My partner Michael Falk pointed out to me that a federal appellate court decision in late July might have significant impact on certain executive compensation issues. Professionals working in the private equity and/or qualified retirement plan areas have been abuzz about Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund, 56 EBC 1139 (1st Cir. 2013), which increased the potential liability of private equity investors for the unfunded pension liabilities of their portfolio companies. However, this decision has tax and securities law implication in the executive compensation area as well.

An important issue throughout executive compensation and benefit plans is the concept of a "controlled group." The tax code provides that, for certain purposes, a family of related entities (such as parent and subsidiaries) will be treated as a single employer. The controlled group rules arise in many compensation areas, including:

  • Section 409A looks to an entire controlled group for several purposes, most notably to determine when a participant has had a "separation from service."
  • The deduction limitations under Section 162(m)(6) apply to all members of any controlled group that includes a "covered health insurance provider."
  • Members of a controlled group share joint and several liability for pension plans subject to Title IV of ERISA (defined benefit and multiemployer union plans).
  • Nondiscrimination testing for qualified retirement plans is typically performed based on employee participation throughout the controlled group.
  • Current taxation of PE funds is based on fact that they are mere passive investors in their portfolio companies not a trade or business. The Sun Capital case endangers the way PE fund executives are taxed.

The First Circuit's decision in the Sun Capital case arguably expanded the definition of a "controlled group" for Internal Revenue Code and ERISA purposes, holding that a private equity fund was engaged in a "trade or business" with respect to its investment and management activity in its portfolio companies. You can read Michael Falk's summary of the case here. Based on this ruling, a private equity fund may be held liable for the pension obligations of a portfolio company that went bankrupt and withdrew from a union pension plan. The decision was not a complete surprise as the PBGC had issued a dubious opinion on the matter several years ago and other courts had hinted at it. 

If you work for a private equity firm or your company is owned by a private equity fund (or may be in the near future), you will want to consider how the developing controlled group analysis may affect your executive compensation and broad-based benefit plans.