whether to invest in a portfolio company with any unfunded multi-employer pension plan liability.

Elizabeth (Lisa) Vandesteeg and Matt Schiff are partners and Tricia Schwallier is an associate at Sugar Felsenthal Grais & Hammer. They can be reached at evandesteeg@%20sugarfgh.com, [email protected], and [email protected], respectively.