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Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund

United States Court of Appeals, First Circuit

July 24, 2013



Renee J. Bushey and Catherine M. Campbell, with whom Melissa A. Brennan and Feinberg, Campbell & Zack, PC were on brief, for appellant.

Eric Field, Assistant Chief Counsel, with whom Judith R. Starr, General Counsel, Israel Goldowitz, Chief Counsel, Karen L. Morris, Deputy Chief Counsel, Craig T. Fessenden, Attorney, and Beth A. Bangert, Attorney, were on brief, for Pension Benefit Guaranty Corporation, amicus curiae.

Patrick F. Philbin, with whom Theodore J. Folkman, P.C., Murphy & King P.C., John F. Hartmann, P.C., Marla Tun, Jeffrey S. Quinn, Kellen S. Dwyer, John S. Moran, and Kirkland & Ellis LLP were on brief, for appellees.

Before Lynch, Chief Judge, Thompson and Kayatta, Circuit Judges.

LYNCH, Chief Judge.

This case presents important issues of first impression as to withdrawal liability for the pro rata share of unfunded vested benefits to a multiemployer pension fund of a bankrupt company, here, Scott Brass, Inc. (SBI). See Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. § 1001 et seq., as amended by the Multiemployer Pension Plan Amendment Act of 1980 (MPPAA), 29 U.S.C. § 1381 et seq. This litigation considers the imposition of liability as to three groups: two private equity funds, which assert that they are mere passive investors that had indirectly controlled and tried to turn around SBI, a struggling portfolio company; the New England Teamsters and Trucking Industry Pension Fund (TPF), to which the bankrupt company had withdrawal pension obligations and which seeks to impose those obligations on the equity funds; and, ultimately, if the TPF becomes insolvent, the federal Pension Benefit Guaranty Corporation (PBGC), which insures multiemployer pension plans such as the one involved here. If the TPF becomes insolvent, then the benefits to the SBI workers are reduced to a PBGC guaranteed level. See 29 U.S.C. §§ 1322a, 1426, 1431. According to the PBGC's brief, at present, that level is about $12, 870 for employees with 30 years of service.

The plaintiffs are the two private equity funds, which sought a declaratory judgment against the TPF. The TPF, which brought into the suit other entities related to the equity funds, [1]has counterclaimed and sought payment of the withdrawal liability at issue. The TPF is supported on appeal by the PBGC, as amicus.[2]

We conclude that at least one of the private equity funds which operated SBI, through layers of fund-related entities, was not merely a "passive" investor, but sufficiently operated, managed, and was advantaged by its relationship with its portfolio company, the now bankrupt SBI. We also conclude that further factual development is necessary as to the other equity fund. We decide that the district court erred in ending the potential claims against the equity funds by entering summary judgment for them under the "trades or businesses" aspect of the two-part "control group" test under 29 U.S.C. § 1301(b)(1). See Sun Capital Partners III, LP v. New Eng. Teamsters & Trucking Indus. Pension Fund, 903 F.Supp.2d 107, 116-18, 124 (D. Mass. 2012).

As a result, we remand for further factual development and for further proceedings under the second part of the "control group" test, that of "common control, " in 29 U.S.C. § 1301(b)(1). The district court was, however, correct to enter summary judgment in favor of the private equity funds on the TPF's claim of liability on the ground that the funds had engaged in a transaction to evade or avoid withdrawal liability. See 29 U.S.C. § 1392(c); Sun Capital, 903 F.Supp.2d at 123-24.

I. The material facts are undisputed.

A. The Sun Funds

Sun Capital Advisors, Inc. ("SCAI") is a private equity firm founded by its co-CEOs and sole shareholders, Marc Leder and Rodger Krouse. Sun Capital, 903 F.Supp.2d at 109. It is not a plaintiff or party in this case. SCAI and its affiliated entities find investors and create limited partnerships in which investor money is pooled, as in the private equity funds here. Moreover, SCAI finds and recommends investment opportunities for the equity funds, and negotiates, structures, and finalizes investment deals. Id. SCAI also provides management services to portfolio companies, and employs about 123 professionals to provide these services.

