All in the Family Brother-Sister Corporate Controlled Groups and Pension Liability

All in the Family Brother-Sister Corporate Controlled Groups and Pension Liability

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The recent agreement between UAL Corp. (UAL) and the Pension Benefit Guaranty Corp. (PBGC) to terminate United Airline's defined benefit pension plans2 has demonstrated the great expense that such plans pose to troubled companies, as well as the benefit that plan termination can bring to a troubled company's reorganization. The decision to terminate a defined benefit plan can have unintended consequences, however, if the troubled company's owners also own other solvent enterprises. This common ownership may constitute a "controlled group" under the Employee Retirement Income Security Act of 1974 (ERISA) and render the healthy, solvent corporation statutorily liable for the troubled company's plan termination liability. Most corporate and restructuring counsel are familiar with parent-subsidiary controlled group liability under ERISA. However, many counsel may be surprised to find that another familial relationship may give rise to controlled group liability under ERISA. In the eyes of ERISA, benefit plan liability lies all in the family, and brother-and-sister corporations (in addition to parent-and-subsidiary corporations) must all bear the burden of their wayward sibling.

The Hypothetical

Midwest Foundry Inc. (Midwest) operates a foundry in a small Midwestern town. It has operated since the early 1920s and has a long, proud history. Midwest's early successes have allowed its shareholders, John Doe (45 percent), Jack Doe (10 percent), Jane Roe (35 percent) and Jim Poe (10 percent) to earn substantial income over the course of these years. The owners, as part of the unionization of the industry, implement a generous defined benefit plan for Midwest employees. Midwest employees are extremely productive due in large part to the benefit plan, and Midwest thrives despite the financial difficulties of other foundries and a generally depressed industry.

John and Jane, facing a difficult stock market and low interest rates, decide to invest some of their savings in Atlantic Coast Manufacturing Corp. (Atlantic), a manufacturing plant on the east coast owned by golfing buddies Dan Smith and Danielle Smythe. John and Jane invest enough funds in Atlantic such that John now owns 15 percent of Atlantic's stock and Jane 65 percent. Dan still maintains a 5 percent interest in Atlantic, while Danielle retains 15 percent of Atlantic's shares. Atlantic, like Midwest, has a defined benefit plan for its employees. Although Atlantic's employees maintain respectable productivity levels, Atlantic's management is not as adept as Midwest's. Atlantic is unable to distinguish itself from other manufacturers with regard to price and goods, and begins to experience significant financial distress.

In order to meet operational capital requirements, Atlantic's management began to defer, and ultimately miss, making its minimum funding payments to the defined benefit plan, resulting in a minimum funding shortfall of $3 million. Atlantic's management informs its board of directors of the company's inability to pay its debts as they become due. The board votes to file a chapter 11 bankruptcy, which ultimately fails and leads to the termination of Atlantic's defined benefit plan.

As a result of Atlantic's failed chapter 11, is Midwest liable for Atlantic's underfunding of, and possibly the more substantial termination liability for, its defined benefit plan under ERISA? The answer is yes.

Controlled Groups Under ERISA

ERISA borrows its definition of corporate "controlled group" from Internal Revenue Code (IRC) §§414(b) and 1563.3 A parent-subsidiary corporate controlled group exists when one business owns at least 80 percent of one or more other businesses. See IRC §414. A brother-sister corporate controlled group is created if five or fewer common owners who are individuals, trusts or estates satisfy (1) an 80 percent common ownership test and (2) a 50 percent identical ownership test. See IRC §414; see, also, Central States, SE and SW Areas Pension Fund v. White, 258 F.3d 636, 641 n.4 (7th Cir. 2001). Neither Midwest nor Atlantic have any ownership interest in the other corporation, removing any basis for parent-subsidiary corporate controlled group liability under ERISA.

Midwest and Atlantic do, however, meet the requirements for brother-sister corporate controlled group liability.4 First, we must look at the combined ownership percentages of the common owners of Midwest and Atlantic: Jack and Jane. Jack and Jane's combined ownership interests in Midwest are 80 percent (45 + 35 percent). They also combine to hold an 80 percent ownership interest in Atlantic (15 + 65 percent). Accordingly, the 80 percent common ownership requirement of IRC §414 is met.

