aN a.s. pratt & soNs publiCatioN JuNE 2014 › news-resources › ...Brian C. McCormally, Nancy L. Perkins, Kevin Hall, and Tengfei (Harry) Wu supplEmENtary lEVEraGE ratio staNdards:

Editor’s NotE: CoNtrollEd Group liability a risk for lENdErsSteven A. Meyerowitz

Sun Ca pita l dECisioN thrEatENs lENdErs with CoNtrollEd Group liabilityJames P. McElligott Jr., Taylor W. French, and Robert M. Cipolla

thE VolCkEr rulE’s impaCt oN CliENt baNk iNVEstorsJulia D. Corelli and Benjamin Mittman

optioNs uNdEr thE VolCkEr rulE for baNks to spoNsor priVatE Equity aNd hEdGE fuNdsSatish M. Kini and Gregory T. Larkin

fEdEral rEGulators issuE JoiNt GuidaNCE oN CompaNy-ruN strEss tEsts for mid-sizEd baNksBrian C. McCormally, Nancy L. Perkins, Kevin Hall, and Tengfei (Harry) Wu

supplEmENtary lEVEraGE ratio staNdards: aN updatELee A. Meyerson, Maripat Alpuche, Mark Chorazak, and Randy Benjenk

warEhousEmaN’s liENsPhilip Antcliffe

a CritiquE of “NEttiNG,” thE liquidity CoVEraGE ratio aNd thE u.s. fsoC’s NoN-baNk sifi CritEriaMichael Nwogugu

baNkiNG briEfsTerence G. Banich

aN a.s. pratt & soNs publiCatioN JuNE 2014

Editor-iN-ChiEfSteven A. Meyerowitz

President, Meyerowitz Communications Inc.

board of Editors

Paul BarronProfessor of LawTulane Univ. School of Law

George BrandonPartner, Squire, Sanders &

Dempsey LLP

Barkley ClarkPartner, Stinson Morrison Hecker

LLP

John F. DolanProfessor of LawWayne State Univ. Law School

David F. Freeman, Jr.Partner, Arnold & Porter LLP

Thomas J. Hall Partner, Chadbourne & Parke

LLP

Jeremy W. HochbergCounsel, Wilmer Cutler Pickering

Hale and Dorr LLP

Kirk D. JensenPartner, BuckleySandler LLP

Satish M. KiniPartner, Debevoise & Plimpton

LLP

Douglas LandyPartner, Milbank, Tweed, Hadley

& McCloy LLP

Paul L. LeeOf Counsel, Debevoise &

Plimpton LLP

Jonathan R. Macey Professor of Law Yale Law School

Martin MayerThe Brookings Institution

Stephen J. NewmanPartner, Stroock & Stroock &

Lavan LLP

Sarah L. ReidPartner, Kelley Drye & Warren

LLP

Heath P. TarbertPartner, Allen & Overy LLP

Stephen B. Weissman Partner, Rivkin Radler LLP

Elizabeth C. YenPartner, Hudson Cook, LLP

Bankruptcy for BankersHoward SeifePartner, Chadbourne & Parke

LLP

Regional Banking OutlookJames F. BauerleKeevican Weiss Bauerle & Hirsch

LLC

RecapitalizationsChristopher J. ZinskiPartner, Schiff Hardin LLP

Banking BriefsTerence G. BanichMember, Shaw Fishman Glantz

& Towbin LLC

Intellectual PropertyStephen T. SchreinerPartner, Goodwin Procter LLP

The Banking Law JournaL (ISBN 978-0-76987-878-2) (USPS 003-160) is published ten times a year by Matthew Bender & Company, Inc. Periodicals Postage Paid at Washington, D.C., and at additional mailing offices. Copyright 2014 Reed Elsevier Properties SA., used under license by Matthew Bender & Company, Inc. No part of this journal may be reproduced in any form — by microfilm, xerography, or otherwise — or incorporated into any informa-tion retrieval system without the written permission of the copyright owner. For customer support, please contact LexisNexis Matthew Bender, 1275 Broadway, Albany, NY 12204 or e-mail [email protected]. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Mey-erowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, [email protected], 631.331.3908. Material for publication is welcomed — articles, decisions, or other items of interest to bankers, officers of finan-cial institutions, and their attorneys. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affiliated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher.POSTMASTER: Send address changes to The Banking Law JournaL LexisNexis Matthew Bender, 121 Chanlon Road, North Building, New Providence, NJ 07974.