The plaintiffs here are two of SCAI's private equity funds (collectively the "Sun Funds"), Sun Capital Partners III, LP ("Sun Fund III")[3] and Sun Capital Partners IV, LP ("Sun Fund IV"). They are organized as Delaware limited partnerships. SBI is one of their portfolio companies, and the two Sun Funds have other portfolio companies. The Sun Funds do not have any offices or employees; nor do they make or sell goods, or report income other than investment income on their tax returns.[4] Id. at 117. The stated purpose of the Sun Funds is to invest in underperforming but market-leading companies at below intrinsic value, with the aim of turning them around and selling them for a profit. As a result, the Sun Funds' controlling stakes in portfolio companies are used to implement restructuring and operational plans, build management teams, become intimately involved in company operations, and otherwise cause growth in the portfolio companies in which the Sun Funds invest. The intention of the Sun Funds is to then sell the hopefully successful portfolio company within two to five years. In fact, the Sun Funds have earned significant profits from sales of various portfolio companies.[5]

These private equity funds engaged in a particular type of investment approach, to be distinguished from mere stock holding or mutual fund investments. See, e.g., S. Rosenthal, Taxing Private Equity Funds as Corporate 'Developers', Tax Notes, Jan. 21, 2013, at 361, 364 & n.31 (explaining that private equity funds differ from mutual funds and hedge funds because they "assist and manage the business of the companies they invest in"). As one commentator puts it, "[i]t is one thing to manage one's investments in businesses. It is another to manage the businesses in which one invests." C. Sanchirico, The Tax Advantage to Paying Private Equity Fund Managers with Profit Shares: What Is It? Why Is It Bad?, 75 U. Chi. L. Rev. 1071, 1102 (2008).

The Sun Funds are overseen by general partners, Sun Capital Advisors III, LP and Sun Capital Advisors IV, LP. Leder and Krouse are each limited partners in the Sun Funds' general partners and, together with their spouses, are entitled to 64.74% of the aggregate profits of Sun Capital Advisors III, LP and 61.04% of such profits from Sun Capital Advisors IV, LP. The Sun Funds' limited partnership agreements vest their respective general partners with exclusive authority to manage the partnership. Part of this authority is the power to carry out all the objectives and purposes of the partnerships, which include investing in securities, managing and supervising any investments, and any other incidental activities the general partner deems necessary or advisable.

For these services, each general partner receives an annual fee of two percent of the total commitments (meaning the aggregate cash committed as capital to the partnership[6]) to the Sun Funds, paid by the limited partnership, and a percentage of the Sun Funds' profits from investments. The general partners also have a limited partnership agreement, which provides that for each general partner a limited partner committee makes all material partnership decisions. Sun Capital, 903 F.Supp.2d at 110-11. Leder and Krouse are the sole members of the limited partner committees. Id. at 111. Included in the powers of the limited partner committees is the authority to make decisions and determinations relating to "hiring, terminating and establishing the compensation of employees and agents of the [Sun] Fund or Portfolio Companies." The general partners also each have a subsidiary management company, Sun Capital Partners Management III, LLC and Sun Capital Partners Management IV, LLC, respectively. Id. These management companies contract with the holding company that owns the acquired company to provide management services for a fee, and contract with SCAI to provide the employees and consultants. See id. When portfolio companies pay fees to the management companies, the Sun Funds receive an offset to the fees owed to the general partner.[7]

B. The Acquisition of Scott Brass, Inc.

In 2006, the Sun Funds began to take steps to invest in SBI, the acquisition of which was completed in early 2007. Leder and Krouse made the decision to invest in SBI in their capacity as members of the limited partner committees.

SBI, a Rhode Island corporation, was an ongoing trade or business, and was closely held; its stock was not publicly traded. SBI was a leading producer of high quality brass, copper, and other metals "used in a variety of end markets, including electronics, automotive, hardware, fasteners, jewelry, and consumer products." In 2006, it shipped 40.2 million pounds of metal. SBI made contributions to the TPF on behalf of its employees pursuant to a collective bargaining agreement.

