Legal Alerts

Private Equity Funds May Be Liable for Portfolio Company's Pension Obligations


The U.S. First Circuit Court of Appeals recently became the first federal appellate court to hold that a private equity fund constituted a "trade or business" for purposes of the Employee Retirement Income Security Act of 1974 ("ERISA"), and therefore may be liable for the ERISA pension obligations of its portfolio company. While this decision is limited to the First Circuit (Massachusetts, Maine, New Hampshire and Rhode Island), it is a major departure from previous court rulings and poses a significant risk to private equity funds.     


In this particular case, two private equity funds sponsored by Sun Capital Partners, Inc. owned 100% of a portfolio company, Scott Brass, Inc., which participated in a union-sponsored multiemployer pension plan. The ownership of Scott Brass was split between the two Sun Capital funds, with one owning 70% and the other 30%. Following the bankruptcy of Scott Brass, the multiemployer plan sought to recover approximately $4.5 million in withdrawal liability from the Sun Capital funds because the multiemployer plan claimed that the private equity funds were a trade or business within the same controlled group as Scott Brass. 

Under ERISA, each member of a "controlled group" that is a "trade or business" is jointly and severally liable for pension liabilities in connection with a member's termination of an underfunded single-employer pension plan or the withdrawal from an underfunded multiemployer pension plan. Generally, in order to be a controlled group the members of the trade or business must have a parent-subsidiary relationship or brother-sister relationship in which there is at least 80% direct or indirect common ownership. Under tax law, an activity is considered a trade or business if the primary purpose of the activity is to make income or profit and the activity is performed with continuity and regularity. Private equity funds have generally taken the position that they are not a trade or business because their involvement with portfolio companies is not sufficiently continuous or regular. The District Court in Massachusetts agreed and dismissed the claims against the Sun Capital funds.

Trade or Business

In partially reversing the District Court ruling, the First Circuit adopted the "investment-plus" standard for evaluating whether a private equity fund constitutes a "trade or business." Under this fact-specific standard, merely making investments in portfolio companies for the principal purpose of making a profit is not enough for a private equity fund to be a trade or business, but engaging in the management and operation of a portfolio company may be sufficient for it to be a trade or business. In holding that the Sun Capital fund owning 70% was a trade or business, the First Circuit focused on the following factors:

  • The governing documents and offering memoranda for the Sun Capital fund stated that they would be actively involved in the management and operation of their portfolio companies.
  • The general partners of the Sun Capital fund had the power to hire, fire and compensate agents and employees of the Sun Capital funds and Scott Brass.
  • The general partners of the Sun Capital fund developed restructuring and operating plans for Scott Brass and participated in discussions about its liquidity, possible mergers, dividends and revenue growth.
  • The general partners of the Sun Capital fund appointed a controlling number of Scott Brass's board members.
  • The general partners of the Sun Capital fund were intimately involved in the management and operation of Scott Brass beyond that of a passive shareholder.
  • The Sun Capital fund had a "management fee offset" that a passive shareholder would not ordinarily receive. The fees that were otherwise payable from the fund to its general partners were reduced by the fees Scott Brass paid directly to the general partners under a management agreement. 

Controlled Group

The multiemployer plan argued that the 70%-30% split in ownership of Scott Brass between the two Sun Capital funds was done intentionally to avoid the 80% threshold for being a controlled group with Scott Brass and that the two Sun Capital funds should be treated as a single joint venture owning 100% of Scott Brass. The First Circuit refused to conclude that the Sun Capital funds were a controlled group merely because they had structured the purchase of Scott Brass with a view to avoid creating an ERISA controlled group, but did remand the case to the District Court to determine whether the fund owning 30% had the same authorities as the fund owning 70% and whether or not the two Sun Capital funds should otherwise be a controlled group with Scott Brass. The outcome of the District Court's decision on this issue (and any appeals thereafter) will determine whether or not the Sun Capital funds are ultimately liable for the Scott Brass pension withdrawal obligations. 

Going Forward

Even though this case only controls transactions and entities in the First Circuit, it does provide guidance to private equity funds in structuring and managing their portfolio investments. While there are still a number of unanswered issues and the potential impact in other areas related to employee benefits is unclear, private equity funds are encouraged to take the following steps:

  • Perform thorough due diligence to determine if the target company has any single-employer pension plans or multiemployer pension plans.
  • Have a clear understanding of the ERISA controlled group of the target company both before and after the transaction. If possible, consider structuring the transaction of the target company so that related funds own less than 80% of the target company. Some of the post-close ownership interests in the target company may be excluded for purposes of making this determination, such as stock owned by an employee of the target company subject to conditions that run in favor of the fund which substantially restrict the employee's right to dispose of the stock.  
  • Limit the fund's or its affiliates' direct engagement in the management and operations of the portfolio company.
  • Do not permit the funds or its affiliates to obtain management or other fees that a passive investor would not ordinarily receive.

Search Tips:

You may use the wildcard symbol (*) as a root expander.  A search for "anti*" will find not only "anti", but also "anti-trust", "antique", etc.

Entering two terms together in a search field will behave as though an "OR" is being used.  For example, entering "Antique Motorcars" as a Client Name search will find results with either word in the Client Name.


AND and OR may be used in a search.  Note: they must be capitalized, e.g., "Project AND Finance." 

The + and - sign operators may be used.  The + sign indicates that the term immediately following is required, while the - sign indicates to omit results that contain that term. E.g., "+real -estate" says results must have "real" but not "estate".

To perform an exact phrase search, surround your search phrase with quotation marks.  For example, "Project Finance".

Searches are not case sensitive.