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Friday, November 9, 2012

Did the PBGC Egregiously Aggregate? - Yes, Says a U.S. District Court

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Private-equity and similar funds sometimes invest in portfolio companies that may have significant liabilities under ERISA and the corresponding provisions of the Internal Revenue Code.  A lurking question that has persisted is whether, if a fund's ownership interest exceeds certain percentage thresholds, the fund and its portfolio companies are aggregated under the so-called "controlled group" rules as a single employer. The implications can extend to other matters, such as nondiscrimination testing and COBRA responsibility.

For many noncorporate funds, the analysis can turn in part on the critical threshold question of whether a particular investment fund is a "trade or business" for these purposes.  If not, it may be the case that aggregation is not required, regardless of the extent of the fund's ownership of its portfolio companies.

This question has attracted some particular attention in recent years, with the release of a Sept. 26, 2007, letter from the PBGC.  The PBGC letter holds that the private equity fund there at issue was a "trade or business," and that certain of its subsidiaries were considered, together with the fund, to be a single employer under ERISA. 

Arguably, the PBGC had taken a result-oriented approach and, in particular, does not seem to have coordinated in the preparation of the 2007 letter with the experts at the IRS/Treasury as to tax analysis that lies at the very heart of the issue.  Nevertheless, as one might expect when a governmental agency speaks, the PBGC letter has caused consternation in the market, despite its arguably dubious reasoning.  See generally Oringer, "Investment Funds and ERISA Controlled Groups - Egregious Aggregation?" 35 Pens. & Bens. Rep. (BNA) 1929 (2008); Moulder, "Controlled Group Liability: The Private Equity Fund's Side of the Story," 16 J. of Deferred Comp. 19 (2011).

A recent decision by a Massachusetts federal district court in the case of Sun Capital Partners III v. N.E. Teamsters and Trucking Industry Pension Fund, Civ. Action No. 10-10921-DPW (D. Mass. Oct. 18, 2012), directly addresses the PBGC's 2007 letter.  The court decision in the Sun Capital Partners case is an important one, as it is the first one to reject the letter after detailed analysis, and may have extensive ramifications for investment funds and, in particular, private equity funds. 

The court addressed, as a threshold matter, whether it should defer to any extent to the PBGC opinion.  The Sun Capital Partners decision states: "I find the [PBGC] Appeals Board opinion unpersuasive.  First, it misunderstood the law of agency in determining whether the private equity firm in that case was a 'trade or business' for purposes of the statute.  Second, it misread Supreme Court precedent [relevant to the 'trade or business' question]."

Next, the court, "[u]ndistracted by an errant agency decision, . . . turn[ed] . . . to consideration of whether the Sun Funds were engaged in a 'trade or business' under governing law.". As to that critical issue, the court stated: "Even taken in the light most favorable to the Pension Fund, the record establishes that the Sun Funds are not a 'trade or business.'  The Sun Funds do not have any employees, own any office space, or make or sell any goods.". After going through further analysis of the Funds' characteristics and activities, the court added: "Because I find that neither of the Sun Funds is a 'trade or business,' I do not reach, nor do I decide, the issue of 'common control.'" 

Not only does the Sun Capital Partners decision squarely reject the PBGC letter, but it uses striking language in doing so: "unpersuasive," "it misunderstood the law," "it misread Supreme Court precedent," "an errant agency decision."  Maybe, at the end of the day, another decisionmaker will give the PBGC letter more credence.  But, at least for now, Sun Capital Partners shows that governmental agencies do not necessarily operate unassailably in an insular bubble.  The effect on the market, even of "errant" pronouncements, can be palpable; at a minimum, if there are issues that call for experts in other areas to be consulted, then arguably such consultation should be pursued, notwithstanding that the agency's desired answer may, after due consideration, ultimately be elusive. 

The court's carefully reasoned decision in the Sun Capital Partners case is a welcome addition to the authority regarding the question of whether investment funds may be aggregated with their portfolio companies for purposes of the controlled-group rules.  While the final words on the matter may well not yet have been written, Sun Capital Partners may at a minimum cause the PBGC's 2007 letter to be viewed by the market with an increasingly jaundiced eye.

 

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