EMPLOYEE BENEFITS IN
ACQUISITIONS,
DIVESTITURES AND OTHER
CORPORATE
TRANSACTIONS
Lori W. Jones & Michael D. Lane
Overview of Employee Benefits
Issues in Transactions
Form of Transaction Impacts Employee
Benefit Issues.
• Stock/Merger:
• Buyer steps into shoes of seller.
• Due diligence is critical.
• Representations with respect to benefit plan compliance are critical.
Overview of Employee Benefits
Issues in Transactions
• Asset Sales:
• Buyer can minimize issues by not assuming plans of seller.
• Potential for benefit issues still remain.
•COBRA
•Union plans – continuing contribution obligation.
Overview of Employee Benefits
Issues in Transactions
Role of HR Specialist:
• Due diligence.
• Negotiation of benefit package for employees of acquired entities.
• Strategy for seller’s employee benefit plans and arrangements.
• Input on employee benefit provisions of acquisition agreement.
• Representations regarding employee benefit law compliance.
• Special provisions regarding treatment of seller’s employee benefit plans.
• Future benefits for seller’s employees.
• Indemnification provisions.
Overview of Employee Benefits
Issues in Transactions
Importance of Due Diligence:
• Existing employee benefit plan compliance issues may impact sales price.
• Existing employee benefit plans may impact future benefit package.
• Access to documentation may become difficult after transaction.
• Access to data needed for testing and reporting may become difficult after transaction.
• Access to vendors may be limited after transaction.
Overview of Employee Benefits
Issues in Transactions
Types of Benefit Plans:
• Retirement Plans.
• Welfare Plans.
• Executive Compensation Plan and Arrangements.
• Severance Agreements.
Possible Issues
Qualified Retirement Plans:
• Discharge of plan participants may result in “partial termination of plan” resulting in 100% vesting.
• Generally, 20% or more.
• Discrimination testing for acquired employees.
Possible Issues
401(k) Plans:
• Buyer can’t terminate seller’s 401(k) plans after closing and distribute plan assets if employee participates in a 401(k) plan of buyer within 12 months of plan termination.
Possible Issues
Defined Benefit Plans:
• Determine funded status of plan.
• Some under-funded plans are subject to restrictions.
•Restriction on lump sum distributions.
•Restrictions on additional benefit accruals. • Determine cost of terminating plan in future.
Possible Issues
• Section 4062(e) liability:
• Cessation of operations at a facility.
• More than 20% reduction in active participants.
• PBGC requires bond or letter of credit up to 150% of termination liability, escrow equal to amount of termination liability, contributions, or combination of above for 5 years after facility closing.
Possible Issues
Multi-employer Plans:
• Cessation of contributions results in withdrawal liability.
• Often difficult to assess amount of potential withdrawal liability due to lag in reporting data.
Possible Issues
COBRA:
• Seller’s controlled group generally retains liability for COBRA so long as seller’s group maintains a group health plan after the transaction.
• Liability shifts to buyer’s controlled group if:
• Seller’s controlledgroup ceases to maintaina group health plan; and
• Buyer continues businessoperations withoutsubstantial change.
• Parties can negotiate COBRA obligations.
• Only with respect to M&A qualified beneficiaries.
• Qualifyingeventoccurs in connection with transaction. • Employmentwas associated with entity acquired (or assets
purchased).
Possible Issues
Retiree medical plans:
• Confirm reservation of right to reduce or eliminate benefits.
Possible Issues
Section 125 Plan:
• IRS guidance permits employees to remain in seller’s plan for balance of year.
• IRS guidance permits employee balances to be transferred to buyer’s plan as if election made under buyer’s plan.
Possible Issues
Executive Compensation:
• Nonqualified deferred compensation – Section 409A compliance.
• Section 280G golden parachute rules.
• Plans and agreements may trigger excess parachute payments.
•No deduction for payments.
•20% excise tax on excess parachute payment. • Section 162(m) limitation on deductions for
FREQUENTLY ASKED
QUESTIONS
FAQ #1 – Can the employees get a
distribution from their 401(k) account?
Facts:
• Client A signs agreement to purchase Business B in a stock transaction.
• Both A and B sponsor a 401(k) plan.
