Sixth Circuit Finds Family Trust, Successors Liable for Pensions

On September 4, 2018, the Sixth Circuit issued an opinion in Pension Benefit Guaranty Corporation v. Findlay Industries, Inc. et al., No. 17-3520 (6th Cir. Sept. 4, 2018), holding that a family trust that owned and leased land to a commonly-controlled plan sponsor is a “trade or business” under ERISA for controlled group liability purposes.  The court also held that the federal common law of successor liability should be applied to determine whether the transferees of the plan sponsor’s assets should be liable for the sponsor’s underfunded pension plan liability. In so doing, the court elevated substance over form, and arguably expanded the multiemployer plan case law in its sister circuits to single employer plans.

Background

Findlay Industries, Inc. (“Findlay”) was an automotive parts producer that sponsored a single employer defined benefit pension plan from 1964 to 2009, when the company went out of business.  In 1986, Findlay transferred two pieces of property to Findlay’s founder and owner, Philip D. Gardner (“Philip”), who in turn transferred the property to an irrevocable trust (“Trust”) set up to provide for Philip’s sisters for the remainder of their lives, and thereafter to be distributed to Philip’s two sons, Philip J. Gardner and Michael Gardner (“Michael”).  The Trust leased the properties back to Findlay from at least 1993 until 2009.

In May 2009, F I Asset Acquisition LLC (“F I”), a company formed by Michael, purchased all of Findlay’s valuable equipment, inventory and receivables for $2.2 million in cash and $1.2 million in assumed debt.  Those assets were eventually transferred to two companies owned in part by Michael—Back in Black and September Ends.  Michael was involved in every aspect of the sale and transfer of assets—Michael was Findlay’s CEO and a director until March 2009, owned almost 45% of Findlay’s stock, and was involved in assessing another offer to purchase the company in 2008 before he made the offer through F I to purchase Findlay in 2009.  Back in Black and September Ends operated out of two former Findlay plants, rehired many of Findlay’s employees, and served Findlay’s largest customer.

Because the sale of Findlay’s assets to F I did not include assumption by F I of Findlay’s underfunded pension plan and Findlay could not meet its pension obligations, PBGC trusteed the plan, which gave rise to joint-and-several liability of Findlay and its controlled group at the time of plan termination in the amount of $30 million.  Under ERISA, an entity is in a plan sponsor’s controlled group if it a “trade or business” under common control with the sponsor.

District Court Litigation

In 2015, the PBGC sued Findlay, the Trust, Michael, Back in Black and September Ends, among others, to collect on the termination liability.  PBGC alleged the Trust, which was under common control with Findlay, was a “trade or business,” and therefore in Findlay’s controlled group, because it shared a substantial economic nexus with Findlay through the lease to Findlay of the properties.  With respect to Michael, Back in Black and September Ends, PBGC alleged that they are liable under the federal common law of successor liability because they had notice of the pension plan liabilities and Back in Black and September Ends substantially continued Findlay’s operations.

The United States District Court for the Northern District of Ohio sided with the defendants. Pension Benefit Guaranty Corporation v. Findlay Industries, Inc., et al., No. 3:15 CV 1421 (N.D. Ohio filed Jul. 17, 2015).  First, the court agreed with the Trust that the Trust is not a “trade or business” under ERISA.  The court analyzed the literal meaning of the words and determined that the Supreme Court’s test in Commissioner v. Groetzinger, 480 U.S. 23 (1987), which turns on whether an entity regularly engages in an activity primarily for profit or income, governs whether the Trust is a “trade or business,” not the “substantial economic nexus” theory promoted by PBGC.  Under the Groetzinger test, the district court found that the Trust is not a “trade or business” because its primary purpose was to provide for Philip’s family.  The Trust, then, cannot be subject to controlled group liability.

With respect to the successor liability claims against Michael and his companies, the district court declined to apply the federal common law to ERISA’s controlled group liability scheme because (1) ERISA is not silent on successor liability for pension underfunding, (2) there is no “awkward gap” in ERISA with respect to single-employer plans and corporate reorganizations (unlike multiemployer plans), and (3) imposition of successor liability is not essential to carrying out the fundamental policies in ERISA.

PBGC appealed.

Sixth Circuit Reverses

The Sixth Circuit reversed the district court on both fronts.  On the question of whether the Trust is a “trade or business,” the Sixth Circuit rejected the district court’s adoption of the Groetzinger test.  The court reasoned that the Supreme Court’s test in that case was limited to specific sections of the tax code, and the plain meaning of “trade or business” does not support a use of the Groetzinger test, which does not encompass all profit-making entities.  Rather, in light of ERISA’s policy of holding employers and their commonly controlled entities to the promises made to employees, the court adopted the categorical test espoused by its sister circuits[1] in the context of multiemployer plans and by PBGC.  Under the categorical test, any entity that leases property to a commonly controlled entity is a “trade or business” under ERISA.  The court noted that the categorical test prevents companies from fractionalizing their assets to avoid controlled group liability while retaining the full benefit and use of those assets, undermining ERISA’s policies.  Employing the categorical test, the Sixth Circuit held that the Trust is a trade or business jointly-and-severally liable for Findlay’s pension obligations to PBGC.

The Sixth Circuit also reversed the district court on the issue of successor liability, holding that the federal common law should be applied to the case to promote ERISA’s fundamental policy of enforcing employers’ promises to their employees.  The common law of successor liability enforces this policy by favoring substance over form for the purpose of controlled group liability.  Here, the court noted that the sale of Findlay’s assets and eventual transfer to Michael’s companies frustrated ERISA’s purposes by attempting to allow Findlay to break its pension promises and shirk its liability to PBGC while allowing Michael to use Findlay’s assets to continue Findlay’s business and turn a profit.  Such a result would be untenable, said the Sixth Circuit, as it would encourage other companies to similarly evade their pension obligations through creative financial transactions, which would in turn put financial strain on PBGC and other plan sponsors.

Implications of the Sixth Circuit’s Opinion

The Sixth Circuit’s opinion in Findlay arguably provides PBGC with a wider net to cast when seeking to collect on termination liabilities.  Commonly-controlled entities that have any business connection with a plan sponsor must consider the court’s decision favoring substance over form when analyzing potential exposure to pension liability.  And, while the court’s holding with respect to successor liability is limited to transactions not conducted at arm’s length, entities that purchase assets of a company with an underfunded plan should continue to consider whether the transaction carries any risk of liability for the seller’s pension obligations.

[1] The Seventh and Ninth Circuits have held that leasing to a commonly-controlled entity constitutes a “trade or business” under ERISA.