Application of the 50 percent identical-ownership test requires us to consider the identical owner's lowest ownership interest in the brother and sister corporation. Here, Jack's lowest ownership interest is his 15 percent stake in Atlantic, whereas Jane's least ownership interest is in Midwest and stands at 35 percent. Because the sum of Jack and Jane's identical ownership interests in Midwest and Atlantic equal 50 percent (15 + 35 percent), Midwest and Atlantic constitute a brother-sister corporate controlled group under the IRC, and in turn, ERISA.

Controlled Group Liability Under ERISA

ERISA was created to "ensure that employees and their beneficiaries would not be completely deprived of anticipated retirement benefits by the termination of pension plans before sufficient funds have been accumulated in the plans. Allied Pilots Ass'n. v. Pension Benefit Guar. Corp., 334 F.3d 93, 98 (D.C. Cir. 2003) (citing Pension Benefit Guar. Corp. v. LTV Corp., 496 U.S. 633, 637 (1990)). To that end, ERISA provides that when a single-employer plan is terminated either in a distressed termination instituted by the PBGC or a termination instituted by a corporation, any person who is, on the termination date, a contributing sponsor of the plan or a member of the contributing sponsor's controlled group shall incur liability under this section. 29 U.S.C. §1362(a) (emphasis added); see, also, Pension Benefit Guar. Corp. v. Beverly, 404 F.3d 243, 247 n.6 (4th Cir. 2005). This liability is joint and several, and is owed both to the plan trustee and to the PBGC. Id. The amount of liability is the total amount of unfunded benefit liabilities as of the date of termination, plus interest. 29 U.S.C. §1362(b); Beverly, 404 F.3d at 247 n.7.5

Applying 29 U.S.C. §1362 to our hypothetical, Midwest, a healthy, solvent company with no interaction or relation with Atlantic other than common ownership by Jack and Jane, now faces a $3 million pension liability, with interest. If Atlantic's plan is terminated or remains underfunded, it is only a matter of time before the PBGC, either in its corporate capacity or as an appointed trustee of Atlantic's defined benefit plan, will seek to collect this large sum from Midwest. See Beverly, 404 F.3d at 247-48. In addition, as Atlantic is liquidating its assets for the benefit of all its creditors, Midwest will likely have little or no contribution from Atlantic's estate. If Midwest happens to have hoarded a large amount of cash, this ERISA liability will not devastate the company; however, few companies in depressed industries can boast such cash reserves. How, then, is Midwest to cope with this unexpected pension liability? File for bankruptcy? Liquidate its assets out of court? These may help, but it is important to note that a sale of the liable company does not remove pension liability. See 29 U.S.C. §1392(c). In addition, a corporation must be cautious in choosing the steps it takes to limit its pension liability as ERISA imposes liability on a company if it enters into a transaction the principal purpose of which is to evade pension liability. 29 U.S.C. §1369(a).

One possible solution lies at the feet of the very entity that threatens Midwest's corporate welfare: the PBGC. The PBGC has statutory authority to make arrangements with plan sponsors and controlled group members who are or may become liable under ERISA for payment of their liability. 29 U.S.C. §1367, see, also, Allied Pilots Ass'n., 334 F.3d at 98.

Two of the most public arrangements entered into by the PBGC involve airlines. In 1992, the PBGC entered into an arrangement with Carl Icahn and his entities regarding Icahn's potential liability for Trans World Airline's (TWA) pension fund liability. See Allied Pilots Ass'n., 334 F.3d at 96, and Adams v. Pension Benefit Guar. Corp., 332 F. Supp. 2d 231, 232 (D. D.C. 2004). Essentially, the arrangement can be summarized as follows: (1) Icahn, through his entities, would sponsor the TWA pension fund; (2) Icahn, through his entities, would loan TWA $200 million; (3) TWA, in turn, would issue $300 million in notes to make part of its annual pension fund contributions; and (4) in return for the obligations undertaken above, the PBGC would agree not to terminate TWA's plans except in certain circumstances, including at Icahn's request. Id. If the TWA plan was terminated, Icahn's plan liability would be limited to $240 million rather than the actual plan shortfall of approximately $445 million. Id. TWA's plans were ultimately terminated in January 2001, and the Icahn/TWA/PBGC arrangement was upheld as a valid exercise of the PBGC's authority under 29 U.S.C. §1367. Allied Pilots Ass'n., 334 F.3d at 98-99.

More recently, UAL and the PBGC entered into an arrangement whereby the PBGC allowed UAL to terminate four of its pension plans, which were underfunded by approximately $10 billion. Field, David, "Pensions Battleground," Airline Bus. (June 1, 2005). The PBGC will guaranty approximately $6.6 billion of the underfunded benefits. Id. In return, UAL will provide $500 million in 6 percent senior subordinated notes, $500 million in 8 percent contingent senior subordinated notes and $500 million of 2 percent convertible preferred stock in the reorganized UAL. In re UAL Corp., et al., No. 02B48191, 2005 WL 1154264 at *4. The arrangement was approved by the bankruptcy court, although an appeal is pending and the U.S. House of Representatives has taken steps to try to block the PBGC from being able to fund the UAL agreement.

Analysis

Brother-sister corporate controlled group liability under ERISA poses a huge and often unanticipated liability to companies under common ownership. However, it is not limited to just companies; formal and informal partnerships may also give rise to controlled group liability. For example, the Fourth Circuit Court of Appeals found that a husband and wife, acting as a partnership in leasing real estate to Don's Trucking and other entities, were personally liable for Don's Trucking's $358,000 pension liability under ERISA because Don's Trucking and the partnership constituted a controlled group. Beverly, 404 F.3d at 252-53. Another telling example of the potential reach of ERISA can be seen in the fallout from a company's withdrawal from a multiemployer plan. There, a husband/company owner and his wife narrowly averted $16 million in pension liability for the company's terminated multiemployer pension plan when the Seventh Circuit reversed a lower court finding that the couple's renting of apartments over their garage constituted a trade or business, thereby triggering controlled group liability under the Multiemployer Pension Plan Amendment Act amendments to ERISA. See White, 258 F.3d at 645.

How can counsel advise a corporation that falls under the brother-sister controlled group requirements of ERISA as to limiting potential pension liability for its brothers and sisters? At best, the only advice is to seek a practicable solution. This practicable solution is to negotiate with the PBGC an arrangement that will satisfy the PBGC by not terminating the plan while at the same time preserving the solvent corporation from liquidation. As noted by the executive director of the PBGC in the UAL plan termination, sometimes an arrangement is in the best interests of the PBGC and its stakeholders, even if it does not result in full funding. The PBGC is under an obligation to reduce its losses, and it may receive more through an agreed funding arrangement than it would as an unsecured creditor in bankruptcy. Field, David, "Pensions Battleground," Airline Bus. (June 1, 2005). Something may be better than nothing, and the PBGC has a duty to protect the solvent corporation's employees' benefit plan as well while limiting its already overburdened finances.


Footnotes

1 This article is not an exhaustive discussion of potential pension liability under ERISA (defined below) and is meant only to highlight one potential pension liability to corporate and restructuring counsel. Counsel should consult with an attorney specializing in ERISA for a more definitive discussion about pension liability under ERISA. Return to article

2 See In re UAL Corp., et al., No. 02B48191, 2005 WL 1154264 (Bankr. N.D. Ill. May 11, 2005). Return to article

3 Control group requirements for noncorporate organizations are provided by IRC §414(c) and Treas. Reg. §1.414(c). Return to article

4 The hypothetical assumes that Jack and Jane are related but not husband and wife, avoiding the application of IRC §1563's attribution rules. Counsel should also be aware of ERISA's adoption of other attribution rules, including parent-child, corporation-shareholder and partnership-partner. See Treas. Reg. §1-414(c). Furthermore, the hypothetical assumes that the voting power and value of ABC and XYZ shares are equal. Return to article

5 Although beyond the scope of this article, corporate and restructuring counsel should note that in addition to monetary liability, ERISA imposes many reporting requirements. Return to article

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Friday, July 1, 2005