United States

Private equity fund liable for portfolio company’s pension

Formal ownership structure not dispositive of common control


The U.S. District court ruled in Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund, (2016 BL 95418, D. Mass., No. 1:10-cv-10921, 3/28/16) that private equity funds were responsible for the pension liability of a bankrupt portfolio company, despite the fact that the ownership structure did not meet the common control definition in form. The private equity funds used a complex ownership structure, which ultimately resulted in the bankrupt company being owned 70 percent and 30 percent by two funds, respectively. In 2013, the appellate court ruled that one of those funds qualified as a trade or business and remanded the case back to the first circuit to decide whether the other fund constituted a trade or business and whether the entities had common control of the bankrupt entity.

Following the previous analysis of the appellate court, the district court found the second fund was also a trade or business. Of greater importance in the recent decision is the analysis related to common control. The cases were filed under the Employee Retirement Income Security Act of 1974 (ERISA) by a pension fund in an attempt to collect the liability owed by the bankrupt entity. Under ERISA, the Pension Benefit Guaranty Corporation (PBGC) and the Multiemployer Pension Plan Amendments Act treat multiple trades or businesses under common control as a single employer, which essentially allows any entity in that commonly controlled group to be held responsible for the pension liability of others.

The PBGC defines common control with respect to IRS rules that include parent-subsidiary groups relevant in the Sun Capital case. A parent-subsidiary group requires 80 percent ownership by another organization, and the Sun Capital entities had purposely each owned less than 80 percent, therefore, the legal form of the structure did not constitute common control. However, the court ruled that the legal form should be ignored because the substance of the structure was that the two entities worked together enough to qualify as a joint venture, which collectively did own greater than 80 percent of the bankrupt entity.

In its analysis of the two entities as a joint venture, the court noted that the intent of the common control provisions is to prevent entities from forming separate entities to avoid ERISA obligations. Specifically, the court stated, “The question of organizational liability is not answered simply by resort to organizational forms, but must instead reflect the economic realities of the business entities created by the Sun Funds…” The court cited earlier case law and the Internal Revenue Code in its analysis for treating entities as a single partnership that were, in fact, formed as separate legal entities.

Following this authority and earlier precedent, the court ruled that the Sun Capital entities should be treated as a joint venture even though they were not a partnership-in-fact. The two funds had identical language in their partnership agreements, operated similarly, were controlled by the same two individuals, and acted and decided jointly when they formed the complex ownership structure to invest in the now bankrupt company. In addition to these factors, which all indicate positive correlation with a joint venture, no factors were present that would indicate a negative correlation. Neither fund had made investments separately from the other fund, and no disagreements had ever occurred between the two funds. Based on these factors, the court concluded that the two entities did not appear to operate as separate businesses.

A joint venture must also be treated as a trade or business to be subject to ERISA liability. Following the analysis of the two separate funds that had already been addressed, the court found the joint venture to also be a trade or business. Therefore, the court found that the funds were responsible for the pension liability of the portfolio company because they were a trade or business under common control with the bankrupt entity.

This ERISA case will likely have many implications that unfold over time. The first and most obvious is the pension risk that private equity funds may be taking on when investing in portfolio companies. Although the ruling does not implicate tax rules since it is an ERISA case, if the IRS took a similar position, the consequences may extend to minimum coverage and nondiscrimination testing for retirement plans of portfolio companies, because the same common control rules apply to those tests. If that were the case, depending on how funds’ investments were structured, each individual operating company may have to take into account the employees of all other operating companies in determining their individual plan’s nondiscrimination testing. For some funds, this expansive testing would likely be a substantial endeavor given the size of their portfolios. In addition, nonqualified deferred compensation rules have a similar single employer analysis that could limit the ability of some portfolio companies to terminate and pay out deferred compensation, depending on the arrangements of other portfolio companies that may be considered the same employer.

Whether or not the IRS would rule similarly or will take any action in this area remains to be seen. It is noted, however, that the court relied on IRS rules in this ERISA case for the definition of common control and partnership. If the IRS were to adopt a position similar to the holding in this case, the impact could reach beyond employee benefit plans to the income tax effects of the funds themselves and their owners.


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