We frequently encounter employers who are excited to purchase an underperforming company with the belief that it can make that company profitable.  While we as ERISA counsel never want to rain on anyone’s parade, we always encourage these employers to do their due diligence with respect to the company’s employee benefits plans.  The last thing an acquirer wants is to learn that it is responsible for a previously unknown pension liability of the acquired entity.  Careful planning can help minimize the risk of such liability.

A recent First Circuit decision involving a private equity fund’s investment in a portfolio company shows just how serious this risk is.  In Sun Capital Partners III LP vs. New England Teamsters & Trucking Indus. Pension Fund, No.12-2312, the First Circuit held that a private equity fund was a “trade or business” under ERISA, as amended by the Multiemployer Pension Plan Amendment Act (“MPPAA”).  As such, it was part of the portfolio company’s “controlled group.”  Pending the outcome of additional controlled group analysis on remand to the District Court, the fund could be liable for withdrawal liability incurred by its portfolio company.

This decision could have a much wider impact beyond private equity funds and multiemployer plans in the First Circuit.  Single employer acquisitions of companies that have pension liabilities often face similar controlled group issues.  These controlled group issues also could affect other qualified plans, executive compensation plans, and health and welfare plans of employers.  This blog will provide details about the case and these potential liability issues.


Sun Capital Advisors, Inc. established Sun Fund III and Sun Fund IV (collectively, the “Sun Funds”).  Sun Fund IV owned 70% of Scott Brass, Inc. (“SBI”), and Sun Fund III owned the remaining 30% of SBI.  Two years after the Sun Funds acquired their interests in SBI, SBI filed for bankruptcy and withdrew from the New England Teamsters and Trucking Industry Pension Fund (“Pension Fund”). The Pension Fund subsequently demanded over $4.5 million from SBI as its share of the “withdrawal liability” (the unfunded but vested liability of the Pension Fund). The Pension Fund also claimed that the Sun Funds were part of a controlled group with SBI and thus were jointly and severally liable for this withdrawal liability amount.

A controlled group of businesses is a group of related employers that are treated as one employer. Whether two or more businesses are considered a controlled group depends on the extent to which there is common ownership and control between the entities. A parent-subsidiary controlled group consists of a parent corporation and one or more subsidiary corporations. A parent-subsidiary controlled group exists if the members of the group (other than the common parent) are at least 80% owned by other members of the group, and if the common parent owns at least 80% of at least one of the member corporations.  A brother-sister controlled group exists when (1) at least 80% of the voting power or total value of two or more organizations is owned by the same five or fewer persons (individuals, estates, or trusts) and (2) the same five or fewer persons own more than 50% of the voting stock or total value of the organizations taking into account only the ownership that is identical for both organizations. Special attribution rules apply to attribute ownership from one person to another. Attribution is a concept that treats a person who does not legally own stock as though he or she owns such stock for purposes of applying the controlled group rules. The significance of a controlled group is that all businesses in the group are treated as a single employer for purposes of certain legal requirements applicable to tax-qualified retirement plans.

Needless to say, a controlled group analysis can be complex and require thorough planning. The specific issues for the Sun Funds were whether (1) they were under common control with the organization required to contribute (SBI), and (2) each of them was a “trade or business.”  The Sun Funds argued that they were passive investors in SBI and therefore not engaged in a “trade or business” that was part of a controlled group with SBI.  The District Court agreed and granted the Sun Funds a declaratory judgment.  The Pension Fund appealed and argued that the First Circuit should apply an “investment plus” standard that the PBGC had described in informal guidance to determine what constitutes a trade or business. The PBGC filed an amicus brief in support of the Pension Fund’s appeal.

On appeal, the First Circuit reversed and remanded the District Court’s decision.  The court noted its “dismay” that the Pension Benefit Guaranty Corporation (“PBGC”) had not issued much guidance on what constituted a trade or business. It also acknowledged that mere passive investment is not enough to make an investor a trade or business. Yet, the First Circuit ultimately applied an “investment plus” test and found that the private equity fund was not merely a “passive investor” but instead an active manager of SBI.  The court used a facts and circumstances test to reach this conclusion and explained that (1) the Sun Funds’ partnership agreements stated that a “principal purpose” of the funds was the management and supervision of the portfolio companies, and (2) as a factual matter, the Sun Funds exerted substantial management control and decision making authority. The court also cited several other facts that showed that the Sun Funds were active in the management and operation of SBI. Based on all of the facts and circumstances, the First Circuit concluded that Sun Fund IV was a trade or business. It could not determine whether Sun Fund III was a trade or business. The court remanded the case to the District Court to make this determination using with the investment-plus test.

Spreading Ownership of the Portfolio Company Across Different Funds

Adoption of the investment plus standard is important, but remember that in order to be a part of a SBI’s controlled group, the Sun Funds must have common control of SBI. That means they must hold at least 80% of SBI. If Sun Fund III is not considered a trade or business, then the Sun Funds would be deemed to own only a 70% interest in SBI and thus be able to evade withdrawal liability. This factor presents an obvious planning opportunity, as well as an opportunity for abuse. The MPPAA addresses this issue by stating that if a “principal purpose” of a transaction is to evade or avoid withdrawal liability, then the structure of the transaction is to be disregarded. The Pension Fund argued that the Sun Funds’ 70-30 ownership split was designed intentionally to evade or avoid withdrawal liability.  The First Circuit rejected this argument.

The court interpreted the “principal purpose” statute to require courts to erase or ignore certain transactions but not to create new transaction terms that never existed in the first place.  The court explained that the parties agreed to the 70%-30% split before the purchase of SBI was completed.  The court added that it was “doubtful” the transaction would have occurred at all without the 70% – 30% split.  The court believed that the statute did not provide authority to redesign the transaction with Sun Fund IV having 100% ownership of SBI.

Implications of the Decision

Again, the decision is binding only in the First Circuit and applied only to determination of withdrawal liability to a multiemployer pension plan.  Still, the decision could have much broader employee benefits and executive compensation consequences.  The following list provides several examples of these consequences.

  1. The combined workforce of the controlled group entities would be tested on an aggregated basis, rather than separately, for purposes of the non-discrimination rules.
  2. The acquirer could be liable for any underfunding of a controlled group entity’s pension plan, regardless of whether it is a multiemployer.
  3. Movement of employees from one entity within the controlled group to another would need to be analyzed to determine whether they constitute a severance or other payment event under both qualified and nonqualified plans.
  4. The acquirer’s ability to terminate a 401(k) plan or nonqualified plan of a controlled group member could be limited.
  5. The controlled group members would be treated as a single employer for purposes of the Affordable Care Act’s shared responsibility provisions (the “pay-or-play” mandate).

As we said at the start of the blog, we try not to let employee benefit issues kill a potential deal, but we recommend thorough due diligence and careful planning to avoid unpleasant surprises.  Due diligence can help acquirers identify the potential liability they could incur.  Controlled group planning may allow acquirers to design the transaction in a way to minimize the liability.  Sometimes, a potential acquierer may decide that the benefits liabilities are too great to make the deal worthwhile.  That’s always disappointing, but it leaves that acquierer in a stronger position for a better deal in the future.  In all cases, forewarned is forearmed.