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Published by Matthew Bender & Company, Inc. in the June 2014 issue of The Banking Law Journal. Copyright © 2014 Reed Elsevier Properties SA.

Sun Capital Decision ThreaTens LenDers wiTh conTroLLeD Group LiabiLiTy

JAMES P. McELLIGoTT JR., TAyLoR W. FRENCH, AND RoBERT M. CIPoLLA

Lenders need to be alert to circumstances that may give rise to potential con-trolled 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 pri-vate 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 li-

James P. McElligott Jr., a partner in the Richmond office of McGuireWoods LLP, advises and defends private and publicly held corporations, public agencies, benefit plans and fiduciaries concerning employee benefits, executive com-pensation, and related labor and employment issues. Taylor W. French is a partner in the firm’s Charlotte office whose employee benefits practice cov-ers a wide-range of traditional executive compensation and employee benefits matters along with a variety of inter-disciplinary practice areas and industries that are affected by executive compensation and employee benefits laws. Rob-ert M. Cipolla, senior counsel at the firm, is the leader in its Richmond office of the employee benefit and executive compensation group. The authors can be reached at [email protected], [email protected] and [email protected], respectively.

THE BANKING LAW JouRNAL

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ability 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 ter-minates 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:

Sun CapiTaL DECISIoN THREATENS LENDERS WITH CoNTRoLLED GRouP LIABILITy

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If a non-corporate entity is not a trade or business, it cannot be part of a controlled group, irrespective of its ownership interest. Unfortu-nately, 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 con-trolled 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, but brother-sister controlled groups are also possible.

Sun Capital — iN briEf

Two Sun Capital funds invested in SBI and collectively owned 100 percent of that company. In connection with its bankruptcy, SBI withdrew from the New England Teamsters & Trucking Industry Pension Fund (the “Teamsters Plan”), a multiemployer pension plan. The Teamsters Plan, like many multiem-ployer pension plans, was underfunded and asserted that the two Sun Capital funds were responsible for SBI’s withdrawal liability of over $4.5 million. The Sun Capital funds obtained a declaratory judgment from the U.S. District Court for the District of Massachusetts that they were not “trades or businesses” and therefore could not be grouped with SBI for purposes of withdrawal liability. The First Circuit reversed the district court and applied an “investment plus” standard to determine whether the Sun Capital funds were trades or businesses. The court of appeals concluded that Sun Capital Partners IV “was not merely a ‘passive’ investor, but sufficiently operated, managed and was ad-vantaged by its relationship with its portfolio company ... [and] that further factual development is necessary as to [Sun Capital Partners III].” The First Circuit did refuse to find that the 70 percent/30 percent ownership structure between the two Sun Capital funds was a transaction designed to “evade or


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avoid” withdrawal liability in violation of ERISA, a ruling that gives some comfort to private equity funds. The court of appeals remanded the case to the district court to determine whether the requisite ownership existed between the Sun Capital funds and SBI to establish joint-and-several liability among the three entities. The Su-preme Court has denied certiorari. Factual issues related to “trade or business” status and “common control” are being litigated in the district court. Given the fact-specific nature of these issues, the district court may be inclined to find that disputed issues of fact prevent summary judgment and require trial on the merits. Because of such disputed factual issues, the district court in Board of Trustees, Sheet Metal Workers’ National Pension Fund v. Palladium Equity Partners, LLC,3 denied the summary judgment motion of a private equity firm that also disputed controlled group withdrawal liability as owners of a bankrupt company. That case settled before trial.

