A "controlled group" is generally two or more "trades or businesses" that are under "common control." Under ERISA all "controlled group" members are jointly and severally liable for the withdrawal liability of any controlled group member. For private equity funds, the more likely arrangement giving rise to a controlled group is a parent-subsidiary relationship, which occurs where one entity owns 80% or more of the other.
In Sun Capital, the ownership interests were such that none of the private equity funds individually owned more than 80% in the portfolio company.
The Teamsters Pension Fund advanced the novel argument that an implied "partnership in fact" existed between the private equity funds such that their individual ownership interests should be aggregated, which together would exceed 80%. Rooted in tax law, a partnership in fact exists where eight factors are shown, and if the "true intent" of the investors was to coordinate their actions with an "identity of interest" and "unity of decision-making."
In a highly fact-sensitive analysis, the First Circuit found that, on balance, a partnership in fact did not exist.
The First Circuit found compelling that the limited partnership agreements expressly disclaimed any partnership relationship; the creation of a limited liability company undercut the claim that there was an intent to form a partnership; each filed separate tax returns; each maintained separate financial records and bank accounts; they did not invest in the same portfolio companies in parallel to one another at fixed or variable ratios, evidencing "independence in activity and structure;" and the limited partners in the Sun funds differed.
In sum, the Sun funds were found to be a trade or business, but did not maintain the 80% ownership necessary to impose controlled group liability.
In October, the U.S. Supreme Court declined to hear an appeal, ending 10 years of litigation.
While the First Circuit's "investment-plus" test has not been adopted by any other circuit, it is sure to be tested. Private equity firms with investments in portfolio companies that contribute to MEPPs should review their arrangements and consider restructuring in light of this holding. For those exploring such opportunities, advance planning is key to insulate against risks.
Michael G. McNally is a partner in the Minneapolis office of Fox Rothschild LLP. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.