PBGC’s position that a private equity fund is a “trade or business” fails its first court test. A 2007 PBGC Appeals Board decision held that a fund that owned 96.3% of the stock of the sponsor of a terminated pension plan was a “trade or business.” As a consequence, it was jointly and severally liable with its subsidiary, the plan sponsor, for the plan’s unfunded benefits following a distress termination.
The fund argued, to no avail, that it was –
not conducting a “trade or business.” The Fund is a passive investment vehicle that has no employees, no involvement in the day-to-day operations of its portfolio investments and no income other than passive investment income such as dividends, interest and capital gains. The Fund cannot be a trade or business because, as the Supreme Court has clearly held, “investing is not a trade or business.”
The PBGC Appeals Board asserted that the fund did much more than passively invest. It “was formed to select, acquire, dispose of, and manage investments (trades or businesses) on behalf of its partners” and “could exercise control over [the acquired company’s] management.” Cases in which investment was held not to be a trade or business were distinguished on the ground that they involved the intermittent activity of individuals. The fund operated on a much larger scale and amply compensated its general partner for what the Board characterized as investment advisory services.
The 2007 decision didn’t lead to further litigation, but the same issue arose in Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, 2012 U.S. Dist. LEXIS 150018 (D. Mass., Oct. 18, 2012). The context was different, but the question in dispute was identical. In considering it, the court found much to fault in the PBGC’s reasoning.
The case stemmed from the acquisition by two Sun Capital limited partnerships of Sun Scott Brass, a maker of brass and copper coil. About two years after being acquired, the company went into bankruptcy and withdrew from the New England Teamsters Pension Fund, owing $4.5 million in employer withdrawal liability. Relying on the PBGC Appeals Board’s definition of “trade or business,” the Pension Fund assessed liability against the Sun Capital partnerships, which together owned 100% of the employer.
The court looked to three Supreme Court decisions that together impart a meaning to the term “trade or business”: Higgins v. Commissioner, 312 U.S. 212 (1941), Whipple v. Commissioner, 373 U.S. 193 (1963) and Commissioner v. Groetzinger, 480 U.S. 23 (1987). The Appeals Board had plucked from the last a two part test: “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and . . . the taxpayer's primary purpose for engaging in the activity must be for income or profit.” In doing so, it gave no weight to the earlier decisions, which, unlike Groetzinger (where the taxpayer argued that his trade or business was gambling), specifically dealt with the status of investment activity. The Sun Capital court swept aside the Appeals Board’s attempts to distinguish those cases. In refutation, it quoted the Supreme Court’s firm statement in Whipple:
Devoting one’s time and energies to the affairs of a corporation is not of itself, and without more, a trade or business of the person so engaged. Though such activities may produce income, profit or gain in the form of dividends or enhancement in the value of an investment, this return is distinctive to the process of investing and is generated by the successful operation of the corporation’s business as distinguished from the trade or business of the taxpayer himself.
The Sun Capital partnerships, the court stressed, did nothing but invest and exercise the powers of shareholders, and they had no income except the return on their investments. Their general partner, it is true, was compensated for investment advisory services, but that income derived from the general partner’s own separate business, which could not be attributed to the partnerships that it managed.
A single district court decision does not, of course, constitute unchallengeable authority, especially since the PBGC wasn’t a party or even an amicus. Nonetheless, the court’s reasoning seems very solid.
As a cautionary note, the court decided at an earlier stage of the proceedings that the question of whether the partnerships were trades or businesses did not have to be submitted to arbitration, which is the normal avenue for resolving withdrawal liability disputes. It is possible that an appellate court will decide otherwise and that the district court’s decision will be vacated for that reason.
Addendum: The case has another interesting aspect. The two partnerships had taken 70% and 30% interests respectively in Sun Scott Brass. They had several reasons for that allocation, but one (explicitly documented) was to avoid the risk of liability if the acquired company should later withdraw from the multiemployer plans to which it contributed. Even if the partnerships were trades or businesses, the 70/30 ownership split would have kept either of them from forming a parent-subsidiary controlled group with Sun Scott Brass.
The Pension Fund contended that this decision was a transaction that had as a principal purpose evading or avoiding withdrawal liability and therefore should be disregarded under ERISA, §4212(c). The court considered this argument as an alternative to its holding on the “trade or business” issue.
While the partnerships advanced a number of reasons why withdrawal liability considerations were a secondary concern in planning the acquisition, the court based its decision on a more fundamental ground: Great judicial creativity would be need to conclude that the transactions in question could be “disregarded” by restructuring them as a 100% purchase by one partnership. A different situation would have existed, of course, if a 100% owner had sold 30% of the company to someone else in an attempt to circumvent withdrawal liability. That maneuver might fall within the ambit of §4212(c), but parties buying an employer are not in the first instance obligated to maximize their exposure.