Court Finds Private Equity Funds Not Liable for Plan Withdrawal Liability

The 1st U.S. Circuit Court of Appeals has reversed a U.S. District Court ruling that two private equity funds are liable under the Multiemployer Pension Plan Amendments Act (MPPAA) for the pro rata share of unfunded vested benefits owed to a multiemployer pension fund by a bankrupt company, Scott Brass Inc., that is owned by the funds.

The District Court held that there was an implied partnership-in-fact which constituted a control group. The 1st Circuit reversed the decision because it concluded the multi-factored partnership test set forth in the case of Luna v. Commissioner had not been met, and it couldn’t conclude that Congress intended to impose liability in this scenario.

Sun Capital Advisors Inc. (SCAI) is a private equity firm which pools investors’ capital in limited partnerships, assists these limited partnerships in finding and acquiring portfolio companies, and then provides management services to those portfolio companies. SCAI established at least eight funds. Two of them, Sun Fund III and Sun Fund IV, are the investors in Scott Brass Inc. (SBI).

As the lower court noted in its opinion, considered separately, one of the fund’s ownership stakes in Sun Scott Brass LLC is 70% and the other’s ownership stake is 30%, both of which separately fall below the necessary 80% threshold necessary to establish a “controlling interest.” However, the court found a limited partnership or joint venture existed. “The Sun Funds are not passive investors in Sun Scott Brass, LLC brought together by happenstance, or coincidence. Rather, the Funds created Sun Scott Brass, LLC in order to invest in Scott Brass, Inc.,” the opinion stated. “[I]t is clear beyond peradventure that a partnership-in-fact existed sufficient to aggregate the funds’ interests and place them under common control with Scott Brass, Inc.” So, combined, the funds’ ownership stake was 100%.

In its opinion, the 1st Circuit noted that 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. On withdrawal, an employer must pay its proportionate share of the plan’s “unfunded vested benefits.” To prevent evasion of the payment of withdrawal liability, the MPPAA imposes joint and several withdrawal liability not only on the withdrawing employers but also on all entities (1) under “common control” with the obligated organization (2) that qualify as engaging in “trade or business.”

According to the opinion, the MPPAA regulations adopted in 1996 by the PBGC, include the Treasury Department’s regulations governing “common control.” The regulations state that entities are under common control if they are members of a “parent-subsidiary group of trades or businesses under common control.” The PBGC has not provided the courts or parties with any further formal guidance on how to determine common control specifically in the MPPAA context. Nor has PBGC updated its regulation on common control since that regulation’s adoption.

So, the Circuit Court looked to the partnership factors the Tax Court adopted in Luna. The factors are:

• “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 co-proprietor, 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.”

While the 1st Circuit found there are some facts under the Luna factors that tend to support a conclusion that the Sun Funds formed a partnership-in-fact to assert common control over SBI, it said consideration of all of the factors leads to the opposite conclusion.

The Luna factors that counsel against recognizing a partnership-in-fact include the clear record evidence that the Funds did not “intend to join together in the present conduct of the enterprise,” at least beyond their coordination within SSB-LLC. The fact that the Funds expressly disclaimed any sort of partnership between the Funds counts against a partnership finding as to several of the Luna factors—specifically, factors one, five and six. The appellate court noted that most of the 230 entities or persons who were limited partners in Sun Fund IV were not limited partners in Sun Fund III. The Funds also filed separate tax returns, kept separate books, and maintained separate bank accounts—facts which tend to rebut partnership formation, and counting against factors six and seven.

The Sun Funds did not operate in parallel, that is, invest in the same companies at a fixed or even variable ratio, which also shows some independence in activity and structure, the appellate opinion states. The creation of an LLC by the Sun Funds through which to acquire SBI also shows an intent not to form a partnership. The formation of an LLC both prevented the Funds from conducting their business in their “joint names”—Luna factor five—and limited the manner in which they could “exercise mutual control over and assume mutual responsibilities for” managing SBI—Luna factor eight.

Using the Luna factors, the 1st Circuit concluded that most of them point away from common control. Moreover, the Circuit Court said it was reluctant to impose withdrawal liability on these private investors because it lacks a firm indication of Congressional intent to do so and any further formal guidance from the PBGC. “Two of [the Employee Retirement Income Security Act] and the MPPAA’s principal aims—to ensure the viability of existing pension funds and to encourage the private sector to invest in, or assume control of, struggling companies with pension plans—are in considerable tension here,” the court stated in its opinion.

The 1st Circuit reversed the entry of summary judgment for the New England Teamsters & Trucking Pension Fund and remanded the case to the lower court with directions to enter summary judgment for the Sun Funds.