Funds Liable for ERISA Liabilities of Portfolio Companies: The Latest Sun Capital Decision
On March 28, 2016, a district court found that two private equity funds were jointly and severally liable for the multiemployer withdrawal liability of a portfolio company even though neither fund owned the 80 percent or greater control specified under the Employee Retirement Income Security Act of 1974, as amended (ERISA). The First Circuit’s 2013 decision—holding that a private equity fund could be a “trade or business” and jointly and severally liable for multiemployer plan withdrawal liability of a portfolio company—resulted in a remand to the district court on certain factual issues. (Read our analysis of the First Circuit’s 2013 decision.)
These decisions assessed liability on the private equity funds for the multiemployer plan withdrawal liability of a portfolio company, Scott Brass, Inc. (Scott Brass), which had declared bankruptcy. The First Circuit decision had held that one of the funds, Sun Capital IV, LP, was a trade or business under an “investment plus analysis” and remanded to the district court to determine (i) whether the second fund, Sun Capital Fund III, LP, was also a “trade or business” based on the facts, and (ii) whether the two Sun Capital funds were under “common control” with Scott Brass. While neither of the funds owned 80 percent or greater control, together they indirectly owned 100 percent control of Scott Brass.
The district court held that Sun Capital Fund III was also a trade or business under the “investment plus analysis,” applying factors similar to those discussed by the First Circuit, despite the fact that the management fee offset was carried forward rather than reducing then-current management fees.
The district court then considered whether the funds, neither of which independently owned the 80 percent control that would cause it to be treated as under common control with Scott Brass, could nonetheless be treated as under common control. The court concluded that the ownership by the two nonparallel funds created a “partnership in fact” based on a number of factors including the funds’ initial joint activity in deciding to co-invest in Scott Brass and their unity of decision-making and coordination. Despite the fact that the funds had different limited partners, were structured as separate funds, filed separate tax returns, had separate financial statements and did not invest in identical portfolio companies in all cases, the court found that the two funds acted as partners in fact. As a result, the court applied the “investment plus analysis” to determine that this deemed partnership in fact was a trade or business and, importantly, controlled 100 percent of Scott Brass, thus treating the two funds collectively as a member of the controlled group with Scott Brass. Since the two funds were treated as partners of the partnership in fact, each of the funds was held jointly and severally liable for the withdrawal liability incurred by Scott Brass.
The decision is very fact specific and the court spent considerable time analyzing the common control and decision-making process and history of the two funds and the management fees. This closely followed case is expected to have significant impact in the private equity industry especially if it is followed by other courts or upheld in any appeal to the First Circuit. Sponsors and general partners will want to consider the effect of this decision in structuring investments, fund structure, and whether to permit two funds to collectively own 80 percent or more of any particular company. Fund sponsors will want to review their existing funds and investments, as well as credit agreements and financing arrangements, to determine whether any liability could be likely to exist under this “partnership in fact” analysis.