On November 28, 2006, a Sun Capital affiliated entity sent a letter of intent to SBI's outside financial advisor to purchase 100% of SBI. In December 2006, the Sun Funds formed Sun Scott Brass, LLC (SSB-LLC) as a vehicle to invest in SBI. Sun Fund III made a 30% investment ($900, 000) and Sun Fund IV a 70% investment ($2.1 million) for a total equity investment of $3 million. This purchase price reflected a 25% discount because of SBI's known unfunded pension liability.[8] SSB-LLC, on December 15, 2006, formed a wholly-owned subsidiary, Scott Brass Holding Corp. (SBHC). SSB-LLC transferred the $3 million the Sun Funds invested in it to SBHC as $1 million in equity and $2 million in debt. Id. at 111. SBHC then purchased all of SBI's stock with the $3 million of cash on hand and $4.8 million in additional borrowed money. Id. The stock purchase agreement to acquire SBI's stock was entered into on February 8, 2007.[9]

On February 9, 2007, SBHC signed an agreement with the subsidiary of the general partner of Sun Fund IV to provide management services to SBHC and its subsidiaries, i.e., SBI. Since 2001, that general partner's subsidiary had contracted with SCAI to provide it with advisory services. In essence, as the district court described, the management company acted as a middle-man, providing SBI with employees and consultants from SCAI. Id.

Numerous individuals with affiliations to various Sun Capital entities, including Krouse and Leder, exerted substantial operational and managerial control over SBI, which at the time of the acquisition had 208 employees and continued as a trade or business manufacturing metal products. For instance, minutes of a March 5, 2007 meeting show that seven individuals from "SCP" attended a "Jumpstart Meeting" at which the hiring of three SBI salesmen was approved, as was the hiring of a consultant to analyze a computer system upgrade project at a cost of $25, 000. Other items discussed included possible acquisitions, capital expenditures, and the management of SBI's working capital. Further, Leder, Krouse, and Steven Liff, an SCAI employee, were involved in email chains discussing liquidity, possible mergers, dividend payouts, and concerns about how to drive revenue growth at SBI. Leder, Krouse, and other employees of SCAI received weekly flash reports from SBI that contained detailed information about SBI's revenue, key financial data, market activity, sales opportunities, meeting notes, and action items. According to the Sun Funds, SBI continued to meet its pension obligations to the TPF for more than a year and a half after the acquisition.

C. SBI's Bankruptcy and This Litigation

In the fall of 2008, declining copper prices reduced the value of SBI's inventory, resulting in a breach of its loan covenants. Unable to get its lender to waive the violation of the covenants, SBI lost its ability to access credit and was unable to pay its bills. See id.

In October 2008, SBI stopped making contributions to the TPF, and, in so doing, became liable for its proportionate share of the TPF's unfunded vested benefits. See 29 U.S.C. §§ 1381(a), 1383(a)(2). In November 2008, an involuntary Chapter 11 bankruptcy proceeding was brought against SBI. The Sun Funds assert that they lost the entire value of their investment in SBI as a result of the bankruptcy.

On December 19, 2008, the TPF sent a demand for payment of estimated withdrawal liability to SBI. The TPF also sent a notice and demand to the Sun Funds demanding payment from them of SBI's withdrawal liability, ultimately calculated as $4, 516, 539. Sun Capital, 903 F.Supp.2d at 111. The TPF asserted that the Sun Funds had entered into a partnership or joint venture in common control with SBI and were therefore jointly and severally liable for SBI's withdrawal liability under 29 U.S.C. § 1301(b)(1). Id.

On June 4, 2010, the Sun Funds filed a declaratory judgment action in federal district court in Massachusetts. The Sun Funds sought a declaration that they were not subject to withdrawal liability under ยง 1301(b)(1) because: (1) the Sun Funds were not part of a joint venture or partnership and therefore did not meet the common ...

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