"Executive Compensation and Benefits Alert: Decision Clarifies That PE Funds Are Not Subject to 'Controlled Group' Liability"

by Skadden, Arps, Slate, Meagher & Flom LLP
Contact

[authors: Stuart N. Alperin, Peter C. Krupp, Neil M. Leff, Ron E. Meisler, Regina Olshan, Erica Schohn, Joseph M. Yaffe, Michael R. Bergmann, Alessandra K. Murata, David C. Olstein]

Private equity funds (PE funds) and their advisors long have been concerned that a fund (or its other portfolio companies) may be liable for unfunded pension plan liabilities of one of its portfolio companies. However, in a decision published last month, the U.S. District Court of Massachusetts held that three PE funds sponsored by Sun Capital were not liable for any portion of the withdrawal liability incurred by a portfolio company in which the funds collectively held a controlling interest. In reaching this decision, the court expressly rejected the analysis contained in a 2007 Pension Benefit Guaranty Corporation (PBGC) Appeals Board opinion, which found that the investment activities of a PE fund constitute a “trade or business” and thus subjected the PE funds to joint and several liability under Title IV of the Employee Retirement Income Security Act (ERISA) for a portfolio company’s unfunded pension liabilities.

Although the Sun Capital Partners case provides a foundation for cautious optimism on the issue of whether PE funds can be held jointly and severally liable for the pension-related liabilities incurred by portfolio companies in which they invest, it remains to be seen whether its analysis will be adopted by other courts and whether the district court’s decision will be upheld on appeal to the First Circuit. PE funds should continue to view control group liability as a potential risk in the acquisition context and, in order to minimize exposure to unfunded pension liabilities, PE funds should consult counsel when encountering these issues.

Background

ERISA treats all members of a “controlled group” as a single employer for purposes of its provisions imposing liability on employers in connection with the termination of an underfunded single employer pension plan or a withdrawal from an underfunded multi-employer pension plan. As a result, if an employer terminates or withdraws from an underfunded pension plan, each member of the employer’s controlled group is jointly and severally liable for the plan’s unfunded pension liabilities (for the employer’s share of such liabilities in the case of a multi-employer plan).

Under ERISA, a controlled group is defined as any group of trades or businesses under common control. Typically, these groups are structured in “parent-subsidiary” or “brother-sister” form, whereby a parent company or a limited number of individuals owns a controlling interest in the affiliated entities.

An organization will be considered a member of a controlled group only if it is conducting a trade or business. Accordingly, if the activities of a PE fund are considered a trade or business, the PE fund’s acquisition of a controlling interest in a portfolio company would establish a parent-subsidiary controlled group consisting of the PE fund and the portfolio company (as well as any controlled subsidiaries of the portfolio company). Membership in the controlled group would expand each time the PE fund acquired a controlling interest in another portfolio company, and if any one of the portfolio companies maintained or contributed to a single employer or multi-employer pension plan, both the PE fund and the other portfolio companies would be exposed to liabilities associated with the pension plan.

On the other hand, if the activities of a PE fund are not considered a trade or business, liability for pension obligations generally would be confined to the portfolio company that maintained or contributed to the plan and any subsidiaries in which the portfolio company owned a controlling interest.

2007 PBGC Opinion

In 2007, the PBGC Appeals Board issued an opinion in which the PBGC determined that a PE fund was engaged in a trade or business and therefore was jointly and severally liable under ERISA for a portfolio company’s unfunded pension liabilities. In reaching this conclusion, the PBGC Appeals Board applied a two-part test established by the Supreme Court in Commissioner v. Groetzinger (in the context of a tax controversy), under which a person is considered to be engaged in a trade or business if (i) the primary purpose of its activity is the realization of income or profit and (ii) the activity is performed with continuity and regularity.

The PBGC Appeals Board found that the PE fund’s investment activities met both prongs of the Groetzinger test because the stated purpose of the PE fund was to make a profit and the size of the PE fund’s overall portfolio and the profits generated from such investment were sufficient evidence of continuity and regularity. The PBGC opinion was the first time that the PBGC had formally determined that a PE fund constituted a trade or business, and created substantial uncertainty regarding the application of ERISA’s controlled group liability provisions to PE fund portfolio company investments.

The Sun Capital Partners Decision and Why It Matters

In the Sun Capital Partners case, the U.S. District Court of Massachusetts expressly rejected the 2007 PBGC opinion and concluded that a PE fund’s one-time investment of capital in a portfolio company does not constitute a trade or business. The portfolio company at issue in Sun Capital Partners was owned by three PE funds sponsored by Sun Capital Advisors, Inc. (the Sun Capital funds). Two of the funds acquired, in the aggregate, a 30 percent interest in the portfolio company, while the third fund acquired the remaining 70 percent interest. The issue of joint and several ERISA liability arose in the context of the portfolio company’s unpaid withdrawal liability to the New England Teamsters and Trucking Industry Pension Fund (Pension Fund).

After the portfolio company withdrew from the Pension Fund and entered bankruptcy, the Pension Fund sought to collect withdrawal liability from the Sun Capital funds in reliance on the 2007 PBGC opinion, arguing that the Sun Capital funds constituted a trade or business that was under common control with the portfolio company. The Pension Fund also asserted that by structuring their investment in the portfolio company so that no single fund held a controlling interest, the Sun Capital funds had entered into the investment with a principal purpose of evading or avoiding liability under Title IV of ERISA. Sun Capital sought summary judgment on the basis that none of the investing funds constituted a “trade or business” and thus were not under “common control” with the bankrupt portfolio company.

The court granted the Sun Capital funds’ motion for summary judgment, finding that the 2007 PBGC opinion was not entitled to deference because the opinion was “unpersuasive” and in direct conflict with Supreme Court precedent. The court found that although profit was the undisputed purpose of the Sun Capital funds’ investments, the funds also must have been engaged in activity with “continuity and regularity” in order for the court to conclude that the Sun Capital funds were engaged in a trade or business. In ruling that the investment activity of the Sun Capital funds did not constitute a trade or business, the court held that “merely holding passive investment interests is not sufficiently continuous or regular” for purposes of satisfying the second prong of the Groetzinger test.

Because the court found the investment activities of the Sun Capital funds did not constitute a trade or business, the portfolio company’s withdrawal liability could not be imposed on the Sun Capital funds.

The court also rejected the Pension Fund’s argument that the Sun Capital funds should be subject to joint and several liability under ERISA on the theory that the Sun Capital funds sought to evade or avoid liability under ERISA by structuring their ownership of the portfolio company so that no single fund owned a controlling interest. Although the Sun Capital funds conceded that one purpose of the ownership structure was to eliminate its potential exposure to withdrawal liability by keeping each fund’s ownership below the 80 percent controlling interest threshold, the court — confirming the view held by most practitioners — determined that the statutory provision authorizing courts to allocate pension liabilities by disregarding transactions entered into with a principal purpose of evading such liabilities was intended to apply only to sellers of companies that were subject to pension liabilities, not to prospective investors.

Download PDF

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP
Contact
more
less

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!