I blogged last year (here and here) about a couple of decisions in which courts concluded that various related companies were part of a controlled group of trades or businesses and therefore liable for the withdrawal liability of one of the companies. As I mentioned in earlier blogs, the courts have noted that to be a trade or business, the taxpayer’s activities must be different from “investment activities or hobbies.” One of the cases was a district court opinion involving a private equity fund that had made an investment in a company that participated in a multiemployer pension plan. The district court had concluded that the equity fund’s participation in the company was consistent with an investment activity so neither the fund nor other businesses owned by the fund were considered to be trades or businesses that were part of a controlled group and therefore liable for the multiemployer withdrawal liability of the company.

The case was Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund from the District of Massachusetts. That district court decision has now been reversed by the Court of Appeals for the First Circuit.

The First Circuit noted that the equity fund touted its expertise in turning around troubled companies. The First Circuit used an “investment plus” test, determining that activities over and above mere investment would be required to create a trade or business. The appeals court noted that the equity fund became actively involved in the management and operation of the portfolio company. The activities were sufficient to make the equity fund a trade or business. Therefore, it and the withdrawing company, in which it had a greater than 80% ownership interest, were part of a controlled group of trades or businesses.

This decision increases the risk for equity funds that they will be found to be trades or businesses and part of a controlled group with their portfolio companies. If so, it will increase the potential liability to them if they purchase companies with multiemployer plan withdrawal liability.

The implications could also be broader. Although the statute being interpreted was ERISA, the Internal Revenue Code contains a similar controlled group concept that applies to a number of rules under the Internal Revenue Code, including 401(k) and other qualified plan nondiscrimination testing, certain welfare benefit plan testing and certain executive compensation matters. If this interpretation is held to apply under the tax code as well, a private equity fund may need to pay closer attention to the application of the controlled group rules to the employee benefits of the fund itself and all the portfolio companies that it controls.