Pension & Benefits News Private equity funds not subject to withdrawal liability of company they owned
Tuesday, March 10, 2020

Private equity funds not subject to withdrawal liability of company they owned

By Pension and Benefits Editorial Staff

Private equity funds were not responsible for the withdrawal liability incurred by a company that was owned by the funds at the time of its bankruptcy, according to the U.S. Court of Appeals in Boston (CA-1). The funds had not established a partnership-in-fact constituting a controlled group, which would have rendered them jointly and severally responsible for the withdrawal liability.

Private equity acquisition. Sun Capital Advisors, Inc. (SCAI) is a private equity firm which pools investor capital in limited partnerships. Among the private equity funds established as limited partnerships by SCAI were Sun Capital Partners III, LP and Sun Capital Partners IV, LP. The Funds are distinct business entities with primarily different investors, but they coordinate efforts, under the direction of two men (the CEOs and sole shareholders of SCAI), to identify, acquire, restructure, and sell portfolio companies. The funds specifically form and finance subsidiary limited liability corporations (LLCs) through which they acquire and control portfolio companies, with the goal of eventually selling the companies.

Among the companies acquired by the Funds was Scott Brass Inc. (SBI), which was owned by the Funds through Sun Scott Brass, LLC (SSB-LLC). It was during the period the Funds jointly owned SBI (through SSB-LLC) that the company filed for bankruptcy and withdrew from a multiemployer pension fund, incurring withdrawal liability. The New England Teamsters & Trucking Industry Pension Fund attempted to collect withdrawal liability from the Funds, claiming that they were jointly and severally liable for the assessment, as they had entered into a joint venture or partnership with SBI.

The central issue addressed by the courts was whether the Funds were under common control with SBI, sufficient to make them responsible for the company’s withdrawal liability. Neither Fund, individually, owned the 80 percent of SBI, generally required to establish a parent-subsidiary control group. However, a federal trial court found that the Funds had formed a partnership-in-fact (SSB-LLC) that owned 100 percent of SBI and engaged in a trade or business in its operation of the company. Thus, the court concluded, the Funds were under common control with SBI and jointly and severally responsible for the company’s withdrawal liability.

The Sun Funds appealed the rulings that they were under common control with SBI and that they had formed a partnership-in-fact that was engaged in a trade or business. The PBGC filed an amicus brief supporting the rulings of the trial court.

Funds were not under common control. Initially, the First Circuit panel noted that the PBGC regulations implementing the common control provision of ERISA Sec. 4001(b) (PBGC Reg. Secs. 4001.2 and 4001.3) incorporate the Treasury regulations governing common control (IRS Reg. 1.414(c)-2(b)). Under the regulations, entities are viewed as being under common control if they are members of a parent-subsidiary group of trades or businesses under common control.

In next determining whether the Funds formed a partnership-in-fact to acquire and operate SBI, the court focused on factors identified by the United States Tax Court in Luna v. Commissioner (42 T.C. 1067 (1964)). Among the Luna factors indicating a partnership-if-fact are: an agreement of the parties and conduct executing the terms of the agreement; a business conducted in the joint name of the parties; and the filing of federal partnership returns by the parties or other representations that they were joint venturers.

The intention of the parties is a central component of the test. However, the court stressed that a partnership-in-fact may still be recognized even if the parties have structured themselves as a limited liability corporation. Thus, if the Sun Funds had, under the Luna test, formed a partnership-in-fact, the court explained, they would be jointly and severally liable for the debts of the partnership, including withdrawal liability, if the separate trade or business test under ERISA Sec. 4001(b) was also met.

In reversing the trial court, the appeals court noted that the Funds did not intend to join together in the conduct of the enterprise (beyond limited coordination) and expressly disclaimed any sort of partnership. Moreover, the court found the Funds: did not, for the most part, share the same limited partners; filed separate tax returns; kept separate books; maintained separate bank accounts; and did not invest in the same companies at a fixed or even variable ratio.

The creation of an LLC by the Sun Funds, through which they acquired SBI, the court further explained, did not indicate an intention to form a partnership. In fact, the formation of the LLC effectively prevented the Funds from conducting the business in their joint names and limited the manner in which they could exercise mutual control over and assume mutual responsibilities for managing SBI.

The trial court determined that the incorporation of SSB-LLC did not prevent recognizing the Funds as being a partnership-in-fact. However, the appeals court reasoned that that SSB-LLC’s incorporation effectively precluded application of many of the Luna factors that would indicate a partnership-in-fact.

Source: Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund (CA-1).

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