The US Court of Appeals for the First Circuit recently delivered a potentially far-reaching decision for the private equity industry. In a case which involved a typical private equity structure, Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Industry Pension Fund, et al., the First Circuit adopted a broad view of what constitutes a “trade or business” for purposes of determining whether a private equity fund (and its portfolio companies) is a “controlled group” that can be held jointly liable for withdrawal liability from a multiemployer pension fund where one of the fund’s portfolio companies withdraws from the fund.

In this case, Sun Capital Funds III and IV (the “Funds”) together acquired 100 percent of a portfolio company, with neither of the Funds owning 80 percent or more of the portfolio company on its own. The Funds had no offices or employees, did not make or sell goods and did not report any income other than investment income. The Funds’ general partner entered into an agreement with the Funds to provide management services to the portfolio company for a fee through a subsidiary of the general partner. When the portfolio company paid the management fee to the subsidiary, the Funds would receive an offset to the other fees it paid to the general partner.   

After the Funds acquired the portfolio company, the portfolio company filed for bankruptcy and incurred withdrawal liability to the multiemployer plan. ERISA imposes joint and several liability for multiemployer plan withdrawals on all entities that are trades or businesses under common control. The issue before the court in this case was whether the Funds are trades or businesses.  

The court applied an investment plus activity test to determine whether the Funds were a trade or business. Because of the substantial management services and control that the Funds had over the operations of the portfolio company in question, the court held that the Funds were engaged in a trade or business for a substantial fee. In reaching its holding, the First Circuit rejected the case law rationale used by many private equity funds for the conclusion that they are not trades or businesses, even where they are acting through subsidiaries and affiliates. 

The court did not determine whether the Funds are to be aggregated for purposes of the 80 percent ownership test that would expose the Funds, and possibly other portfolio companies, to joint and several withdrawal liability. That issue will be determined by the district court on remand. 

Thus, while this case may have far-reaching consequences, it is too early to tell what those consequences will be. It is important to remember that other Circuits have not yet adopted the same or similar position as the First Circuit, and they may not do so. It is also important to wait to see whether on remand the Funds are aggregated for purposes of the 80 percent ownership test for common control. It additionally remains to be seen whether there are other consequences for the Funds and their portfolio companies beyond ERISA withdrawal liability.  

A copy of the case is available here.