In Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, a multiemployer pension fund sued two private equity funds, claiming that they were liable under ERISA, as amended by the Multiemployer Pension Plan Amendment Act (MPPAA), for the withdrawal liability of a bankrupt company that they owned and which had ceased contributing to the pension fund. On July 24, 2013, the US Court of Appeals for the First Circuit:

Sun Capital Advisors, Inc. (SCAI) sponsors two private equity funds, Sun Capital Partners III, LP (Sun Fund III) and Sun Capital Partners IV, LP (Sun Fund IV), (together, the Sun Funds) that invest in underperforming companies. SCAI provides capital to the Sun Funds and, through related entities, takes an active role in the management of the Sun Funds' portfolio companies. For ERISA purposes, the Sun Funds are venture capital operating companies (VCOCs) (see Practice Note, ERISA Plan Asset Rules: Venture Capital Operating Company (VCOC)). In 2007, the Sun Funds purchased Scott Brass, Inc. (SBI), a closely-held corporation that contributed to the New England Teamsters and Trucking Industry Pension Fund (the TPF). The general partner of Sun Fund IV, through a subsidiary, contracted with SCAI to provide management and consulting services to SBI.

In October 2008, due to its poor business performance, SBI stopped contributing to the TPF, which made it liable for its proportionate share of the TPF's unfunded vested benefits. An involuntary Chapter 11 bankruptcy proceeding was brought against SBI in November 2008. In December 2008, the TPF demanded that SBI pay its estimated withdrawal liability of $4.5 million. The TPF also demanded this amount from the Sun Funds, asserting that they were part of a joint venture or partnership under common control with SBI, and were therefore jointly and severally liable for the entire amount of SBI's withdrawal liability under ERISA.

In response, the Sun Funds filed a declaratory judgment action in the US District Court for the District of Massachusetts, seeking a declaration that they were not subject to withdrawal liability because they did not meet MPPAA's two requirements for withdrawal liability as set out in ERISA Section 4001(b)(1). Specifically, the Sun Funds alleged they were not:

The TPF counterclaimed, arguing that the Sun Funds were jointly and severally liable for SBI's withdrawal liability and that they had engaged in a transaction to evade or avoid liability under ERISA Section 4212 (29 U.S.C. § 1392(c)).

The district court did not reach the issue of common control. However, the court held that the Sun Funds were not a "trade or business" under MPPAA because they did not:

Furthermore, the court accorded only persuasive authority to a September 2007 PBGC appeals board letter (PBGC Letter) that stated that a private equity fund similar to the Sun Funds was a "trade or business" in the single employer pension plan context.

On the question of whether the Sun Funds sought to evade or avoid liability, the court held that ERISA Section 4212 did not apply to an outside investor structuring a transaction to avoid assuming a potential liability. The court granted summary judgment in favor of the Sun Funds.

The TPF appealed the court's decision to the US Court of Appeals for the First Circuit.

On July 24, 2013, the First Circuit, presented with a case of first impression:

Under ERISA Section 4001(b)(1), withdrawal liability can be imposed on an organization other than the one obligated to the pension fund if the organization is both:

The First Circuit noted that "trade or business" has not been defined by the PBGC in applicable regulations or by the Supreme Court, and the only guidance is the 2007 PBGC Letter that the district court rejected as unpersuasive. In that letter, the PBGC itself purported to rely on Commissioner v. Groetzinger, which characterized a trade or business as being engaged in an activity for the primary purpose of income and profit and with continuity and regularity, as did the Seventh Circuit in Central States, Southeast and Southwest Areas Pension Fund v. SCOFBP (see Practice Note, Qualified Retirement Plans in Mergers and Acquisitions: Controlled Group Liability: Caveat for Passive Investors and Private Equity Funds and Legal Update, Seventh Circuit Holds That For-profit Limited Liability Companies are Trades or Businesses under the MPPAA).

Analyzing the PBGC Letter, the First Circuit characterized the test that the PBGC applied for determining if a private equity fund is a trade or business as an "investment plus" standard. Under the "investment plus" standard, a private equity fund is a trade or business if it is engaged in a profit-seeking activity that is performed with continuity and regularity. In the case analyzed in the PBGC Letter, the PBGC found that both requirements were satisfied, and that the fund exercised control over the company through management and advisory services performed by its agent. The First Circuit agreed with the district court that the PBGC Letter was entitled to no more deference than the power to persuade. However, the court decided that in determining whether there is mere passive investment so as to defeat pension withdrawal liability, some form of investment plus approach is appropriate when evaluating the existence of a trade or business. The court pointed out that it was not merely persuaded by the PBGC Letter but would have reached the same result if it had ignored the PBGC Letter, as was done by the Seventh Circuit in Central States, Southeast & Southwest Areas Pension Fund v. Messina Products, LLC.

In applying the investment plus approach, the First Circuit considered a number of factors (none of which was dispositive on its own) in determining that the investment plus test had been met, at least by Sun Fund IV:

Furthermore, Sun Fund IV received a direct economic benefit from its active management of SBI that an ordinary, passive investor would not receive: an offset against the management fees it otherwise would have paid its general partner for managing the investment in SBI.

The Sun Funds also argued that the activities of their affiliates could not be attributed to them. Because the Sun Funds were established under Delaware law, the First Circuit analyzed Delaware agency law to determine that the general partner of Sun Fund IV acted as an agent of the Sun Funds by providing management services to SBI. Therefore those activities could be attributed to the Sun Funds themselves.

Based on these factors, the First Circuit held that Sun Fund IV satisfied the "trade or business" requirement under ERISA. The court made clear that it was basing its conclusion on the facts of the case and declined to set out general guidelines on applying the investment plus approach. In addition, since it was not clear whether Sun Fund III also received an offset of management fees, the district court was directed to determine the extent of the economic benefit it received on remand.

The Sun Funds also argued that the First Circuit's interpretation of "trade or business" was inconsistent with the Supreme Court's interpretation of that phrase in two tax decisions. The First Circuit rejected that argument because the cited cases did not relate to withdrawal liability under the MPPAA and were distinguishable on their facts. Unlike those cases, the Sun Funds actively managed SBI and at least Sun Fund IV received a direct economic benefit (the offset).

The Sun Funds' structure and the management activities engaged in by their affiliates are fairly typical of VCOCs in general. Private equity funds investing in companies subject to the jurisdiction of the First Circuit, particularly those operating as VCOCs, will want to closely evaluate future portfolio acquisitions with special attention to the amount of potential withdrawal liability at stake. This decision may limit funds' incentive to invest in companies where there is a likelihood that they could face significant withdrawal liability for pension obligations. Although this case addressed controlled group liability for multiemployer plans, similar concepts apply in the case of single employer defined benefit plan termination liability and heightened awareness should be given to the potential liability of those plans as well. Finally, private equity funds may want to take another look at their current portfolio companies and reevaluate any potential plan termination liability that could arise.