Private Equity Funds: Part of the ERISA Controlled Group?
December 19, 2007
The Appeals Board of the Pension Benefit Guaranty Corporation ("PBGC") recently held that an undisclosed private equity fund was jointly and severally liable for a funding shortfall in a pension plan of one of its portfolio companies. The PBGC's position is that the private equity fund was a "trade or business" and was accordingly a member of the same controlled group as the portfolio company. As far as we know, this is the PBGC's first public statement that takes this approach. While the PBGC's decision applies solely to the private equity fund involved, it could be a bellwether for future action.
All members of a "controlled group" are jointly and severally liable for underfunded defined benefit pension plans sponsored by any member of the controlled group. In general, a parent-subsidiary controlled group is comprised of each "trade or business" in an 80% ownership chain.
Controlled group liability is imposed by statute, and the application of the controlled group rules to a portfolio company and all of its 80%-owned subsidiaries is not controversial. However, prior to publication of this PBGC decision, it was widely believed that private equity funds should typically not be included in the same controlled group as their portfolio companies because a fund typically does not carry on a "trade or business" within the meaning of the Employee Retirement Income Security Act ("ERISA"). Although the PBGC's decision determined only that the particular fund involved was a trade or business, the PBGC's reasoning could extend to other funds.
If the PBGC's position endures, it could have significant ramifications for private equity fund investments in portfolio companies that sponsor defined benefit pension plans. For example, if a portfolio company that is part of the same controlled group as a fund is unable to meet its pension obligations in a bankruptcy, joint and several liability would attach to the entire fund. Thus, the fund could be required to use any or all of its assets, including the ownership interests of the fund in any or all of its portfolio companies, to fund the pension obligations of the bankrupt portfolio company. In addition, portfolio companies could be placed in technical breach of their credit agreements because credit agreement provisions prohibiting pension plan underfunding typically apply to all members of a controlled group.
Our private equity fund clients should consider the implications of the PBGC's position for the operation and structure of any portfolio companies that sponsor defined benefit pension plans. It may be possible to structure transactions in ways that reduce or eliminate the possibility that a private equity fund sponsor would be considered part of the same controlled group as its portfolio companies even if the fund is viewed as a "trade or business." This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Bruce Goldberger, an O'Melveny counsel licensed to practice law in New York, and Wayne Jacobsen, Linda Griffey and Jeff Walbridge, O'Melveny partners licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.