Private Equity Fund Gains Important Victory
In Sun Capital Partners III v. New England Teamsters and Trucking Industry Pension Fund, the Court of Appeals for the First Circuit ruled on November 22 in favor of private equity funds, thus settling a long-running dispute as to whether two Sun Capital Funds could be held liable for the withdrawal of a portfolio company from the New England Teamsters Multiemployer Pension Plan.
When private equity funds invest in portfolio companies, one of their concerns is to avoid controlled group status with the portfolio company. One such concern is with pension liability, either for withdrawal liability for a multiemployer plan or joint and several liability for a funding deficiency for a single employer plan. Another concern is with nondiscrimination testing for tax-qualified plans, which is also done on a controlled group basis. Under the Internal Revenue Code, as is relevant in this context, employees of trades or businesses under common control are treated as a single employer. In connection with a private equity fund's ownership of a portfolio company, this would be 80% of the voting power or 80% of the value of the portfolio company. In Sun Capital, one of the funds held a 70% ownership interest, and the other fund held a 30% ownership interest in the portfolio company. Therefore, the only way in which the two funds could be found to have controlled group liability with the portfolio company would be if the two funds were in substance a partnership. Private equity funds had two theories for avoiding controlled group liability. The threshold position was that they are investors, and not engaged in a trade or business. However, in a previous appeal in this case, the First Circuit held that a private equity fund could be a "trade or business" and therefore potentially liable for withdrawal liability as a member of the controlled group. The issue of whether the two funds were liable under the controlled group rules was remanded to the Massachusetts District Court, which concluded that the two private equity funds were a partnership in fact, but the Court of Appeals for the First Circuit reversed. The trade or business issue was not addressed in this appeal, but had the First Circuit found for the pension fund, it is quite possible that the private equity funds would have filed a writ of certiorari with the Supreme Court, seeking review of the First Circuit's decision.
The PBGC was not a party to the litigation, but filed an amicus brief with the Court of Appeals in support of the District Court's decision. However, the First Circuit noted that ERISA indicated that controlled group for purposes of this part of ERISA should be "consistent and coextensive" with IRS regulations, and the PBGC regulations implementing that section of ERISA, essentially tracked the statutory language, thereby not providing the First Circuit with much guidance. The First Circuit held that under the Internal Revenue Code, whether or not the two private equity funds were a partnership was a question of federal law. It determined the relevant federal law for determining the existence of a partnership was the Tax Court decision in Luna v. Commissioner, a decision applying a multi-factor analysis to determine the existence of a partnership. Under that test, while some of the factors supported a conclusion that the two funds were a partnership, consideration of the other factors caused the First Circuit to conclude that the two funds did not constitute a partnership. As a result, there was no controlled group liability with respect to the multiemployer withdrawal liability claim.
The scope of the case can be confined. It was the first appellate decision on this issue, and it is a fact-specific decision binding only in the First Circuit. However, from a broader perspective, it reflects the fact that federal common law (treating principles of federal income taxation as federal common law), while generally narrowly defined, is available to fill the gaps in ERISA, in the same way that courts have held asset purchasers liable to multiemployer plans for withdrawal or to the PBGC for single employer plan termination, as common law successors.
The Court noted that there were policy arguments that could be made for both the Pension Funds and the private equity funds, but indicated that resolution of those policy issues was for Congress not the courts. While Congress may not ultimately address those issues or related provisions in Senator Warren's Stop Wall Street Looting bill, the House has recently begun hearings on the bill.