United States: Employers, Investors and Lenders Need to Understand Controlled-Group Liability

In 2013, the First Circuit sent shockwaves through the private equity industry when it held that two Sun Capital funds were "trades or businesses" under ERISA and potentially part of a controlled group that included Scott Brass, Inc. (SBI), a bankrupt portfolio company owned in part by the funds. Sun Capital Partners III, LLP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013), cert. denied, 82 U.S.L.W. 3509 (U.S. Mar. 3, 2014). The U.S. Supreme Court recently denied the Sun Capital funds' appeal of the First Circuit decision, and the Sun Capital funds are now litigating these controlled-group liability issues in the district court.

Basic Aspects of Controlled-Group Liability

ERISA provides that entities within the same controlled group are jointly and severally liable for the following:

  • Multiemployer plan withdrawal liability
  • Single employer pension underfunding liability;
  • Minimum funding obligations; and
  • Pension Benefit Guaranty Corporation premiums

Additionally, for purposes of the Internal Revenue Code (Code), the minimum coverage and nondiscrimination requirements for qualified retirement plans are tested on a controlled-group basis and the members of a controlled group may be liable for penalties imposed on any group members for its failure to meet minimum funding obligations.

The controlled-group rules are highly technical; however, at their core, the following must exist in order for there to be a controlled group:

  • The members of the controlled group can be individuals (acting as sole proprietors), corporations, estates, trusts, partnerships or limited liability companies. However:
    • If a non-corporate entity is not a trade or business, it cannot be part of a controlled group, irrespective of its ownership interest. Unfortunately, there is no definition of "trade or business" in ERISA or the Code for this purpose.
    • For Code or ERISA purposes, a corporation cannot form a controlled group with a non-corporate entity unless the corporation is a trade or business.
    • For Code purposes, two or more corporations can form a controlled group without all such corporations having to be trades or businesses.
  • There generally must be interlocking ownership between the entities. For example, one entity's ownership of 80 percent or more of another entity can result in a controlled group, but brother-sister controlled groups are also possible.

Sun Capital Partners Case History— In Brief

Two Sun Capital funds invested in SBI and collectively owned 100 percent of that company. In connection with its bankruptcy, SBI withdrew from the New England Teamsters & Trucking Industry Pension Fund (the Teamsters Plan), a multiemployer pension plan. The Teamsters Plan, like many multiemployer pension plans, was underfunded and asserted that the two Sun Capital funds were responsible for SBI's withdrawal liability of over $4.5 million.

The Sun Capital funds obtained a declaratory judgment from the U.S. District Court for the District of Massachusetts that they were not "trades or businesses" and therefore could not be grouped with SBI for purposes of withdrawal liability.

The First Circuit reversed the district court and adopted an "investment plus" standard. The court of appeals concluded that Sun Capital Partners IV "was not merely a 'passive' investor, but sufficiently operated, managed and was advantaged by its relationship with its portfolio company. . . . We also conclude that further factual development is necessary as to [Sun Capital Partners III]." The First Circuit did refuse to find that the 70 percent/30 percent ownership structure was a transaction designed to "evade or avoid" withdrawal liability in violation of ERISA, a ruling that gives some comfort to private equity funds.

The court of appeals remanded the case to the district court to determine whether the requisite ownership existed between the Sun Capital funds and SBI to establish joint-and-several liability among the three entities. See our  prior article for a discussion of the court of appeals decision.

Sun Capital on Remand

The Sun Capital funds have now moved for summary judgment in the district court, arguing that (i) Sun Capital Partners IV did not meet the First Circuit's "investment plus" criteria for "trade or business" status at the time of withdrawal from the multiemployer plan and (ii) the "common control" element of ERISA Section 4001(b)(1) is lacking among the Sun Capital funds, so that their joint ownership of 100 percent of SBI does not establish controlled-group liability. Sun Capital Partners III, LLP, supra, on remand, Case 1:10-cv-10921 (D. Mass). The Sun Capital funds contend that there was no explicit or implicit "Sun Fund III/IV Partnership," and that such an alleged joint venture could be no more than a passive investor.

The Sun Capital funds may find it difficult to prevail on summary judgment, given the detailed fact-specific nature of these issues and the district court's earlier reversal by the court of appeals. The district court may be inclined to find that disputed issues of fact prevent summary judgment and require trial on the merits.

Because of such disputed factual issues, the district court in Board of Trustees, Sheet Metal Workers' National Pension Fund v. Palladium Equity Partners, LLC, 722 F.Supp. 2d 845 (E.D. Mich. 2010) denied the summary judgment motion of a private equity firm that also disputed controlled-group withdrawal liability as owners of a bankrupt company. That case settled before trial.

Lender Defeats Withdrawal Liability Claim

In Hotel 71 Mezz Lender LLC v. Nat'l Ret. Fund, No. 13 C 03306, 2014 U.S. Dist. LEXIS 27016 (N.D. Ill. Mar. 3, 2014), a mezzanine lender that bought the assets of a bankrupt hotel to protect its loan became the target of a multiemployer plan's withdrawal liability claim. The plan alleged that the lender was a trade or business due to its controlling interest in the hotel. The court disagreed and found that its passive investment was insufficient to establish the hotel lender as a trade or business in the hotel's controlled group.

In coming to its decision, the district court relied on the two-part test established in Comm'r v. Groetzinger, 480 U.S. 23 (1987), which looks at whether the organization has engaged in an activity:

  • With continuity and regularity; and
  • For the primary purpose of income or profit.

The district court cited activities such as creating a formal business entity, having employees and claiming business exemptions and deductions as indicators of the existence of a trade or business. The hotel lender was a formal business entity, but did not possess any of the other facts indicating it was a trade or business.

Despite the favorable result for this lender, the case shows the aggressiveness of multiemployer plans in pursuing claims for withdrawal liability. In addition, the case turned on the facts, thereby leaving lenders little comfort that a different court could not come to a different conclusion.

What to Do Now

Private equity funds should carefully consider their ownership structures in light of the Sun Capital litigation. Some may decide to use an investment from a parallel fund or another unrelated minority investor (which could include management rollovers) to reduce the risk of creating a controlled group between a fund and its portfolio companies.

Private equity funds should also take the following actions to help lower their risk:

  • Be wary of investing in companies that sponsor defined benefit pension plans or that contribute to multiemployer plans and perform thorough due diligence.
  • Know the controlled-group rules.
  • Minimize or avoid active management (including hiring or firing employees) of portfolio companies.
  • Be mindful of private placement memoranda that describe extensive involvement in the operation of portfolio companies.
  • Avoid fee-offset arrangements between funds and non-fund entities for management services provided to portfolio companies.

These steps may not be practical for all funds.

Lenders should also be aware of controlled-group liabilities that can impact their borrowers, and potentially make the lenders targets for multiemployer plan withdrawal liability or pension plan liability claims.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions