United States: Court Rejects PBGC Position That An Investment Fund Is Part Of A Controlled Group For Purposes Of Pension Liabilities Of A Portfolio Company

Keywords: PBGC, investment fund, pension liabilities, portfolio company

Late in 2012, in Sun Capital Partners v. New England Teamsters ("Sun Capital"),1 a federal district court in Massachusetts (the "District Court") held that certain private equity funds were not trades or businesses that could be held jointly and severally liable for the pension obligations of a portfolio company in which such funds had invested. In so holding, the District Court rejected a 2007 ruling of the Appeals Board of the US Pension Benefit Guaranty Corporation ("PBGC") that a private equity fund was engaged in a trade or business and, therefore, a member of one of its portfolio companies' controlled group for purposes of pension liabilities to the PBGC. The District Court's decision in the Sun Capital case was also a departure from a 2010 Michigan district court decision that examined similar facts and issues and found the PBGC Appeals Board's reasoning persuasive.2

While the decision in Sun Capital is an encouraging development, the issue is far from settled. Accordingly, as discussed below, in structuring their investments, private equity funds must continue to be mindful of the potential for controlled group liabilities for the pension obligations and liabilities of their portfolio companies.


Under the Employee Retirement Income Security Act ("ERISA"), and the Internal Revenue Code (the "Code"), all employees of trades or businesses, whether or not incorporated, that are under common control are treated as being employed by a single employer for purposes of applying various employee benefit requirements and imposing various employee benefit liabilities. As the guarantor (up to statutory limits) of participants' accrued benefits under private pension plans, the PBGC will seek to recover from the members of a controlled group, the liabilities it has incurred as a result of an underfunded pension plan's termination. Under ERISA, withdrawal liability to multiemployer pension plans is also imposed on a controlled group basis. In addition, the PBGC lien that arises on the date of an underfunded plan's termination applies to all assets of a controlled group that includes the sponsor of the underfunded plan, and all members of a controlled group are liable for the payment of contributions to pension plans.3

The liability of a controlled group member for pension obligations under ERISA is joint and several. Because of this joint and several liability, the PBGC or a multiemployer plan may seek to recover against any member of the controlled group, including a private equity fund if it is deemed to be part of a controlled group. The PBGC need not look first to the actual sponsor of an underfunded pension plan for recovery.

Applicable regulations provide that trades or businesses are under common control if they are part of one or more chains of trades or businesses connected through ownership of a controlling interest with a common parent. In general, a controlling interest means stock possessing at least 80 percent of the combined voting power of all classes of stock entitled to vote, or at least 80 percent of the total value of all classes of stock of a corporation, or ownership of at least 80 percent of the profits interests or capital interests of a partnership.

The Appeals Board Ruling. As noted above, in 2007 the PBGC Appeals Board ruled that a private equity fund (the "Fund") that owned an 80 percent controlling interest in a portfolio company was a "trade or business" and therefore a member of the portfolio company's controlled group for purposes of pension liabilities to the PBGC. As a member of the portfolio company's controlled group, the Fund (along with other portfolio companies owned 80 percent or more by the Fund) was held to be jointly and severally liable to the PBGC for the unfunded pension liabilities that the PBGC had assumed following the portfolio company's bankruptcy.

Under the Supreme Court case of Commissioner v. Groetzinger,4 a person will be deemed to be engaged in a trade or business if (i) its primary purpose is to produce income or profit, and (ii) its activities are performed with continuity and regularity. In its decision, the PBGC Appeals Board concluded that the Fund constituted a trade or business under the Groetzinger test because (i) the stated purpose of the Fund was to make a profit (its partnership tax returns stated that it was engaged in investment services), and (ii) it attributed the activities of the Fund's advisor and general partner to the Fund, which received consulting fees, management fees and carried interest, thereby satisfying the "continuity and regularity" test of Groetzinger. The PBGC Appeals Board distinguished two Supreme Court cases5 and a Fifth Circuit opinion6 holding that passive investment activities do not constitute a trade or business, finding that those cases dealt with individuals managing their own personal investments.

Sun Capital. In Sun Capital, a multiemployer pension plan ("Multiemployer Plan") sought to recover approximately $4.5 million in withdrawal liability from two investment funds (the "Sun Funds") established by Sun Capital Advisors following the bankruptcy of Scott Brass, Inc. ("Scott Brass"), a portfolio company whose employees were covered by the Multiemployer Plan and which, prior to its bankruptcy, had made contributions to the Multiemployer Plan pursuant to a collective bargaining agreement. The Sun Funds together owned 100 percent of the equity interests in Scott Brass; Sun Fund IV held a 70 percent ownership interest and Sun Fund III held a 30 percent interest. The Sun Funds defended against the Multiemployer Plan's claims on the grounds that they were passive investors and therefore not trades or businesses and not under common control with Scott Brass.

In ruling that the Sun Funds were not trades or businesses, the District Court found that the Appeals Board had misread Groetzinger and had incorrectly limited Higgins and Whipple. In applying Groetzinger and finding that the Fund had engaged in investment activities with regularity and continuity (and accordingly, was no mere passive investor), the District Court found that the Appeals Board incorrectly attributed the activities of the Fund's investment advisor and its general partner to the Fund itself. It also found no basis for limiting Higgins and Whipple to individuals, noting court cases and IRS rulings to the contrary. The Multiemployer Plan also sought to hold the Sun Funds liable for its portfolio company's withdrawal liability under ERISA § 4212(c),7 which imposes liability on parties to a transaction if a principal purpose of the transaction is to evade or avoid liability.

The Multiemployer Plan argued that the Sun Funds' decision to invest in Scott Brass at a 70 percent/ 30 percent ratio was itself sufficient to trigger liability under ERISA §4212(c). In rejecting this theory, the District Court found that while the Sun Funds may have considered potential withdrawal liability when structuring their initial investments, it was not their principal purpose and that their structuring was not aimed at avoiding or evading a known or impending withdrawal liability. In reaching that conclusion, the District Court also distinguished between transactions that would evade or avoid withdrawal liability that is a predetermined certainty (such as a sale transaction involving a company for which withdrawal liability already exists) from transactions that minimize a prospective future risk of withdrawal liability.

The District Court also addressed the Multiemployer Plan's claim that regardless of whether or not the Sun Funds constituted trades or businesses, they should still be jointly and severally liable as partners of Scott Brass. The Multiemployer Plan argued that because ERISA, the Multiemployer Pension Plan Amendments Act of 1980 and applicable federal tax regulations do not recognize limited liability companies, Scott Brass should be considered an unincorporated organization and, by default, a partnership with liabilities extending to its partners (e.g., the Sun Funds). Rejecting this argument, the District Court concluded that Delaware law (and not federal law) was applicable and that under Delaware law, the Sun Funds, as members of a limited liability company, would not be personally responsible for any debt, obligation or liability of Scott Brass.

The Multiemployer Plan has appealed the District Court's decision in Sun Capital, and there are no federal appellate court decisions addressing this issue. The issue remains unsettled, and the PBGC has given no indication that it has changed its views on the issue. Accordingly, until there is more clarity regarding the application of ERISA's controlled group liability to private equity investment funds, such funds and their advisors should take controlled group liability considerations into account in structuring their investments. The lowest level of risk is, of course, an investment in a portfolio company in which the private equity fund's ownership percentage is always less than 80 percent, with unrelated entities or investors holding the remaining interests. If that is not feasible, consideration should be given to spreading the ownership interest among two or more funds.


1 No. 1:10-cv-10921-DPW, 2012 WL 5197117, (D. Mass. Oct. 18, 2012).

2 Board of Trustees, Sheet Metal Workers' National Pension Fund v. Palladium Equity Partners, LLC, 722 F.Supp.2d 854 (E.D. Mich. 2010) . In this case (referred to herein as "Palladium"), two multiemployer pension plans brought an action against three private equity funds and their common advisor alleging that the funds were liable for the withdrawal liability of bankrupt portfolio companies in which the funds invested. The Palladium court found the PBGC Appeals Board's reasoning "persuasive" and described it as being "faithful to the general rule that no matter how large an investor's portfolio or how much managerial attention an investor pays to his investments, investing alone does not constitute a 'trade or business.'" The Palladium court described the standard coined by the Appeals Board as an "investment plus" standard. In applying this standard to the facts at hand, the Palladium court found that the private equity funds' activities might support a conclusion that the "investment plus" standard had been met. However, due to unresolved factual matters, the Palladium court did not reach a conclusion on the question.

3 Other liabilities or actions determined on a controlled group basis include liability under transactions in which a principal purpose of the transaction is to evade liability for unfunded pension benefits where the plan terminates within five years of the transaction (determined on the date of plan termination), liability for PBGC premiums, and the ability of a portfolio company to terminate an underfunded pension plan.

4 480 U.S. 23 (1987).

5 Higgins v. Commissioner, 312 U.S. 212 (1941) and Whipple v. Commissioner, 373 U.S. 193 (1963).

6 Zink v. United States, 929 F.2d 1015 (5th Cir. 1991).

7 29 U.S.C. §1392(c).

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