Only “trades or business” under common control are treated as part of an ERISA controlled group. Neither ERISA nor the Treasury regulations define “trade or business.” Courts have generally adopted the standard articulated in Commissioner v. Groetzinger, where the Supreme Court held that in the context of IRC § 162: “to be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. Sporadic activity, a hobby, or an amusement diversion does not qualify.” 480 U.S. 23, 35, 107 S.Ct. 980, 987, 94 L.Ed.2d 25 (1987).
With regard to private equity funds many practitioners have taken the view that since they are passive investment vehicles with no employees and no involvement in day-to-day operations, they are not trades or businesses, and the portfolio companies owned by a private equity fund would not be in the same ERISA controlled group. However, a 2007 PBGC Appeals Board ruling held that a private equity fund was a trade or business, because it was engaged in an activity with the primary purpose of income or profit and conducted business through an agent (the general partner) who managed fund investments on a regular basis. PBGC Appeals Board Opinion dated
Sept. 26, 2007, http://www.pbgc.gov/prac/appeals-board/appeals-decisions.html (a private equity fund
is a “trade or business” under the standard set forth in Comm’r v. Goetzinger,
480 U.S. 23 (1987) that “trade or business” depends on (i) whether the taxpayer
is engaged in an activity with the primary purpose of income or profit, and
(ii) whether the act is conducted with continuity and regularity; in the fact of
the letter that the private equity fund engaged in an activity with the primary
purpose of income or profit and it conducted its business through an agent who
managed the fund’s investments on a regular basis; the private equity fund was
therefore in the same controlled group as its bankrupt portfolio company that
sponsored a pension plan). According to this ruling, 80%-owned portfolio
companies of a private equity fund may be in the same ERISA controlled
group. In the rare case that the facts
and circumstances indicate that the private equity fund does not meet the
Groetzinger standard, it would not be part of the controlled group. (See ABA JCEB Q & As for PBGC (May 2008), Q
& A 11, that in unusual circumstances that the fund is not a trade or
business, it would not be in the controlled group.)
A 2010 district court in the Sixth Circuit found the 2007 PBGC Appeals Board Opinion to be persuasive. Board of Trustees, Sheet Metal Workers National Pension Fund v. Palladium Equity Partners, LLC, 722 F. Supp. 2d 854 (E.D. Mich. 2010) (genuine issue of material fact existed as to whether three Palladium limited partnerships and Palladium Equity Partners, LLC which served as advisor (the Palladium funds) were an ERISA controlled group parent liable for ERISA multiemployer withdrawal liability of the Haden group of companies: court found 2007 PBGC Appeals Board Opinion to be persuasive that although investment alone is not a trade or business, "investment plus" where there is investment advisory and management services by the fund for the benefit of its partners and there is compensation for the investment advisory and management services would constitute a trade or business; court found there was a genuine issue of material fact as to whether the Palladium funds had a business purpose other than merely investment; the Palladium funds joined their investments to exert power over financial and managerial activities of the portfolio companies, selected five of the seven board members and set up several committees to control the internal operations of the portfolio companies; there was also general issue of material fact regarding alter-ego liability).
Likewise, a 2012 First Circuit case overturned the district court and found the PBGC Appeals Board Opinion to be persuasive. Sun Capital Partners III, L.P. v. New England Teamsters and Trucking Industry Pension Fund, __ F.3d. __, 2013 WL 3814984 (1st. Cir. July 24, 2013) (two private equity funds managed by Sun Capital owned 70% and 30% of Scott Brass, Inc. which withdrew from a multiemployer pension plan prior to filing for bankruptcy; the district court at 903 F.Supp.2d 107 (D. Mass. 2012), had granted the Sun Capital Partners equity funds motion to dismiss since the private equity funds were passive investors and not a trade or business and the 2007 PBGC Appeals Board Opinion was found by the district court to be unpersuasive because activity of the general partner should not have been attributed to the investment fund and continuity and regularity of an activity should not be found merely based on the size of the investment and profitability; however, the First Circuit overturned the district court ruling regarding the funds being a “trade or business” and held that at least the larger of the two Sun funds was engaged in a trade or business since there was more than mere passive investment, noting that the funds sought out potential portfolio companies that were in need of extensive management intervention, indirect management and consulting fees were provided, the funds had the power to appoint a majority of board members, and the general partners had authority regarding hiring, firing and compensation which could be attributed at least to the larger of the two funds through limited partnership agreements; both the district court and the circuit court found in regard to Sun Capital funds that the purchase of Scott Brass, Inc. in a 70%-30% split was not done with a principal purpose to evade or avoid liability under ERISA § 4212(c), according to the district court because there were legitimate business reasons for the investment ownership in order to decrease investment risk for each fund and according to the First Circuit because disregarding a 70%-30% split would leave zero ownership; the First Circuit remanded the case to the district court to determine if there was common control by the 70%-30% ownership (for example if the joint venture is seen as common ownership)).
Nevertheless, to avoid any doubt it may be advisable to specify in agreements with representations about controlled group members that representations are (or are not) made with regard to private equity investors and other portfolio companies.