Hotel 71 Mezz rEJECts Claim that lENdEr is “ tradE or busiNEss” liablE for withdrawal liability

In Hotel 71 Mezz Lender LLC v. Nat’l Ret. Fund,4 a mezzanine lender became the target of a multiemployer plan’s withdrawal liability claim when the lender acquired its bankrupt hotel borrower to protect its loan. The multiemployer plan alleged that the lender was a member of the hotel em-ployer/borrower’s controlled group, because the lender was a trade or business with a controlling interest in the hotel, citing the First Circuit’s decision in Sun Capital. The district court found that Hotel 71 Mezz Lender was in common control with the hotel because it acquired a 100 percent ownership interest in the hotel through a Uniform Commercial Code foreclosure sale in an effort to collect on its loan. The court found, however, that the lender’s ownership was only a “passive investment” insufficient to establish the hotel lender as a trade or business in the hotel’s controlled group:

[A] passive investment is insufficient to establish that an entity is a trade or business. The Seventh Circuit has held that creating a formal business en-


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tity, having employees, and claiming business exemptions and deductions, indicates the existence of a trade or business…. But personal investments, such as stocks, commodities, leases, or something else, without more is the hallmark of an investment.… Despite being formal business entities, the factual record is devoid of any facts indicating that Plaintiffs have a trade or business under the MPPAA. Based on the facts the parties present, the Court can only conclude that the relationship between Hotel 71 Lender and Chicago H&S is one of a “passive investment.” Accordingly, the Court concludes that Hotel 71 Lender is not a trade or business.5

In coming to its decision, the district court relied on the two-part test es-tablished in Comm’r v. Groetzinger,6 which looks at whether the organization has engaged in an activity:

• With continuity and regularity; and

• For the primary purpose of income or profit.

The district court cited activities such as creating a formal business entity, having employees and claiming business exemptions and deductions as indi-cators of the existence of a trade or business. The hotel lender was a formal business entity, but did not possess any of the other facts indicating it was a trade or business. The court did not discuss Sun Capital, limiting its discus-sion to Seventh Circuit precedents. Despite the favorable result for this lender in the district court, appeal to the Seventh Circuit remains a possibility as of this writing. The case il-lustrates the aggressiveness of multiemployer plans in pursuing claims for withdrawal liability against all available deep pockets. The case turned on very specific facts, and a different fact pattern before a different court could lead to a different result.

pbGC Claims that lENdEr had CoNtrollEd Group liability for uNfuNdEd pENsioN bENEfits

In a January 14, 2009 decision of the Pension Benefit Guaranty Corpora-tion (“PBGC”) Appeals Board, the PBGC Appeals Board considered a bank’s


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appeal of a PBGC determination that the bank was jointly and severally liable to PBGC for the unfunded benefit liabilities of its borrower’s pension plan, the Arkansas General Industries, Inc. Hourly-Wage Employees Group Pen-sion Plan.7 The PBGC’s initial determination stated that as of the pension plan’s termination date, the bank was in a controlled group with its borrower. In 1996, the bank became the secured creditor of Arkansas General Industries (“AGI”) by financing AGI’s reorganization in bankruptcy and later entered into an agreement in which AGI pledged its stock to the bank. In 2000, AGI defaulted on its obligations to the bank and AGI’s board of directors (stockholders who had not guaranteed AGI’s debt to the bank) threatened to abandon AGI. The stockholders transferred their stock to the bank in ex-change for a release, and the bank began to investigate the potential sale of AGI in order to preserve its collateral. Soon thereafter, the bank transferred the AGI stock to an entity controlled by its outside attorney, which entity supervised operation of AGI, dealt with creditors and ultimately sold AGI assets in 2003. The pension plan was terminated with an unfunded benefit liability of $738,569, plus interest on the unpaid obligation. PBGC issued an initial determination in 2008 that as of the plan’s termi-nation date, 100% of AGI stock was owned by the bank as beneficial owner. PBGC filed suit to enforce the controlled group liability, and the bank filed an administrative appeal with the PBGC Appeals Board, arguing, among other things, that PBGC had failed to follow controlled group rules under ERISA and the Code. Ultimately the PBGC Appeals Board ruled in favor of the bank, declin-ing to find that a “resulting trust” gave the bank beneficial ownership of the stock. In concluding that the bank was not under common control with AGI, the Appeals Board reasoned that:

• the bank received no consideration for the stock transfer (other than a release from stockholders);

• the evidence indicated that the bank acted to further its interest as a se-cured creditor; and

• the bank did not exercise rights normally incident to stock ownership or receive the benefits or incur the obligations of stock ownership.


