On November 22, 2019, the First Circuit Court of Appeals decided Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, 943 F.3d 49 (1st Cir. 2019) ("Sun Capital"). The decision has implications for structuring investments of private equity funds in distressed or underperforming companies with outstanding multiemployer plan ("MEP") pension liabilities under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). Investors in private equity funds or special purpose vehicles created by the funds for a particular group of investors, co-investors, investments or a combination thereof, may be liable for pension obligations of a portfolio company that ceases making required employer contributions to, and withdraws from a MEP. Withdrawal liability under section 4001(b)(1) of ERISA, which codified Multiemployer Pension Plan Amendments Act of 1980, Pub. L. No. 96-364, 94 Stat. 1208 (1980) (“MPPAA”) is a two-prong test. A person must be engaged in a trade or business and be under common control with the withdrawn employer for the withdrawal liability to be imputed to such person, whether an individual or an entity.
Under Sun Capital, the more sringent “investment plus” test for the trade or business liability prong remains controlling authority in the First Circuit and persuasive authority in other federal jurisdictions. In addition, under Sun Capital, an eight-factor test applies to determine whether an investor is within the same controlled group as the portfolio company that withdrew from the MEP. The First Circuit reversed the District Court and held the funds were not liable for approximately $4.5 million in MPPAA pension plan withdrawal liability, because the economic reality of the investment as expressed in the eight factor analysis did not evidence a partnership-in-fact between the funds. But the First Circuit elucidated additional legal theories that could be asserted by a trustee of a MEP to look through the portfolio company and impose MPPAA withdrawal liability on the investors.
The court holdings impact private equity funds that use acquisition vehicles akin to an LLC used by the private equity funds in Sun Capital to co-invest in a portfolio company that eventually filed for bankruptcy and incurred MPPAA withdrawal liaiblity as a result of defaulting on its MEP obligations. Private equity funds must take into account the court holdings in structuring and capitalizing the portfolio investments, drafting the operating agreements and ancillary documents for the acquisition vehicles and ensuring that conduct of the managers, limited partners and service providers conforms to the deal structure to avoid MPPAA liability exposure. Accordingly, fund managers doing due diligence on a potential investment that involves a MEP should consult a tax advisor on the appropriate structure, provisions in deal documents and subsequent compliance to avoid potential liability under ERISA.