As the old saying goes, “the wheels of justice turn slowly.” We return today to Sun Capital private equity funds’ multiyear litigation defending against unfunded pension liability related to one if its portfolio companies. We first reported on this controversy in an article in the Legal Intelligencer in 2013. At that time, the U.S. Court of Appeals for the First Circuit held the Sun Capital funds could be engaged in a “trade or business,” one of the requirements for pension withdrawal liability under the Multiemployer Pension Plan Amendments Act of 1980 (the MPPAA), and remanded the case to the U.S. District Court for the District of Massachusetts for additional proceedings. In 2016, the district court held that the Sun Capital funds were liable because the funds were engaged in trade or business and had formed a partnership-in-fact, thereby meeting the “common control test” under MPPAA law. In a decision dated Nov. 22, the First Circuit found the funds did not constitute an implied partnership-in-fact, reversed the decision of the district court, and held withdrawal liability could not be imposed. The opinion appears as Sun Capital Partners III v. New England Teamsters & Trucking Industry Pension Fund, Case No. 16-1376 (1st Cir. Nov. 22, 2019).
The Organization of the Funds
Once again, the court noted in its opinion, the two funds at issue, Sun Capital Partners III and Sun Capital IV, the funds) were each distinct Delaware business entities with primarily different investors and investments, but controlled by the same two men, Marc Leder and Rodger Krouse. The funds had no employees, did not make or sell goods, and reported only investment income to the IRS. The opinion notes, “The funds expressly disclaimed in their respective limited partnership agreements any partnership or joint venture with each other.” They maintained separate books and records, bank accounts, and filed distinct tax returns.
The funds each had one general partner, whose decisions were controlled by a “limited partnership committee” consisting of Leder and Krouse. The funds had a total of 354 limited partners, including pension funds, other private equity funds, family trusts and universities. Of that total, the funds shared 64 investors. The opinion notes in a footnote that “at the relevant times,” the funds held interests in 88 entities, of which only seven overlapped.
The funds were established by Sun Capital Advisors, Inc. (SCAI), a private equity firm that pooled investors’ capital in limited partnerships, helped the partnerships target and acquire portfolio companies, and provided management services to the acquired companies. In addition to the funds, SCAI had formed at least six other funds. SCAI contracted with two separate management companies owned by the funds’ respective general partners. Under the contracts, SCAI employees and consultants provided management services to the funds.
The funds’ subsidiaries acquired, controlled, restructured and sold portfolio companies. The funds jointly owned Scott Brass, Inc. (SBI), a brass manufacturing company. The funds owned SBI through intermediary companies, and owned their direct subsidiary 30%/70%, respectively. The subsidiary formed and financed its own subsidiary, and then combined the funds’ $3 million investment with $4.8 million in debt to purchase all of SBI’s stock. According to the opinion, “The funds used their controlling share of portfolio companies to implement restructuring and operations plans, build management teams, become intimately involved in company operations, and otherwise cause growth in the portfolio companies.” The opinion notes, “The funds, through SCAI employees placed in SBI, jointly operated SBI.”
Potential Pension Liability for the Funds
Under MPPAA, an employer completely withdraws from a multiemployer plan when it “permanently ceases to have an obligation to contribute under the plan, or permanently ceases all covered operations under the plan,” see 29 U.S.C. Section 1383(a). On withdrawal, an employer must pay its proportionate share of the plan’s unfunded vested benefits. SBI filed for bankruptcy in 2008 and withdrew from the New England Teamsters & Trucking Industry Pension Fund. The withdrawal caused SBI to incur $4,516,539 in liability.
MPPAA also imposes joint and several withdrawal liability not only on withdrawing employers, but also on all entities under “common control” with the employer and that qualify as engaging in “trade or business,” see 29 U.S.C. Section 1301(b)(1). On remand from the First Circuit’s 2013 decision, the district court held the funds and SBI were under common control and imposed liability on the Sun Capital Funds. The funds appealed the decision to the First Circuit.
The court cited its prior opinions and analyses that the MPPAA’s common control provision exists to prevent the shirking of pension funding obligations by fractionalizing operations into many separate entities. Further, “the common control provision, in effect, pierces the corporate veil and disregards formal business structures.” The MPPAA regulations adopted by the Pension Benefit Guaranty Corp. mirror Treasury Department regulations, which find common control if the entities are members of a parent-subsidiary group of trades or business under common control. The Treasury Department regulations focus on whether the parent owned at least 80% of the subsidiary, which the court reasoned sought to impose liability on the party in control of the subsidiary.
