But the point of this post is not to argue about Sun Capital Partners. Rather, the point here is to address an ancillary point that seems to be creeping into the discourse, at least in part because of the light being shined on aggregation issues by the Sun*** case. In particular, I am starting to hear people express concern that, even if a parent fund is not a ToB, the downstream portfolio companies could be aggregated with each other, if the fund's level of ownership is sufficiently high. I've previously heard this concern from time to time, but Sun seems to be generating renewed heat**** on the point by virtue of raising the aggregation issue generally.
To get to the punch line at the very outset, I think that any concern that downstream companies owned by a non-ToB should be aggregated under 414(c) is borne of a flat-out misreading of the applicable regulations. (The gauntlet is thrown down!) My analysis is as follows -
1. Let's start with the regulatory text itself.
A. The confusion centers in the following passage in the 414(c) regs.:
A. The confusion centers in the following passage in the 414(c) regs.:
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The term "parent-subsidiary group of trades or businesses under common control" means one or more chains of organizations conducting trades or businesses connected through ownership of a controlling interest with a common parent organization if . . . . ******
B. The red herring here is that "common parent organization" as used at the end of the above passage isn’t expressly modified by a ToB qualifier. The concern as I understand it is that the use of the phrase "common parent organization" is not expressly modified by the ToB concept, so that the sentence could supposedly be read to reach "common parent organizations" that are not ToBs. But is there really any legal significance to the lack of such an express qualifier? My answer, as explained below, is a resounding "no". As I will hopefully show, the concern being expressed ignores the derivation of the 414(c) rules, as well as the language that appears earlier in the very sentence under consideration, and is also fundamentally inconsistent the underlying nature and structure of the rules.
2. Let's now examine the derivation of the rules.
A. The 414(c) regulations bring over the language of the 1563 regs. This approach makes sense, of course, in that 414(c) refers to 414(b), which in turn operates by cross-reference to 1563. The gist, or at least a key aspect, of 414(c) is to cause the 1563 aggregation rules to be effective as to entities "whether or not incorporated", so the regs. needed to expand the 1563 rules so as to cover the non-corporate setting.
B. And from where does the language in the 414(c) regulations come? The answer, as one would expect, is that it comes from the 1563 regs. Those regs., at Section 1.1563-1(a)(2)(i), state:
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The term "parent-subsidiary controlled group" means one or more chains of corporations connected through stock ownership with a common parent corporation if . . . . ******
Look familiar? It should. The 414(c) rules parrot the 1563 rules, often in a word-for-word fashion, with modification as relevant here only as needed to adjust for the coverage of non-corporate, as well as corporate, entities.
C. Staying with 1563 for the moment, there is no doubt that, in order to be a 1563 parent-subsidiary group, all of the entities in the putative group need to be entities to which 1563 applies. Thus, the language from the 1563 regs. quoted in "2(B)" above refers to a "common parent corporation". Then, retaining the fundamental structure of the underlying 1563 rules, the drafters of the 414(c) regs. did a cut-and-paste job on the 1563 rules, and gave us the 414(c) rule quoted in "1(A)" above.
3. Let’s go through the transformation step by step, parsing the 414(c) regulatory language and the way it is derived from its 1563 foundation.
A. First, they replaced "parent-subsidiary controlled group" with "parent-subsidiary group of trades or businesses under common control". So far so good.
B. Then they replaced "one or more chains of corporations connected through stock ownership" with "one or more chains of organizations conducting trades or businesses connected through ownership of a controlling interest". Everything still foots. Identical concepts have been brought over, adjusting merely to expand the potential form of relevant ownership from corporate-only (under 1563) to corporate or non-corporate (under 414(c)). No squishiness in the language, yet, and all is still well.
C. Then we come to the next part of the cut-and-paste exercise. They replaced the phrase "with a common parent corporation" with the phrase "with a common parent organization". Ahhh, therein lies the rub. While the use by the 1563 regs. of "common parent corporation" here definitively lays to rest any concern under 1563 that subsidiaries might have to be aggregated even though the common parent is not a 1563-covered entity, the 414(c) regs. were not quite so specifically crafted. In particular, the 414(c) regs. do not expressly append another ToB modifier to the "common parent organization" phrase. But that’s just an accident of the syntax. All of the other linguistic substitutions that were used in porting the 1563 language over to 414(c) neatly self-execute the inclusion of the ToB concept. It’s just that the replacement of "corporation" with "organization" at the final substitution point didn’t happen expressly to subsume the ToB concept. Because of the way the grammar works, additional definitive clarification for the "corporation"/"organization" substitution would have required the further addition of extra words - for example, the addition of "that engages in trade or business activities" after the word "organization". The addition of those seven words would, of course, have even more obviously maintained the parallelism between the two sets of regulatory language; but the fact that the drafter of the 414(c) regulations didn't think to reemphasize the point by including those (or similar) as an additional modifier is not a valid reason to misinterpret the words that were in fact used.
