PE fund deemed a ‘trade or business’ — may be liable for portfolio companies’ pensions

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By Peter J Hunt, Susan P Serota and Matthew C Ryan

The First Circuit Court of Appeals recently became the first federal appellate court to hold that a private equity (PE) fund can be a ‘trade or business’, and thus potentially included in a ‘controlled group’ with its portfolio companies for purposes of the Employee Retirement Income Security Act (ERISA). The court’s decision in Sun Capital Partners III, LP v New England Teamsters and Trucking Industry Pension Fund exposes PE funds to potential liability for underfunded pension plans at their portfolio companies.

Various provisions of the ERISA and the Internal Revenue Code treat all companies within one ‘controlled group’ as a single employer. A controlled group exists when two or more ‘trades or businesses’ are under ‘common control’. Trades or businesses are under common control if they are related through parent-subsidiary relationships of at least 80 per cent ownership (measured by capital or profits interests for unincorporated entities taxed as partnerships). Under certain circumstances, each member of a controlled group can become jointly and severally liable for another member’s funding obligations to a single employer pension plan or for another member’s withdrawal liability to a multi-employer pension plan.

The First Circuit’s decision in Sun Capital focused on the threshold requirement of whether the PE funds in question were engaged in a ‘trade or business’. The term ‘trade or business’ is not defined in ERISA or the Internal Revenue Code. In a series of tax cases culminating in Commissioner v Groetzinger, the US Supreme Court held that an entity engaging in investment activity alone cannot be a trade or business. Nonetheless, the long-held position that entities focused on investment activity — such as PE funds — are not trades or businesses has been contested in various venues since 2007…

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