Since neither of the funds owned 80% or more of SBI, the court looked to federal common law to determine whether the funds had formed a “partnership-in-fact” to acquire and operate SBI. The court looked to federal tax law governing the existence of a partnership. The court used the eight factors set forth in Luna v. Commissioner, 42 T.C. 1067 (1964):
- The agreement of the parties and their conduct in executing its terms;
- The contributions, if any, which each party has made to the venture;
- The parties’ control over income and capital and the right of each to make withdrawals;
- Whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income;
- Whether business was conducted in the joint names of the parties;
- Whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers;
- Whether separate books of account were maintained for the venture; and
- Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise.
If the funds formed a partnership-in-fact under the Luna factors above, then they would be jointly and severally liable for the MPPAA withdrawal liability if the “trade or business” test was also met. The court reasoned that a partnership-in-fact could exist notwithstanding that the partners had incorporated. The court wrote, “Under federal law, if entities have in fact formed a partnership, merely creating a corporation through which they pursue the goals of the partnership does not necessarily end that partnership.” When parties, including when operating as a partnership, control a subsidiary as a mere agency or instrumentality, courts may disregard the separateness of the subsidiary “as the justice of the case may require.”
Turning to the substance of the parties’ relationship, the court found facts that both supported a finding of a de facto partnership and no partnership under the Luna factors. The opinion describes how the funds together sought out potential portfolio companies in need of managerial and operational intervention. The funds, through SCAI, developed restructuring plans to address those issues. The organization of control of the funds and SBI by Leder and Krouse was further evidence of a de facto partnership. SCAI provided management and consulting employees to its portfolio companies, including SBI.
However, the court found the funds did not intend to join together to control SBI, at least beyond the intermediate holding company that owned SBI. They expressly disclaimed any partnership. Most of the funds’ limited partners were not partners in both funds. The court noted the funds did not invest in the same companies and, as such, did not “operate in parallel” with respect to SBI. The opinion notes the funds’ creation of a holding company to act as the immediate parent of SBI also showed an intent not to form a partnership, although creation of an intermediate holding company did not act as a per se bar to liability. Here, the intermediary holding company limited the funds’ mutual control over and assumption of mutual responsibilities for managing SBI. The funds’ formal organization that used limited liability business entities under state law distinguished the funds’ situation from cases where courts found parties to have formed partnerships-in-fact. The latter cases often involved individuals rather than limited liability businesses. Ultimately, the court concluded the majority of the Luna factors weighed in favor of a finding of no common control. The decision of the district court was reversed, and the court ordered summary judgment in favor of the funds.
Difficult Policy Choices Are Presented
Six years ago the court held the Sun Capital Funds could be a “trade or business” as defined in the MPPAA, potentially exposing investors to large unfunded pension liabilities. The decision attracted significant attention at the time. It is clear this matter involved complex legal and policy issues. The court recognized this and noted the stakes involved. At the outset of the opinion, the court observed:
“If the MPPAA imposes such withdrawal liability, PBGC states it assumes the New England Teamsters & Trucking Industry Pension Fund intends to look to the private equity funds, including their general partners and their limited partners, to pay the liability. The issues raised involve conflicting policy choices for Congress or PBGC to make. On one hand, imposing liability would likely disincentivize much-needed private investment in underperforming companies with unfunded pension liabilities. This chilling effect could, in turn, worsen the financial position of multiemployer pension plans. On the other hand, if the MPPAA does not impose liability and the pension fund becomes insolvent, then PBGC likely will pay some of the liability, and the pensioned workers (with 30 years of service) will receive a maximum of $12,870 annually.”
The court’s 2019 decision provides some comfort to the private equity sector, but it remains unclear how and when courts will impose withdrawal liability on private equity funds in the future.
Andrew C. Kassner is the chairman and chief executive officer of Drinker Biddle & Reath, a national law firm with more than 635 lawyers in 12 offices. He chaired the corporate restructuring group for almost 20 years. He can be reached at [email protected] or 215-988-2554.
Joseph N. Argentina Jr. is a senior attorney in the firm’s corporate restructuring practice group in the Philadelphia and Wilmington, Delaware, offices. He can be reached at [email protected] or 215-988-2541.