Sun Capital - Pension Liability under MPAA (1st Cir.)
On November 22, 2019, the United States Court of Appeals for the First Circuit1 reversed the U.S. District Court for the District of Massachusetts’s grant of summary judgment in favor of the New England Teamsters & Trucking Industry Pension Fund, which would have imposed pension fund withdrawal liability on two private equity funds—Sun Capital Partners III2 and Sun Capital Partners IV, LP—under the Multiemployer Pension Plan Amendments Act of 1980. The First Circuit remanded the matter to the district court with instructions to enter summary judgment in favor of the Sun Funds. The key issue presented was:
- Whether Sun Capital Partners III (“Sun III”) and Sun Capital Partners IV, LP (“Sun IV”, and together, the “Sun Funds”), notwithstanding their express corporate structure, created an implied partnership-in-fact constituting a “control group” under the Multiemployer Pension Plan Amendments Act of 1980 (the “MPPAA”)3?
By way of background, Sun Capital Advisors, Inc. (“SCAI”) pools capital in limited partnerships with the goal of targeting and ultimately acquiring portfolio companies, managing them through corporate intermediaries, and ultimately restructuring and growing such companies in order to conduct a business disposition that will result in a return for investors. Sun III and Sun IV are two distinct SCAI funds organized for investment purposes under Delaware law as limited partnerships that do not have offices or employees, do not make or sell goods, and only report investment income to the IRS.
While the Sun Funds are ultimately controlled by the same two individuals, they do have primarily different investors and investments. Both Funds disclaimed in their limited partnership agreements any partnership or joint venture with one another and maintained separate tax returns, financial books and bank accounts. At the time the district court considered the issue, Sun III had 124 limited partners and Sun IV had 230 limited partners, with 64 overlapping between the two.
The Sun Funds pursued SCAI’s strategy independently and together, which consisted of eighty-eight total investments at the relevant times but only seven overlapped. One such investment was in Sun-Scott Brass, LLC (“SSB-LLC”). Sun Fund III owned 30% of SSB-LLC and Sun Fund IV owned 70% of SSB-LLC, keeping each funds’ interest in SSB-LLC below the 80% threshold that establishes a controlling interest according to Treasury regulations.4
SSB-LLC in turn formed and financed Scott Brass Holding Company (“SBHC”), a wholly-owned subsidiary. SBHC then purchased Scott Brass, Inc. (“SBI”), a brass manufacturing company. While the Sun Funds owned SBI through SBHC, SBI filed for Chapter 11 and withdrew from a multiemployer pension fund, incurring a $4,516,539 withdrawal liability.
The MPPAA governs whether an employer is subject to withdrawal liability under a qualified pension plan. Under the MPAA, if the Sun Funds had created an implied partnership-in-fact constituting a control group, then the New England Teamsters & Trucking Industry Pension Fund (“Pension Fund”) could look to the Sun Funds’ general and limited partners to pay the liability because the parties would be jointly and severally liable. If the Sun Funds had not created an implied partnership-in-fact constituting a control group, however, then the withdrawal liability would be a general unsecured claim subject to discharge as part of SBI’s bankruptcy case.
Following SBI’s withdrawal from the multiemployer pension fund, the Pension Fund assessed withdrawal liability against the Sun Funds. In response, the Sun Funds filed suit against the Pension Fund in district court seeking a declaratory judgment that the Sun Funds were not an implied partnership-in-fact constituting a control group, however, the district court denied this relief and granted summary judgment in favor of the Pension Fund. The First Circuit reversed, finding: first, that the partnership-in-fact test had not been met and, second, that it could not conclude Congress intended to impose liability under these circumstances.
In evaluating whether the Sun Funds formed a partnership-in-fact to acquire and operate SBI through SSB-LLC, the First Circuit first looked to the Pension Benefit Guaranty Corporation (“PBGC”) regulations, which incorporate by reference the Treasury Department’s regulations governing common control. Because the definition of common control comes from the Treasury Department’s regulations, courts must look to the Tax Court and federal tax law precedent to analyze whether a partnership-in-fact existed at the applicable time. The Tax Court applies a multi-factor test first set out in Luna v.Commisioner5 to determine partnership status. Under Luna, the factors that a court must evaluate to establish a partnership 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 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.”6
The First Circuit used Luna to evaluate the Sun Funds, rejecting the Sun Funds’ argument that the Luna test did not apply because they operated SBI through a limited liability company. Instead, the First Circuit recognized its ability to look through the corporate form to establish a partnership-in-fact stating that merely operating as a limited liability company does not preclude courts from recognizing the existence of a partnership.
Ultimately, the First Circuit determined that the Luna factors weighed in favor of a finding that the Sun Funds were not an implied partnership-in-fact. The Court refused to recognize a partnership-in-fact because the Sun Funds: (i) expressly disclaimed any sort of partnership between funds; (ii) did not share many limited partners; (iii) filed separate tax returns; (iv) kept separate books; (v) maintained separate bank accounts; (vi) did not operate in parallel; and (vii) used a limited liability company corporate form. And although the First Circuit found that SCAI’s control over the Sun Funds and control over SBI, as well as the Sun Funds conduct in managing SSB-LLC, could evidence a partnership-in-fact, the Court ultimately concluded the evidence more strongly supported a finding that the Sun Funds did not create an implied partnership-in-fact.
Importantly, the First Circuit also expressed a reluctance to impose withdrawal liability on private investors under these circumstances absent both clear congressional intent to do so and formal PBGC guidance on what constitutes a control group. The Court’s decision highlighted the tension between ERISA and the MPPAA’s competing policy goals of ensuring the viability of existing pension funds while also encouraging private sector investment in struggling companies with underfunded pension plans.
Summary of Key Takeaways:
- Courts may look through entities’ express corporate form in evaluating whether to recognize an implied partnership-in-fact when evaluating potential withdrawal liability;
- Private equity funds that jointly hold an entity will likely not be subject to pension withdrawal liability if they adhere to corporate formalities, expressly disclaim a partnership, show independent activity (including diverse limited partners), and limit the exercise of mutual control over management of the jointly-held entity;
- Congress and the PBGC may ultimately determine whether private investors should bear the costs of withdrawal liability under the MPPAA under these circumstances by modifying applicable laws and regulations; and
- Courts will evaluate and try to balance the competing interests of imposing withdrawal liability and disincentivizing private investment, which could worsen the financial position of multiemployer pension plans, and not imposing liability, leaving the PBGC to assume some of the cost and to enforce a statutorily capped rate likely below what pension workers are entitled to receive.
This update presents a high-level summary of several key takeaways from the First Circuit’s ruling in Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Industry Pension Fund, et al. (Case Nos. 16-1376 and 19-1002) issued on Friday, November 22, 2019.
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1 The First Circuit has appellate jurisdiction over the federal district courts in Maine, Massachusetts, New Hampshire, Rhode Island, and Puerto Rico.
2 Sun Capital Partners III is technically comprised of two separate funds: Sun Capital Partners III, LP and Sun Capital Partners III QP, LP. But the First Circuit treated the two funds as one entity, Sun Fund III, because they were parallel funds sharing a single general partner and made nearly identical investments.
3 The MPPAA is a provision of the Employee Retirement Income Security Act of 1974 (“ERISA”).
4 26 C.F.R. § 1.414(c)-2(b)(2)(i).
5 42 T.C. 1067 (1964).
6 42 T.C. at 1077–78.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.