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By now, I would imagine that every operator of a private equity fund has heard more than they want to hear about the recent First Circuit U. S. Court of Appeals ruling in Sun Capital Partners, III, LP v. New England Teamsters & Trucking Industry Pension Fund.  As we discussed in a recent Client Alert, the ruling held that a private equity fund was conducting a “trade or business” and was part of a “controlled group” of corporations under ERISA that included at least one of its portfolio investment companies.  As a result of this finding, the private equity fund was found to be jointly and severally liable for the withdrawal liability obligations owed by the portfolio company to a multi-employer pension plan fund when the portfolio company ceased contributing to the pension fund.  For a more thorough discussion of the ruling, please refer to our recent Client Alert.


Whether Sun Capital Partners is ultimately successful when it eventually appeals this holding, or whether other courts or jurisdiction choose to follow this line of thinking is simply unknown.  Furthermore, Congress could step up and clarify the intentions of the ERISA controlled-group rules.  However, for the time-being, private equity funds should carefully review the holding in the Sun Capital Partners case and determine how their operations and ownership structure might fare under the rationale used by the First Circuit U.S. Court of Appeals in that case.


If a private equity fund is ultimately determined to be part of the same controlled group of corporations as its portfolio companies, all of the “trades or businesses” within that controlled group will be deemed to be one company for certain plan requirements and rules under ERISA.  Private equity funds that are at risk that the holding may have some application to them should also look at the potential liabilities and obligations of their investment portfolio companies to the extent that such liabilities and obligations are the type that are shared among members of a “controlled group of corporations” under ERISA. 


The most significant of these types of liabilities are obligations owed with respect to unfunded obligations of a single-employer defined benefit pension plan and withdrawal liability obligations to a multi-employer defined benefit pension plans (the subject of the Sun Capital Partners case).  These potential liabilities clearly represent the most significant potential issue for private equity funds should the Sun Capital Partners ruling become the applicable law in the jurisdiction applicable to the fund.  However, there are other ERISA controlled group rules that will also have to be considered. 


The ERISA controlled group rules are applicable with respect to the continuation of health benefits required under COBRA and non-discrimination testing required for health and welfare benefit plans.  In addition, the rules are applicable with respect to the deduction limits, determination of service for vesting and participation, accrual and benefit limitations, determination of when a separation of service has occurred, non-discrimination testing and minimum participation requirements imposed on qualified retirement plans (e.g., such as under a 401(k) Plan).  Thus, as an example, a 401(k) plan sponsored by one of the members of the controlled group would need to factor in the employees of all of the members of the controlled group In order to determine whether it met the various qualification requirements referred to above.  This could make it difficult for each member to operate their own separate retirement plans; a practice that is commonly used by private equity funds.


Of course, there are several exceptions and sophisticated techniques that can potentially be employed to avoid or help navigate around or through some of these requirements.  However, before they get to that point, private equity funds should first assess their risk of being treated as a “trade or business” for purposes of the controlled group rules.  If the fund determines that it is at risk of being treated as a “trade or business” under the applicable law in its jurisdiction, it then needs to determine which other trades or businesses would be part of its controlled group.  Only then can it begin to address the potential issues and options that are created by that controlled group relationship.


If you would like more information about this issue or if we can be of help, please let us know.