• After the closing.
• B employees employed by A, covered in A’s 401(k) plan.
• Business B 401(k) plan will be frozen.
Answer: Unless B’s 401(k) plan is terminated
before closing, former B employees cannot get a distribution from the Business B 401(k) plan.
FAQ #1 (cont.)
Even though former B employees now work
for A, Business B is still a member of the Client A controlled group of companies.
B employees have not had a “severance from
employment” for purposes of the 401(k) distribution requirements.
The B 401(k) plan cannot be terminated and
distribute assets after closing unless the A 401(k) plan is also terminated.
FAQ #2 – Can the employees get a
distribution from their 401(k) account?
Facts:
• Same as FAQ #1, except:
• Client A purchases the assets of Business B.
• Business B retains sponsorship of the B 401(k) plan after closing.
Answer: Yes, former B employees can
receive distributions. They have severed from employment from Business B for purposes of the 401(k) distribution requirements.
FAQ #2 (cont.)
Note: if B no longer operates a business,
then B is likely to terminate the plan after closing.
• Consider whether to transfer plan B sponsorship to A.
• A can control the plan transition or termination process and protect A’s new employees.
• A is now responsible for compliance of plan B.
What if sponsorship of the B 401(k) plan is
transferred to A as part of the closing?
• Then the answer is the same as FAQ #1.
FAQ #3 – We are freezing an acquired
plan. Can we prevent default on 401(k)
loans?
Facts:
• Client C is purchasing Company D. • Both C and D sponsor a 401(k) plan. • After the closing:
• D employees will participate in C’s 401(k) plan.
• Company D 401(k) plan will be frozen.
Answer: There are several ways to prevent employee loan defaults depending on the structure of the transaction and the sponsorship of the acquired plan. Note that loan repayments areinvestment earnings, notcontributions.
FAQ #3 (cont.)
Continue making payroll deductions to pay
off loan.
• Will Client C payroll sync with plan D provider?
• Who will be the sponsor of the plan after closing?
Transfer note from plan D to plan C and
continue payroll deductions.
• Will plan D provider allow in-kind transfer?
• Will plan C provider accept in-kind transfer?
• Do the terms of both plans permit this?
Achieve repayment “outside” the plan.
FAQ #4 – Can Acquired Employees
Continue to Participate in Acquired Plan?
Facts:
• Client C is purchasing Company D (stock sale).
• Both C and D sponsor a 401(k) plan.
• After the closing:
• C employees will participate in C’s 401(k) plan.
• D employees will participate in D’s 401(k) plan.
Answer: Yes, subject to coverage testing
requirements.
FAQ #4 (cont.)
Special M&A grace period for coverage test:
• Plan C and Plan D separately passed coverage test before transaction.
• No significant changes in plan coverage occur.
• Both plans are deemed to satisfy coverage requirements until the end of the plan year following the plan year of the transaction.
After grace period (or if grace period does
not apply), plans must pass 410(b) coverage tests.
FAQ #5 – When can we freeze a target
company’s defined benefit plan?
Facts:
• Client C is purchasing Company D.
• Company D sponsors a defined benefit pension.
• C desires to freeze pension accruals before closing.
Answer: Pension plans may be frozen,
subject to anti-cutback rules and advance participant notice requirements.
FAQ #5 (cont.)
Plan freeze amendment must be adopted
before it is effective.
Notice requirements under ERISA 204(h).
• General rule: 45-day advance notice for amendments significantly reducing rate of benefit accrual.
• M&A exception: 15-day advance notice required. Penalties for notice failures include
restoration of accruals and excise tax.
FAQ #6 – Who is responsible for
COBRA?
When an acquired company maintains a
group health plan, there are often employees currently on COBRA or who become eligible for COBRA in connection with the
transaction.
COBRA rules provide default and requiring
one party to provide COBRA.
Contracts can alter the default rules, but if a party fails in its COBRA obligation, the statutory default applies.
FAQ #6 (cont.)
Oversimplified summary of defaults• Stock sales:
• Seller generally mustprovide COBRA to M & A qualified beneficiaries.