4. So, with that background, let's go back and look at the term that is itself being defined earlier in the very same sentence: "parent-subsidiary group of trades or businesses under common control". Geez, if that’s not a pretty clear indication that the common parent and the subsidiaries both need to be ToBs in order for their to be aggregation, I don’t know what is.
5. At this point, I'd like to consider how the rules work – and should work - as a big-picture matter. Before we all do that thing we so often do and identify words here and there that, when taken out of context, could raise some imagined interpretive issue, can we please made sure that we don't miss the forest for the trees (or, as a mentor used to say, with nary the slightest hint of irony, miss the forest for the bushes)?
4. So, with that background, let's go back and look at the term that is itself being defined earlier in the very same sentence: "parent-subsidiary group of trades or businesses under common control". Geez, if that’s not a pretty clear indication that the common parent and the subsidiaries both need to be ToBs in order for their to be aggregation, I don’t know what is.
5. At this point, I'd like to consider how the rules work – and should work - as a big-picture matter. Before we all do that thing we so often do and identify words here and there that, when taken out of context, could raise some imagined interpretive issue, can we please made sure that we don't miss the forest for the trees (or, as a mentor used to say, with nary the slightest hint of irony, miss the forest for the bushes)?
A. What I’m saying above regarding the 414(c) rules isn't some tricky linguistic game. To the contrary, the result I'm reaching is completely consistent with and even compelled by the basic structure of both the 414(c) and the 1563 rules. Having subsidiaries aggregated under 414(c) where the parent is not a 414(c)-covered entity (i.e., not a ToB) would result in a fundamental structural difference between 1563, which, as noted, clearly and indisputably aggregates subsidiaries of a common parent only when the common parent is also a 1563-covered entity, and 414(c).
B. I think it's important to note that it's not like the rules specifically INclude a non-ToB common parent as a parent that would activate 414(c) parent-subsidiary aggregation. Rather, we've got a 414(c) rule that on its face aggregates parent/subsidiary ToBs, but which doesn't happen expressly to reconfirm a second time that the common parent, like the subsidiary, needs to be a ToB. (Cf. the Verizon case, where an errant cut-and-paste actually did result in a document that on its face provided for the "wrong" result, and my post thereon.) Obviously, if the 414(c) regs. had specifically said that downstream subs. do indeed need to be aggregated even where the common parent is a ToB, this story would quite be a different one. But that's not at all what happened. Here, it's simply that the latter part of the introductory portion of the sentence in question was not as amenable to a straight "trade or business" substitution as was the earlier part, so, unfortunately, the additional ToB language from earlier in the sentence (in the defined term itself) didn’t resurface again at the end of the introductory portion of the sentence. But to take that lack of repetition and use it to turn the whole 414(c) parent-subsidiary rule on its head from the ground up is, to me, a clear over-reading of a simply substituted word - "organization" for "corporation" - especially where, as here, as noted in "4" above, the defined term in question is "parent-subsidiary group of trades or businesses under common control".
B. I think it's important to note that it's not like the rules specifically INclude a non-ToB common parent as a parent that would activate 414(c) parent-subsidiary aggregation. Rather, we've got a 414(c) rule that on its face aggregates parent/subsidiary ToBs, but which doesn't happen expressly to reconfirm a second time that the common parent, like the subsidiary, needs to be a ToB. (Cf. the Verizon case, where an errant cut-and-paste actually did result in a document that on its face provided for the "wrong" result, and my post thereon.) Obviously, if the 414(c) regs. had specifically said that downstream subs. do indeed need to be aggregated even where the common parent is a ToB, this story would quite be a different one. But that's not at all what happened. Here, it's simply that the latter part of the introductory portion of the sentence in question was not as amenable to a straight "trade or business" substitution as was the earlier part, so, unfortunately, the additional ToB language from earlier in the sentence (in the defined term itself) didn’t resurface again at the end of the introductory portion of the sentence. But to take that lack of repetition and use it to turn the whole 414(c) parent-subsidiary rule on its head from the ground up is, to me, a clear over-reading of a simply substituted word - "organization" for "corporation" - especially where, as here, as noted in "4" above, the defined term in question is "parent-subsidiary group of trades or businesses under common control".
