The 1st Circuit Court of Appeals reversed a district court’s in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund
(Nos. 16-1376, 19-1002
), holding that two separate, but related private equity funds had not created an implied partnership-in-fact when they co-invested in the same portfolio company and were not jointly and severally liable for the multiemployer pension plan withdrawal liability incurred by the portfolio company.
The cases involved a private equity firm that pools investors’ capital in separate investment funds to acquire portfolio companies. The investment funds themselves do not have offices or employees, do not make or sell goods, and report to the IRS only investment income. The investment funds expressly disclaimed in their respective partnership agreements any partnership or joint venture with each other. The investment funds also maintained separate tax returns, financial books and bank accounts.
The portfolio company in which the two investment funds co-invested was a participating employer in a multiemployer pension plan. While the investment funds jointly owned the portfolio company, it filed for bankruptcy and subsequently withdrew from the pension plan, incurring withdrawal liability.
Withdrawal liability is incurred when a participating employer in a multiemployer pension plan completely withdraws from the plan, which occurs when the employer either (i) permanently ceases to have an obligation to contribute under the plan, or (ii) permanently ceases all covered operations under the plan. Upon withdrawal, an employer must pay its proportionate share of the plan’s unfunded vested benefits.
To prevent evasion of the payment of withdrawal liability, ERISA imposes joint and several withdrawal liability not only on the withdrawing employer but also on all entities that are part of the withdrawing employer’s controlled group, which includes all entities that are under common control with the withdrawing employer and that are engaged in a trade or business. For this purpose, common control generally exists when an entity owns at least 80% of another entity. Thus, in order for a private equity fund and a portfolio company to be part of a controlled group, the fund must be a trade or business and must own at least 80% of the portfolio company.
The 1st Circuit looked at whether the two investment funds formed a partnership-in-fact to acquire and operate the portfolio company. In a series of prior decisions, the lower district court found that the two funds had formed a partnership-in-fact and were engaged in a trade or business, and therefore, the investment funds were in control of the portfolio company and are jointly and severally liable for the portfolio company’s withdrawal liability.
In reviewing the district court’s finding of a partnership-in-fact, the 1st Circuit looked to the partnership factors considered by the district court, which were first adopted by the Tax Court in another case in 1967 (see Luna v. Commissioner, 42 T.C. 1067 (1964)). The factors are:
- The agreement of the parties and their conduct in executing its terms
- The contributions, if any, which each party has made to the venture
- The parties’ control over income and capital and the right of each to make withdrawals
- Whether each party was a principal and co-proprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income
- Whether business was conducted in the joint names of the parties
- Whether the parties filed Federal partnership returns or otherwise represented to persons with whom they dealt that they were joint-venturers
- Whether separate books of account were maintained for the venture
- Whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise
In considering these factors, the 1st Circuit acknowledged that there were some facts in this particular case that tend to support a finding that the two private equity funds formed a partnership-in-fact to assert common control over the portfolio company, but the 1st Circuit ultimately concluded that a consideration of all of the factors leads to the opposite conclusion. The 1st Circuit commented that the district court too greatly discounted the Luna factors that rebutted a partnership-in-fact formation.
The key factors relied on by the 1st Circuit to conclude that there was not a partnership-in-fact include, but are not limited to, the following:
- The evidence that the two private equity funds did not intend to form a partnership-in-fact, including the express disclaimers in their respective limited partnership agreements of any sort of partnership between the funds
- The limited overlap in investors/limited partners in the two investment funds – the 1st Circuit noted that most of the 230 entities or persons who were limited partners in one of the funds were not limited partners in the other fund
- The funds filed separate tax returns, kept separate books, and maintained separate bank accounts
- The funds did not operate in parallel – that is, invest in the same companies at a fixed or even variable ratio, which the 1st Circuit indicated shows some independence in activity and structure
In addition to considering the Luna factors, the 1st Circuit also mentioned that it was reluctant to impose withdrawal liability on the private equity funds (and their investors) because it lacked a firm indication of congressional intent to do and any formal guidance from the Pension Benefit Guaranty Corporation (PBGC), the government agency responsible for administering the multiemployer pension plan withdrawal liability provisions under ERISA.
Because the 1st Circuit concluded that there was no partnership-in-fact in this particular case, and therefore, no common control (the first prong to finding a controlled group), the 1st Circuit declined to consider whether the private equity investment funds were involved in a trade or business (the second prong). As noted previously, the district court, in earlier decisions, had concluded that the two investment firms were involved in a trade or business because, among other reasons, the investment funds (and/or one of their affiliates) were actively involved in the management and operation of the portfolio company.
Although the 1st Circuit reversed the district court’s earlier finding of a partnership-in-fact, the decision was fact-specific and did not overrule the use of the partnership-in-fact analysis to determine whether a controlled group exists for purposes of ERISA. In addition, the 1st Circuit did not address the earlier trade or business decisions by the district court, which remain outstanding. As a result, although this particular 1st Circuit decision is generally a favorable development for private equity firms with investment funds structured in a similar manner, investment funds should continue to assess the extent to which target portfolio companies may be subject to multiemployer pension plan withdrawal liability because a potential path to finding joint and several liability still exists.
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