First Circuit Holds Private Equity Fund May Be Liable For Portfolio Company’s Pension Liability

On July 24, the U.S. Court of Appeals for the First Circuit held that two private equity funds managed by Sun Capital could be liable for their portfolio company's withdrawal liability from a multiemployer pension plan (Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund, 2013 WL 3814984 (1st Cir. July 24, 2013)). In a partial reversal of a Massachusetts district court ruling, the First Circuit found that at least one of Sun's private equity partnerships is engaged in a "trade or business" for purposes of assessing liability under Title IV of the Employee Retirement Income Security Act (ERISA). The case also raises certain income tax questions. Both are addressed below.

Background

Under ERISA, all members of a "controlled group" are treated as a single employer for purposes of imposing liability on employers in connection with the termination of an underfunded pension plan or the withdrawal from an underfunded multiemployer pension plan. Thus, if an employer terminates or withdraws from an underfunded pension plan, each member of the employer's controlled group is jointly and severally liable for the plan's unfunded pension liabilities (or, for multiemployer plans, the employer's share of the liability). If a private equity fund is found to be a member of a controlled group with a portfolio company, the fund would be exposed to liabilities associated with a pension plan maintained or contributed to by that company. Additionally, membership in the controlled group arguably could extend to a fund's other portfolio companies and each of those companies could be exposed to the pension plan liabilities. In contrast, if the fund is not considered a member of a controlled group with its portfolio company, liability for pension obligations would be confined to the portfolio company that maintained or contributed to the plan (and its controlled subsidiaries).

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 (480 U.S. 23 (1987)), 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.

In 2007, the Pension Benefit Guaranty Corporation (PBGC) issued an opinion (PBGC Appeals Board opinion dated September 26, 2007) finding that a private equity fund was engaged in a trade or business and consequently jointly and severally liable for its portfolio company's unfunded pension liability. In its opinion, the PBGC concluded that the fund in question engaged in a trade or business under the Groetzinger test because the stated purpose of the fund was to make a profit, and it attributed the activities of the fund's advisor and general partner to the fund, which received consulting fees, management fees and carried interest (in other words, the fund did not receive just investment income as a passive investor). While many...