Restructuring

In March 2014, the U.S. Supreme Court declined to hear an appeal from Sun Capital Partners Inc. of the decision by the First Circuit Court of Appeals in Sun Capital Partners III, L.P. et al. v. New England Teamsters & Trucking Industry Pension Fund, an important 2013 case under the Employee Retirement Income Security Act of 1974 (ERISA) relating to the potential for “controlled group” liability of private equity funds for underfunded pension plans of portfolio companies. In that case, the First Circuit held that a private equity fund with an investment in a portfolio company managed by the fund’s general partner would be considered a “trade or business” with potential joint and several liability under ERISA for that portfolio company’s withdrawal liability from a multiemployer pension plan. As such, it continues to be the case (in the First Circuit, and in other jurisdictions if this precedent is followed) that a private equity fund may become liable for certain pension liabilities of its portfolio companies if the additional “common control” tests under ERISA’s controlled group rules are satisfied.
“Controlled Group” Liability under ERISA
Under Title IV of ERISA, significant pension liabilities can arise upon the withdrawal by a participating employer from a union multiemployer pension plan (at issue in the Sun Capital case), as well as upon the termination of an underfunded single employer pension plan (i.e., in a “distress” or “involuntary” plan termination under ERISA). Under the “controlled group” liability rules of ERISA, an entity other than the direct employer is also responsible for these liabilities, on a joint and several basis, if the entity is (i) a “trade or business” and (ii) under “common control” with the employer, which generally requires common ownership of at least 80 percent. The Sun Capital decision deals with the first such test.
In this case, two private equity funds sponsored by the same firm, Sun Capital Advisors, Inc. (Sun Capital), acquired a 100 percent ownership interest in Scott Brass, Inc. (SBI) in 2007: “Fund IV” acquired a 70 percent interest, and “Fund III” acquired a 30 percent interest. These respective ownership interests apparently were arrived at with a view toward avoiding ERISA’s 80 percent common control test. When SBI subsequently withdrew from a union-sponsored multiemployer pension plan, the plan sought to collect SBI’s withdrawal liability from the two funds under ERISA’s controlled group liability rules.
Private Equity Fund as a “Trade or Business”
The First Circuit held that Sun Capital Fund IV constituted a “trade or business” and thus could potentially be treated as a member of the controlled group for purposes of ERISA. In reaching its conclusion, the court held that Sun Capital was more than merely a passive investor (which would not be deemed a “trade or business” under ERISA) by applying the “investment plus” test to the activities of Sun Capital and Fund IV. This test looks at whether, unlike a mere passive investor, the investor is also exercising control over the management and operations of that company. The court acknowledged that this is a facts and circumstances test and requires a case-by-case determination.
Implications of the Sun Capital Case
As a result of the Supreme Court’s refusal to hear an appeal of the Sun Capital case, it continues to have important implications for private equity firms, private equity fund investors, and their portfolio companies. If a single fund holds more than 80 percent of the equity of a portfolio company, that fund and even its other 80 percent-owned portfolio companies could become liable for the pension liabilities of the company, if the Sun Capital precedent is followed. This will put additional emphasis on due diligence, pricing, indemnities, and structuring in transactions involving significant potential pension liabilities.
Additional details regarding the Sun Capital case can be found in a prior blog post. We will continue to stay apprised of this matter and update you on any further developments in this area.