C. Indeed, to aggregate the downstream entities under 414(c) notwithstanding that the common parent is not 414(c)-covered would be flatly inconsistent with the remaining structure of the other rules under 414(c). Like the 1563 rules, the 414(c) rules have separate regimes for parent-subsidiary groups and for brother-sister groups. It's in the case of brother-sister groups, and only in the case of brother-sister groups, that 1563 aggregates subsidiaries where the parent is not itself covered by 1563, and the 414(c) rules maintain that fundamental dichotomy. Thus, under the brother-sister rules of 1563 and of 414(c), you get aggregation of downstream companies which are owned by individuals, estates or trusts, where the owners are not themselves subject to 1563 and 414(c), respectively. (The individuals, estates and trusts that are the owners would not themselves be part of the applicable "brother-sister controlled group" under 1563 or the "brother-sister group of trades or businesses under common control" under 414(c).) So now we're going to make the parent-subsidiary rules under the 414(c) regs. act like the brother-sister rules on this key point merely because the word "organization" was used in replacement of the word "corporation" when the 1563 rules were exported to 414(c)? I sure hope not. If that kind of a sea change (staying with the Mother Nature theme of this post) to the basic underpinnings of the structure of the aggregation rules were intended, then presumably there would have been some kind of explanatory statement or at least indication to that effect. I find none, which, to me, is not surprising, given that I think it’s quite obvious that no such sea change was at all intended. And to those who might ask, "Well, why NOT aggregate downstream portfolio companies of a non-ToB common parent?" - I would say that there are innumerable reasons for crafting the aggregation rules in any particular way, and, in this case, the detailed and extensively developed parent-subsidiary rules just do not effect such an extended aggregation.
Would it have been great if they had said "organization that engages in trade or business activities" instead of just "organization"? Sure. Is that what they meant? Well, sure it is. If someone had pointed this particular drafting issue out as they were crafting the rule, would they have added words like that? I suspect so. Does it matter that the words aren't in there a second time? Again, I sure hope not. So if you're moved to wondering why "organization" is used at the tail-end of the 414(c) lead-in without a ToB qualifier, I hope I've provided an explanation. As I've tried to show, what we've got here are some extra confirmatory words that happened not to have been repeated in the drafting process, not some effort by the drafters to expand the scope of the rule so as to recast the basic regulatory structure from the ground up.
In conclusion, while some seem to have become concerned that the 414(c) rules governing a "parent-subsidiary group of trades or businesses under common control" might somehow aggregate subsidiaries of a non-ToB parent, it seems evident to me that the 414(c) rules were not intended to provide, and do not provide, for that result. Thus, just like there cannot be a 1563 "parent-subsidiary controlled group" with a non-corporate common parent, there cannot be a 414(c) "parent-subsidiary group of trades or businesses under common control" with a non-ToB common parent. A contrary interpretation (i) ignores the derivation of the 1563/414 rules, (ii) is inconsistent with the very words used to form the defined term ("parent-subsidiary group of trades or businesses under common control") here in question, and (iii) would conflict with the fundamental regulatory structure under 1563 and 414, even blurring and maybe trivializing the clear dichotomy between the set of rules governing parent-subsidiary groups and the set of rules governing brother-sister groups.
In conclusion, while some seem to have become concerned that the 414(c) rules governing a "parent-subsidiary group of trades or businesses under common control" might somehow aggregate subsidiaries of a non-ToB parent, it seems evident to me that the 414(c) rules were not intended to provide, and do not provide, for that result. Thus, just like there cannot be a 1563 "parent-subsidiary controlled group" with a non-corporate common parent, there cannot be a 414(c) "parent-subsidiary group of trades or businesses under common control" with a non-ToB common parent. A contrary interpretation (i) ignores the derivation of the 1563/414 rules, (ii) is inconsistent with the very words used to form the defined term ("parent-subsidiary group of trades or businesses under common control") here in question, and (iii) would conflict with the fundamental regulatory structure under 1563 and 414, even blurring and maybe trivializing the clear dichotomy between the set of rules governing parent-subsidiary groups and the set of rules governing brother-sister groups.
So, how do I really feel about this? I'll bet my views on this are sneaking through. Hey, after all, it is Saturday as I complete this post, and, as we all know - Saturday night's alright for fighting!
Cheers! . . .
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* Please forgive the Genesis reference haphazardly thrown in here, notwithstanding the nod to Elton John in the title. As to Sir Elton, and with no disrespect to Michael Jackson or Billy Joel, when it's all said and done, I think that the body of work produced by the piano man named Reggie Dwight may well rank with anyone's in the pop/rock genre. (And, just for the "record", I mean to include Bernie Taupin here. It amazes me that Elton John is not the writer of the lyrics that he so effortlessly sings, and that so much of what he has sung through the years are Bernie Taupin's words.)Cheers! . . .
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** Sorta reminds me of Donovan v. Bierwirth, an oft-cited case making extremely important law, which resulted in no recovery whatsoever to the plaintiffs.
*** One would think that I'd get tired of all the "Sun" puns, but I guess that hasn't happened yet.
**** See the immediately preceding footnote.
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