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Friday, November 9, 2012
by Andrew L. Oringer
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
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
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
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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