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The Sun Capital Case Could Have Broader Implications for Employee Benefit Plans

The widely publicized case of Sun Capital Partners III, L.P. v. New England Teamsters & Trucking Ind. Pension Fund, No. 12-2312, __ F.3d __, 2013 WL 3814984 (1st Cir. July 24, 2013), has made the private equity investment community a touch uneasy. In holding that a fund organized by Sun Capital Advisors, Inc. ("Sun Capital") was subject to a withdrawal liability assessment as "trade or business" under the Multiemployer Pension Plan Amendments Act ("MPPAA"), the First Circuit clearly created a new area of risk for private equity firms. But the Sun Capital case could also have broader implications for the way corporate organizations can be characterized for employee benefits purposes.


The case arose out of the 2007 acquisition of a metals manufacturer, Scott Brass, Inc. ("SBI"), by two private equity funds (the "Sun Funds") organized by Sun Capital. SBI was a union shop participating in and making contributions to the New England Teamsters & Trucking Industry Pension Fund (the "Pension Fund"). In 2008 SBI filed for bankruptcy under Chapter 11 of the Bankruptcy Code, ceased making contributions to the Pension Fund, and withdrew from the Pension Fund. Consistent with the requirements of ERISA and the MPPAA, SBI became liable for its share of the Pension Fund's unfunded benefit obligations and received a withdrawal liability assessment in excess of $4.5 million.

ERISA and the MPPAA provide that all members of a controlled group can be held jointly and severally liable for payment of the multiemployer plan withdrawal liability of any member. The Pension Fund, therefore, demanded payment from the Sun Funds, as the 100% owners of SBI, on the theory that they constituted a "trade or business" under common control with SBI. The Sun Funds succeeded in obtaining a declaratory judgment in federal district court confirming that they had only made a passive investment in SBI and therefore should not be considered engaged in a "trade or business" under common control with SBI.

On appeal of the decision the Pension Fund and the PBGC (joining as a friend of the court) argued that the Sun Funds were indeed engaged in a "trade or business" under common control with the debtor. In particular, they argued that the court should apply the "investment plus" standard articulated by the PBGC in informal guidance in order to determine what constitutes a trade or business. Under the "investment plus" standard the activities undertaken by the Sun Funds to take a more active role in the management of SBI would become highly relevant (and counter their apparent positions as passive investors).

The Decision

On appeal the First Circuit found that the "investment plus" standard promoted by the PBGC was indeed appropriate. The Court noted the well-recognized principle that a mere investment, without something more, does not render the investor a "trade or business." The Court then, however, engaged in a fact intensive analysis to conclude that Sun Capital and the Sun Funds went beyond their roles as a passive investors: making decisions about the hiring, termination, and compensation of the employees of SBI (all of which were allowed under their agreements with SBI); placing Sun Capital employees in two of three director positions at SBI; and, through service agreements, providing management and consulting personnel to SBI. While no one factor was dispositive and a number of other distinguishing circumstances were present, the Court was persuaded the Sun Funds were intimately involved in the management and operation of SBI and that this level of involvement was consistent with "trade or business" status.

The Impact of the Decision

The Sun Capital decision is meaningful because it classifies an entire private equity fund as a "trade or business" based on the fund's involvement in the management of one of the portfolio companies and the benefit the fund derived from the nature of that involvement. In essence, actual passive investors were subjected to liability as a result of the structure of their arrangement with active fund managers (namely the general partner of the fund). Because the entire fund was a "trade or business" the legal construct that allowed private equity to invest with virtual impunity was collapsed and the fund was liable for withdrawal liability under the MPPAA.

The holding is limited to what constitutes a "trade or business" for purposes of assessing withdrawal liability under 29 U.S.C. § 1301(b) and the First Circuit expressly stated that it was not establishing general guidelines for what the "plus" in the investment plus standard might be under different circumstances. Certainly, private equity firms should carefully consider the factors identified by the First Circuit in structuring their investments and exceeding their roles as "passive" investors. But one wonders whether the Sun Capital decision could ultimately have broader implications in the world of employee benefits and executive compensation, where the controlled group rules arise in many contexts.

If a private equity fund and one or more of its portfolio companies can be treated as a controlled group (and, therefore, as a single employer) under the "investment plus" standard of Sun Capital, the constituent entities could experience a number of undesirable consequences:

  • The retirement plans maintained by the controlled group members would be subject to coverage and nondiscrimination testing based on the entire combined workforce of the fund and the portfolio companies.
  • There would be joint and several liability for any defined benefit pension plan unfunded benefit obligations (not just for multiemployer plans).
  • Employees who move from one portfolio company to another may not be considered to have separated from service in a way that would trigger the right to receive benefit payments.
  • The employers would have to be combined for purposes of applying the employer shared responsibility requirements of the Affordable Care Act (a/k/a the play or pay mandate).

It remains to be seen whether the Sun Capital decision will affect the manner in which the IRS and the DOL enforce their respective rules. Fortunately, for now at least, these questions appear to be largely academic.

Topics: Plan Administration, Retirement Plans