First Circuit Holds Private Equity Fund Is A 'Trade Or Business' For Purposes Of Erisa Withdrawal Liability

In a decision with far-reaching consequences for the private equity industry, the U.S. Court of Appeals for the First Circuit has adopted an expansive view of what constitutes a "trade or business" for purposes of determining whether a private equity fund can be held jointly liable for Employee Retirement Income Security Act (ERISA) multiemployer pension withdrawal liability incurred by the fund's portfolio companies. Although the case specifically deals with ERISA liability, a finding that a private equity fund constitutes a trade or business could also have wider tax implications for the fund, its managers and investors, as discussed below.

Background of Case

The case, Sun Capital Partners III, LP et al. v. New England Teamsters & Trucking Industry Pension Fund et al., No. 12-2312 (1st Cir. 2013) (Doc 2013-18003), involved a fairly typical private equity structure in which Sun Capital Funds III and IV (the "Sun Funds") together acquired 100 percent of a portfolio company, with neither fund owning 80 percent or more on its own. The Sun Funds neither had offices or employees nor did they make or sell goods, and they did not report income other than investment income. The general partner of the funds entered into an agreement with the Sun Funds to provide management services to the portfolio company for a fee, with the services to be provided by a subsidiary of the general partner. When the portfolio company paid fees to the management company, the Sun Funds would receive an offset to the fees the Sun Funds owed to the general partner. At some point after the Sun Funds made their investment, the portfolio company filed for bankruptcy and triggered an ERISA withdrawal liability event.

Trade or Business Analysis

ERISA generally imposes joint and several liability for multiemployer withdrawal liability on all entities that are "trades or businesses" under "common control" (generally 80-percent common ownership). The question of what constitutes a trade or business—versus mere investment activity—is not defined in ERISA or its regulations, and it is also not defined in comparable provisions relating to pension plans in the Internal Revenue Code. As noted by the First Circuit in Sun Capital, although there are various references to the concept of "trade or business" in the Internal Revenue Code, there has never been a definition of general application or any regulations expounding a definition for all purposes.

In holding that Sun Fund IV...