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As with Hotel 71 Mezz, the Appeals Board decision in the Arkansas Gen-eral Industries case is very fact specific and offers no assurance that PBGC will not pursue similar claims in the future. Lenders must be aware of controlled group liabilities that can impact their borrowers and of actions that poten-tially make the lenders targets for multiemployer plan withdrawal liability or pension plan liability claims.

pbGC aNd multiEmployEr plaNs arE motiVatEd to assErt CoNtrollEd Group liability Claims

Under the single employer program of Title IV of ERISA, PBGC is liable for the payment of guaranteed benefits with respect to underfunded termi-nated plans and seeks to recover funding shortfalls from the plan sponsor and members of the plan sponsor’s controlled group, as defined by ERISA. Because its estimated liabilities far exceed its assets, PBGC has been on the General Accounting Office’s “High Risk” list of federal agencies for more than ten years.8 Not surprisingly, PBGC has increasingly litigated controlled group claims and filed an amicus brief with the First Circuit in support of the multiemployer plan in Sun Capital. Multiemployer plans assert withdrawal liability claims against a with-drawing employer and its controlled group members. Many plans are badly underfunded, in declining industries that have suffered numerous bankrupt-cies. With a lack of new entrants, an aging workforce and declining union-ization, many plans face future insolvency and mass withdrawals.9 All this motivates these plans to aggressively pursue withdrawal liability claims like those made in Sun Capital and Hotel 71 Mezz. Lenders have also been the target of WARN Act claims from former em-ployees.10

CoNClusioN

Lenders need to understand controlled group liability rules, not only in assessing liabilities faced by borrowers, but also in understanding the circum-stances in which the lender might be alleged to be a controlled group mem-


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ber. Multiemployer plans are particularly aggressive in asserting Sun Capital-type claims, but PBGC will make such claims where circumstances permit in the single employer plan context. Lenders should always be wary of loans to companies that sponsor de-fined benefit pension plans or that contribute to multiemployer plans. The PBGC is generally an unsecured contingent creditor until specific ERISA liabilities trigger PBGC liens, but such liens can hamstring a business and create problems for a lender extending credit through a revolver loan. In cases where a borrower faces unfunded benefit liabilities from either a multiemployer plan or single employer plan, lenders should carefully consid-er their options when exercising their security rights. Lenders should clearly document that their actions are strictly those of a secured creditor seeking only recovery of a debt, not an owner controlling the business and benefiting from the business operations. In short:

• Know the controlled group rules.

• Minimize or avoid management of a borrower’s operations.

• Be careful about communications that indicate involvement in the man-agement of operations.

NotEs1 Sun Capital Partners III, LLP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013), cert. denied, 82 U.S.L.W. 3509 (U.S. Mar. 3, 2014).2 Hotel 71 Mezz Lender LLC v. Nat’l Ret. Fund, No. 13 C 03306, 2014 U.S. Dist. LEXIS 27016 (N.D. Ill. Mar. 3, 2014). 3 722 F.Supp. 2d 845 (E.D. Mich. 2010).4 2014 U.S. Dist. LEXIS 27016 (N.D. Ill. Mar. 3, 2014).5 Hotel 71 Mezz Lender LLC v. Nat’l Ret. Fund, 2014 U.S. Dist. LEXIS 27016, 25-26 (N.D. Ill. Mar. 3, 2014).6 480 U.S. 23 (1987).7 PBGC Case No. 19724100.8 See GAO, High-Risk Series: An Update, GAO-11-278 (Washington, D.C.: February 2011).


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9 “Timely Action Needed to Address Impending Multiemployer Plan Insolvencies,” GAO-13-240: Published: Mar 28, 2013. Publicly Released: Apr 8, 2013.10 See Pearson v. Component Tech. Corp., 247 F.3d 471 (3d Cir. Pa. 2001), cert. denied 534 U.S. 950 (2001)(determining that even if secured lender had technically become the owner and parent of the employer, evidence did not establish the degree of integration required for WARN Act liability under 20 C.F.R. § 639.3(a)(2)).

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aN a.s. pratt & soNs publiCatioN JuNE 2014 › news-resources › ...Brian C. McCormally, Nancy L. Perkins, Kevin Hall, and Tengfei (Harry) Wu supplEmENtary lEVEraGE ratio staNdards: