Issues in Sun Capital Continue to be Top of Mind for Investment Funds

LD Sergi
Published Date:
Jun 1, 2017

In March 2016, the federal district court in Massachusetts (the “District Court”), issued a decision in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund, 2013 U.S. App. LEXIS 15190 (1st Cir. 2013) (“Sun Capital”), holding that, for purposes of pension withdrawal liability under Title IV of the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Multiemployer Pension Plan Amendment Act of 1980 (MPPAA), two private equity funds were engaged in a trade or business and that they were under “common control” with the portfolio company such that they were jointly and severally liable for its pension withdrawal liability.

Although Sun Capital is an ERISA case, tax practitioners and investment funds continue to be concerned that the principles of the case, if extended to the tax arena, could have broad implications for the tax treatment of the income and activities of Private Equity (“PE”) funds and their investors.

The District Court’s decision followed remand of the case from the United States Court of Appeals for the First Circuit (the “First Circuit”) pursuant to a July 24, 2013 decision. That First Circuit decision addressed whether the private equity partnership litigants in the case were engaged in “trades or businesses” for purposes of the MPPAA. Reversing a decision by the District Court, the First Circuit held that one of the investing funds was more than a mere passive investor and therefore was engaged in a trade or business for purposes of ERISA. The First Circuit remanded for additional fact finding with respect to the second fund as well as whether the two funds were under “common control” with the bankrupt portfolio company under section 4001(b)(1) of ERISA, thereby making the funds jointly and severally liable for the portfolio company’s pension withdrawal liability.

The District Circuit’s holding in the case addressed only provisions of ERISA. However, the ERISA definition of “trades or businesses...under common control” cross-references the definition set forth in the Treasury Regulations (under section 414(c)) of the Internal Revenue Code (the “Code”). This has made many PE funds and similarly situated taxpayers uncomfortable as they have historically relied on various case law, including United States Supreme Court cases, to support the position that they are not engaged in a “trade or business” for federal income tax purposes.


Two private equity partnerships, Sun Fund III and Sun Fund IV, invested (through a holding company) in Scott Brass Inc. (“SBI”), a failing business with an obligation to contribute to the New England Teamsters Fund (the “Teamsters Fund”). One partnership held 70% of the holding company shares and the other partnership held 30%. The general partner of one of the Sun Funds (the “Sun GP”) also owned a subsidiary management company that provided management services to SBI. Within two years of the Sun Funds’ purchase of SBI, SBI was bankrupt and liable for over $4 million in withdrawal liability (greater than the total Sun Funds’ cash investment). The Teamsters Fund sought the unpaid withdrawal liability from the Sun Funds under the MPPAA.

Trade or Business and Common Control

The MPPAA imposes liability on an organization, other than the one obligated to the pension fund, when two conditions are satisfied: the organization is engaged in a “trade or business,” and the organization is under “common control” with the organization obligated to the pension fund. The First Circuit decision concluded that Sun Fund IV was engaged in a trade or business but remanded to the District Court for additional factual findings for Sun Fund III. The specific focus was on whether Sun Fund III had management fee offsets or other economic benefits similar to those that the First Circuit believed existed for Sun Fund IV but that a passive investor ordinarily would not obtain.

The District Court then turned to the second issue: whether the funds were under “common control” with SBI. The Court did conclude the funds are under common control with SBI but only after determining the Sun Fund III and Sun Fund IV had formed a partnership-in fact to hold SBI and certain other shared portfolio investments.


In addition to SBI, the two funds also co-invested in several other entities using a similar structure. Sun Fund III owned 30% of the investment holding company and Sun Fund IV owned the remaining 70%. Each fund also invested in other assets that were either not owned in the same proportion or not owned by the other fund at all. The District Court concluded after considering cases such as Commissioner v. Culbertson 337 U.S. 733 (1949) and Luna v. Commissioner, 42 T.C. 1067 (1964), and substance over form, that the funds were deemed to form a partnership to hold all investments held in the same structure with the same ownership. Thus, Sun Fund III and Sun Fund IV formed a partnership that held SBI.

The District Court then concluded that this partnership-in-fact was both engaged in a trade or business and under common control with SBI, thereby making the two funds jointly and severally liable for SBI’s withdrawal liability.

Significance of Sun Capital

Sun Capital specifically involves the provisions of ERISA. Accordingly, Sun Capital is quite significant to investors who are considering purchasing a business with substantial withdrawal liability exposure or substantially underfunded single employer plans. The specific ERISA provision at issue in Sun Capital essentially imports the Treasury Regulations under section 414(c), suggesting that the District Court’s holding may be extended beyond Title IV of ERISA to various nondiscrimination rules and other provisions of the Code that cross-reference section 414(c).

Furthermore, it is important to consider how this case may affect the definition of “trade or business” for purposes of the Code. One may expect many PE Funds and PE investors to continue to take the position, based on Whipple v. Commissioner, 373 U.S. 193 (1963), Higgins v. Commissioner, 312 U.S. 212 (1941), and similar authorities, that they are not engaged in a “trade or business” for federal income tax purposes. It is also critical to consider when and to what extent separate partnerships should be treated as one partnership, and when tax partnerships might exist without the formation of a legally separate entity.

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SERGILD Sergi is a tax principal in the Los Angeles office of Deloitte Tax LLP.  

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