In a recent decision, a Massachusetts Federal District Court judge held two private equity funds, Sun Capital Partners III and Sun Capital Partners IV (the Funds), jointly and severally liable for a $4.5 million multiemployer pension plan withdrawal liability incurred by a commonly owned portfolio company, Scott Brass, Inc. (SBI). The court supported its decision by finding that the Funds were engaged in a trade or business under common control.

In its analysis of whether the Funds were engaged in a trade or business, the court applied a facts-and-circumstances test to determine whether the funds’ activities rose beyond that of mere “passive investor[s] who [do] not engage in management activities.” Specifically, the court emphasized the following factors in support of its conclusion: the Funds invested in portfolio companies as a profit-making activity; the Funds actively managed and operated SBI in a manner similar to their other portfolio companies; and the Funds’ economic benefits would not be available to an ordinary passive investor, that is, offsets against and carried interest associated with typical fund management fees.

In determining that SBI was under common control, the court also approached this issue by looking through the economic substance of SBI’s ownership structure. Under the applicable Pension Benefit Guaranty Corporation (PBGC) regulations, a parent and subsidiary are under common control provided that the parent owns at least 80 percent of the subsidiary’s equity. While the formal ownership had the Funds owning SBI in a 70/30 split, the court looked to the spirit of the PBGC regulations, finding that the economic reality of the ownership structure created a “partnership-in-fact” between the Funds. To support its assertions that SBI was truly a “partnership-in-fact” and that both the Funds and SBI were under common control, the court analogized the ownership of parallel funds, which co-invest in a similar fashion as the shared general partner, to the current situation. Honing in on a number of specific factors, the court focused on the following elements: using the same structure in their other shared investment activities; joint activity prior to the Funds’ co-investment conclusion; and the Funds’ decision to split the investment 70/30 and their supporting reasoning. Relying on this analysis, the court concluded that each Fund and SBI were each engaged in a trade or business and were under common control.

This case illustrates the willingness of courts to look beyond the formal structure to the economic realities of the arrangement when deciding multiemployer plan liability cases. Funds and their advisors should closely consider the factors used by the court when structuring their investments in operating businesses and assessing potential withdrawal liability risk.

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