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Investment Plus What? Sun Capital and the “Investment Plus” Standard

Earlier this year, the First Circuit Court of Appeals delivered its opinion in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund1, overturning a lower court’s decision and sending lawyers in the private equity industry scrambling to make sense of it.2 In short, Chief Judge Lynch’s opinion held that, in the presence of certain circumstances, private equity investors would be responsible for the undercapitalized pensions of their target companies should those target companies become insolvent.3  Going forward, determining the circumstances Judge Lynch relied on will be paramount for lawyers to ensure that in the event of insolvency, clients will not be left holding the often hefty pension bags of their target companies.

The plaintiffs in Sun Capital, two private equity funds, were organized as limited partnerships and were overseen by two general partners. The partners pooled investments into the funds and subsequently sought to acquire, “underperforming but market-leading companies at below intrinsic value, with the aim of turning them around and selling them for a profit.”4 In 2006, the partners acquired Scott Brass, Inc. (“SBI”), a Rhode Island corporation and producer of high quality brass, copper, and other metals.5 However, rather than acting as passive investors in SBI, the general partners “exerted substantial operational and managerial control over SBI.”6 Importantly, the opinion notes that the general partners were involved in hiring decisions, capital expenditures, dividend payouts, discussions about potential acquisitions, and were also included on weekly “flash reports.”7

The partners, through their holding company, made regular contributions to SBI’s pension fund until at least October 2008.8 The following month SBI entered involuntary Chapter 11 proceedings.9 After SBI’s pension fund demanded continued payments, the general partners sought a judgment in federal court declaring that they were not subject to liability because: “(1) the Sun Funds were not part of a joint venture or partnership and therefore did not meet the common control requirement; and (2) neither of the Funds was a “trade or business.”10 Although a Massachusetts district court granted the partners’ summary judgment motion, the First Circuit overruled that decision, finding in part that at least one of the funds did qualify as a “trade or business”.11 In finding that the Sun Capital fund qualified as a “trade or business”, Judge Lynch relied on what is commonly called the “investment plus” test.12

Although the “investment plus” test provided the touchstone for liability in Sun Capital, the First Circuit “[saw] no need to set forth general guidelines for what the ‘plus’ is”.13 Instead, the court stated plainly: “we go no further than to say that on the undisputed facts of this case, Sun Fund IV is a “trade or business.”14 By providing no true standard for determining whether the activities of an investment fund qualify as the “plus” in the “investment plus” test, the Sun Capital decision offers little direction for structuring future private equity investments.

Still, while Sun Capital may not provide explicit guidance for deciphering the “investment plus” standard, within the opinion there do exist certain waypoints for the lawyer tasked with structuring a private equity investment. Judge Lynch focuses on certain activities that together may go far toward meeting the “investment plus” standard. For one, the language of investment agreements and memos may be dispositive, as “the Sun Funds’ limited partnership agreements and private placement memos explain that the Funds are actively involved in the management and operation of the companies in which they invest.”15 Second, the ownership agreements between general partners may factor into consideration. As the opinion notes, “the general partners are empowered through their own partnership agreements to make decisions about hiring, terminating, and compensating agents and employees of the Sun Funds and their portfolio companies.”16 Finally, the payment structure between the general partners and their private equity funds certainly play a role in the “investment plus” standard. In this case, payments the SBI made to the private equity funds were used to offset any management fees that the funds ultimately owed to the general partners. In this way, “[the] offset was not from an ordinary investment activity, which in the Sun Funds’ words results solely in investment returns.”17 Though there are many potential factors to consider, for the First Circuit’s purposes, the above three may be helpful in structuring future private equity investments.

Lastly, the Sun Capital decision has done more than simply force lawyers to reexamine how they structure private equity investments. Beyond that, the opinion that potentially exposes private equity investors to significant and unforeseen pension liability also raises a question about whether private equity investors should ever have been able to avoid making good on the pensions of their target companies. At first glance, many would argue that sophisticated investors should not be able to shield themselves from the responsibility to make retirement payments to the workers of their target companies. And yet, with further reflection, that question may not be answered so simply. Advocates of a continued shield against pension liability point to the typical target company and the goals for funds such as Sun Capital—that is, the goal of turning around “underperforming” companies. If there is value in that – and there certainly is – then there is also value in incentivizing such investments. To that end, insulating private equity investors from the undercapitalized pensions of potential target companies is perhaps, in some ways, a means to a worthy end.

  1. Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013)  

  2. See, e.g., Memorandum from Davis Polk (August 6, 2013) available at; Memorandum from Skadden Arps (July 29, 2013) available at 

  3. See Sun Capital, 724 F3d at 132-33. 

  4. Sun Capital, 724 F.3d at 134. 

  5. Id. at 135. 

  6. Id. at 136. 

  7. See Id. 

  8. Id. 

  9. Sun Capital, 724 F.3d at 136. 

  10. Id. 

  11. Id. at 137, 149. 

  12. Id. at 141. 

  13. Id. (emphasis added). 

  14. Id. 

  15. Id. at 142. 

  16. Id. 

  17. Id. 

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