Sun Capital Decision Threatens Lenders With Controlled Group Liability

Lenders need to be alert to circumstances that may give rise to potential controlled group claims, which have been brought both by multiemployer pension plans and by the Pension Benefit Guaranty Corporation.

In 2013, the First Circuit Court of Appeals 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.1 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.

Earlier this year, Sun Capital was cited by a multiemployer plan seeking to hold a lender jointly and severally liable for the employer's withdrawal liability as a member of the employer's controlled group.2 Lenders need to be alert to circumstances that may give rise to such potential controlled group claims, which have been brought both by multiemployer pension plans and by the Pension Benefit Guaranty Corporation.

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 qualified retirement plans, the minimum coverage and nondiscrimination requirements are determined on a controlled group basis and the members of a controlled group may be liable for penalties imposed on any group member for its failure to meet minimum funding obligations. For nonqualified deferred compensation plans, distributions may be made only upon certain specified events, including a "separation from service." Under the rules, a separation from service occurs where a participant terminates employment with the employer and all members of the employer's controlled group. Failure to properly identify the controlled group members, and as a result, failure to follow the deferred compensation rules may result in immediate taxation of the deferred compensation amount, as well as a 20 percent excise tax imposed upon the participant.

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 Internal Revenue Code ("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...