Sun Capital and Its Implications for Private Equity Funds
In a highly watched case, the Court of Appeals for the First Circuit recently held that two Sun Capital private equity funds under common management were not jointly and severally liable for the multiemployer pension plan withdrawal liability assessed against one of their portfolio companies. This decision rejects the U.S. District Court for the District of Massachusetts’ decision, which held that the two funds, owners of an underlying portfolio company, had established a partnership-in-fact above the LLC formed by the Sun Capital funds to invest in the portfolio company. As a result, the funds were liable as general partners of an Employee Retirement Income Security Act of 1974 (ERISA)-controlled group for the withdrawal liability of one of their portfolio companies.
Under ERISA, all corporations that are part of a controlled group of corporations and all trades or businesses under common control are treated as a single employer for purposes of defined benefit pension plans, including multiemployer pension plans. Based on this federal statute, courts have held that all members of a controlled group are jointly and severally liable for the withdrawal liability assessed against any member of the controlled group, despite the fact that they are not parties to the collective bargaining agreement or a contributing employer to the multiemployer pension plan. A controlled group includes any one or more chains of organizations (1) conducting trades or businesses, and (2) connected through ownership of at least 80% by a common parent. A controlled group can consist of parent-subsidiary organizations, brother-sister organizations or any combination of the two.
The issue on appeal here was whether two private equity funds, Sun Capital Partners III, LP and Sun Capital Partners IV, LP (collectively, the “Sun Capital Funds”), were liable for the pension fund withdrawal liability of a portfolio company. The portfolio company was owned by an LLC formed by the Sun Capital Funds to acquire the portfolio company when neither of the funds had an 80% or more equity interest in the LLC. Liability hinged on whether the two funds, despite their express structuring of this acquisition by the LLC formed only for this purpose, created an implied general partnership-in-fact – the true owner of such LLC, which was also a member of the controlled group.
The First Circuit determined whether federal tax law governs Sun Capital Funds’ creation of a general partnership-in-fact. In making the determination of whether a general partnership existed, the First Circuit applied the partnership multi-factor test adopted by the tax court in Luna v. Commissioner to the facts and circumstances relevant to the Sun Capital Funds. Although the First Circuit found some of the factors under the Luna test supported the finding of a general partnership-in-fact, ultimately, the remaining factors weighed in favor of the court’s ruling that the two Sun Capital Funds were not a partnership. Specifically, the First Circuit pointed to the independence in the activity and structure of each Sun Capital Fund as key in supporting the finding that the funds were not a partnership. Additionally, the First Circuit determined that these factors weigh in favor of its conclusion that no partnership was established:
(i) the LLC formation documents expressly disclaimed any intent or the existence of a partnership between the two Sun Capital Funds;
(ii) there was minimal overlap in the investors in each of the Sun Capital Funds;
(iii) the Sun Capital Funds and the LLC each filed separate tax returns, kept separate books and records and maintained separate bank accounts;
(iv) the Sun Capital Funds did not normally invest in the same portfolio companies, but when they did they did not invest at the same fixed percentage or even variable ratio; and
(v) the creation of the LLC specifically to purchase all of the equity interests in the portfolio company.
Implications for Private Equity Funds
Although this case’s decision is based on facts and circumstances specific to the two Sun Capital Funds and is only binding on federal courts in the First Circuit, it may provide some relief for private equity funds looking to acquire companies with unfunded pension obligations. This case suggests that private equity funds considering investing in a portfolio company that participates in or sponsors defined benefit pension plans should try to minimize their risk of exposure to withdrawal liability or liability associated with an underfunded single-employer pension plan. This can be achieved by carefully structuring investments, including investments by parallel funds in a single portfolio company, and operating the private equity funds and holding companies formed in connection with their investments in a way that reflects each organization’s independence and separate existence.
 Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, No. 16-1376 (1st Cir. 2019).
 ERISA § 4001(b)(1); 29 U.S.C. § 1301(b)(1).
 IRC §§ 414(b) and (c); IRC § 1563(a).
 Notably, the First Circuit treated Sun Capital Partners III, LP and Sun Capital Partners III QP, LP collectively as a single entity because they are parallel funds, share a single general partner and invest nearly identically.
 42 T.C. 1067 (1964).
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