Is a Private Equity Fund Responsible for the Pension Obligations of a Bankrupt Portfolio Company?

“… the First Circuit found that the Sun Capital fund having a 70 percent ownership interest in SBI had ‘undertaken activities as to the [Scott Brass Inc. (SBI)] property,’ became ‘actively involved in the management and operation’ of SBI, and that the general partners of the funds had authority to make decisions about ‘hiring, terminating, and compensating [SBI’s] agents and employees.’” (Pepper Hamilton

Can a private equity fund be held responsible for the pension obligations of a portfolio company? As of last month, the answer is “yes.”

On July 24, 2013, the First Circuit Court of Appeals ruled that PE fund Sun Capital Partners was more than a passive investor in Scott Brass – it was a “trade or business” actively managing the company. Accordingly, said the court, the fund should be held liable for the now-bankrupt company’s underfunded pension liability under the rules of the Employee Retirement Income Security Act (ERISA).

For your reference, here’s a roundup of recent commentary and analysis on the decision:

First Circuit Holds That a Private Equity Fund May be Liable for Portfolio Company Pension Obligations (Skadden, Arps, Slate, Meagher & Flom LLP):

“Although there has long been uncertainty regarding whether a private equity fund or its other portfolio companies may be liable for the unfunded pension obligations of one of the PE fund’s portfolio companies, this is the first appellate court decision to address the issue of whether a PE fund constitutes a trade or business for purposes of ERISA’s withdrawal liability provisions. While the decision is not binding on courts in other circuits, it underscores the risk of controlled group liability that PE funds face.” Read on>>

Appeals Court Reverses ERISA “Trade or Business” Ruling Favoring Private Equity Funds; Creates Uncertainty on Controlled Group Liability (Akin Gump Strauss Hauer & Feld LLP):

“The appeals court trade or business decision hinged on (i) the active management of the fund’s portfolio company by the fund’s general partner under the authorities afforded the general partner in the fund’s partnership agreements, and (ii) the economic benefit realized by Sun Fund IV as a result of the fee offset for fees paid directly by the portfolio company to the general partner. Further factual development was required to determine whether Sun Fund III realized a similar economic benefit.” Read on>>

First Circuit Holds Private Equity Fund May Be Liable For Portfolio Company’s Pension Liability (Pepper Hamilton LLP):

“An entity can be a member of a controlled group only if it is engaged in a ‘trade or business.’ The Supreme Court of the United States, in Commissioner v. Groetzinger, established a test for when an activity constitutes a ‘trade or business’ for certain tax purposes. Under Groetzinger, for a person to be engaged in a trade or business, the primary purpose of the activity must be income or profit, and the activity must be performed with continuity and regularity.” Read on>>

First Circuit Finds that a Private Equity Fund Can Be Liable for the Pension Obligations of its Portfolio Company (Sheppard Mullin Richter & Hampton LLP):

“The private equity fund’s partnership agreement was also a major factor in the court’s decision because it gave the private equity fund’s general partner the exclusive authority to act on behalf of the fund and it granted actual authority for the general partner to provide management services to portfolio companies.” Read on>>

First Circuit: Private Equity Fund May Be “Trade or Business” and Subject to Portfolio Company Pension Liabilities (White & Case LLP):

“The Sun Funds also argued that the portfolio company management activities of their general partners and their affiliates cannot be attributed to the Sun Funds themselves, and, accordingly, withdrawal liability cannot be imposed on the Sun Funds. The First Circuit noted that the limited partnership agreements of the Sun Funds gave their general partners exclusive authority to act on behalf of the limited partnerships to effectuate their purposes. The First Circuit stated that ‘under Delaware law, it is clear that the general partner of Sun Fund IV, in providing management services to Scott Brass, was acting as an agent of the Fund.’” Read on>>

PE Fund Deemed a ‘Trade or Business’—May Be Liable for Portfolio Companies’ Pensions (Pillsbury Winthrop Shaw Pittman LLP):

“Various provisions of the ERISA and the Internal Revenue Code treat all companies within one ‘controlled group’ as a single employer. A controlled group exists when two or more ‘trades or businesses’ are under ‘common control.’ […] Under certain circumstances, each member of a controlled group can become jointly and severally liable for another member’s funding obligations to a single employer pension plan, or for another member’s withdrawal liability to a multiemployer pension plan.” Read on>>

Private Investment Funds May Be Liable for Portfolio Company’s Underfunded Pension Liabilities under First Circuit Ruling (Proskauer Rose LLP):

“In addition, being a member of a ‘controlled group” may create other administrative issues, such as nondiscrimination testing on a controlled group basis for tax-qualified retirement plans and certain welfare plans. Controlled group members also have to consider the implications of being in a controlled group for purposes of COBRA, health care reform and Section 409A of Code, among other legal requirements.” Read on>>

Not Exactly a Day in the Sun: U.S. Court of Appeals Holds Private Equity Fund Is Engaged in a Trade or Business (Sutherland Asbill & Brennan LLP):

“Private equity funds (as well as hedge funds and other pooled investment vehicles) provide efficient structures for various types of investors to pool their funds for investment purposes. […] The success of pooled investment vehicles as an efficient means of providing capital to portfolio companies hinges, in no small measure, upon the underlying position that these vehicles are not considered engaged in trades or businesses, but, rather, are treated as mere investors in the underlying portfolio companies.” Read on>>

Private Equity Funds Can Be Liable for Portfolio Company Pension Plan Obligations (Choate Hall & Stewart LLP):

“The First Circuit left several related questions for the District Court to decide, including whether a related fund, Sun Capital Partners III, LP, which owned the remaining 30% of Scott Brass, was a trade or business and whether either or both of the funds were under ‘common control’ with Scott Brass. The First Circuit avoided creating a bright-line test to determine whether a private equity fund is a trade or business for purposes of ERISA and stressed that any determination would depend upon the facts and circumstances of the fund’s structure and operation.” Read on>>

First Circuit Finds Private Equity Partnerships Can be Liable for Employer’s Withdrawal Liability (Littler):

“This case is significant for private equity investors holding interests in companies with unfunded pension liabilities, since the holding applies equally to single employer plan terminations as well as multiemployer plan obligations.” Read on>>

First Circuit: Private Equity Sponsor Liable for Portfolio Company Pension Underfunding (K&L Gates LLP):

“Many (if not most) multiemployer plans are presently underfunded due to a combination of investment performance, low discount rates used to calculate liabilities, and union bargaining tactics. In addition, with private-sector union membership declining, many multiemployer defined benefit pension plans have a smaller base of active workers from which to keep the plan funded. These pension liabilities continue as significant potential liabilities for entities that previously thought of themselves only as investors that limited their risk to the equity investment.” Read on>>

Private equity fund deemed a “trade or business” under ERISA, exposing it to federal liabilities (Saul Ewing LLP):

“To minimize the risk of exposure to withdrawal liability and in other contexts, private equity funds should structure their investments in a manner that reduces their control over the portfolio companies’ operations and financial affairs. Failure to do so may have far reaching results – beyond that of multiemployer liability. The aggregation of portfolio companies with private equity companies may unwittingly cause tax problems and compliance issues with respect to employee benefit plans that would also be required to be aggregated.” Read on>>


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