• If the seller ceases to provide grouphealth plan coverage to any employees,the buyer mustprovide COBRA as long as the buyer continues to maintaina group health plan. This can create “springing” COBRA liability.
• Asset sales:
• Generally the same as stock sales, but the requirementsfor the buyer to provide COBRA only apply if the buyer is a “successor employer”.
• Successor employerrules apply when,in connection with the sale, the seller ceases to provide any grouphealth plan to employees and the buyer continues the business operationsof the seller withoutinterruption.
Important to identify M & A qualified beneficiaries.
FAQ #7 – What if we find problems
with qualified plans after closing?
Company A acquires Company B and its 401(k)plan.
Six months later, Company A finds out that Company B has a history of poor plan operations.
The fix:
• IRS correction guidance allows extended self-correction period following corporate transaction. • Voluntary compliance when self-correction
unavailable (consider costs).
• Company A may have recourse against sellers depending on the facts and the purchase agreement.
FAQ #7 (cont.)
What if Company A already merged the B
401(k) plan into its own 401(k) plan?
Correction still available – if the issue is caught quickly (within first 2 plan years), cost of voluntary compliance based on the size of the pre-merger B 401(k) plan.
FAQ #8 – Can We Carry Over Flexible
Spending Plan Elections?
Facts:• Company A purchases assets from Company B. • Some B employees will work for A.
• Both Company A and Company B sponsor flexible spending account (FSA) plans.
Answer: If plans permit, it is permissible to allow FSA elections to continue after the sale (check plan terms).
Two Options Under IRS Guidance:
• Company B can continue to cover former B employees in the B FSA through the end of the year.
• Company A can cover former B employees in the A FSA.
FAQ #8 (cont.)
Practical Considerations:
• Option 1 is impractical if B no longer in business.
• Option 1 requires both employees and Company A to interact with Company B.
• Option 2 requires transfer of data from B plan to A Plan.
• Option 2 – consider purchase price adjustments.
• Option 2 – former B employees no longer eligible for B plan, therefore may elect COBRA. Consider excluding B plan COBRA employees from A plan.
FAQ #9 – Can We Terminate an
Executive SERP?
Facts:
• Client A sponsors non-qualified SERP for execs.
• Client A is selling Division C to Buyer B.
• Some Division C execs participate in the SERP.
• Buyer B does not want to maintain the SERP.
• Client A wants to continue SERP only for continuing A employees.
Answer: Possible to achieve these goals.
Treadcarefullythrough 409A rules and plan
FAQ #9 (cont.)
Section 409A has very stringent plan
termination rules:
• All similar arrangements must be terminated.
• Cannot adopt a new NQ plan for 3 years.
• Timing of payments > 12, < 24 months. Special M&A exception:
• Termination must be in specified period proximate to sale.
• All similar arrangementsfor affected employees
must be terminated.
• Timing of payments < 12 months.
FAQ #10 – We Closed Division D.
Why is PBGC Calling?
Facts:
• Client A sponsors defined benefit plan.
• Client A reorganized and shut down Division D.
• PBGC has sent demand letter to Client A.
Answer: PBGC is aggressively enforcing
previously obscure rule in ERISA – 4062(e).
4062(e) requires additional payment/security
when employer ceases operations at a facility and 20% of participants are terminated.
FAQ #10 (cont.)
Reportable Event.
Proposed Regulations Take Broad View.
Liability to PBGC.
• Based on plan’s unfunded liability on a termination basis.
• Additional Contributions.
FAQ #11 – We Bought Assets from Seller.
Why Worry About Seller’s Multiemployer
Plans?
Facts:
• Seller S contributes to multiemployer plan for union employees.
• Buyer B discovers delinquent contributions and potential withdrawal liability during diligence.
• Buyer B wants to avoid this liability, structures an asset sale.
Answer: Multiemployer plans have been
successful in convincing courts to impose “successor” liability on buyers of assets.
FAQ #11 (cont.)
Imposes secondary liability on buyers who
continue business of seller with knowledge of liability or potential liability.
Several courts have imposed liability on
buyers for outstanding delinquent contributions.
Courts in seventh circuit have imposed
liability on buyers for withdrawal liability.
Case law still developing.
FAQ #12 – Can we continue seller’s
existing welfare benefits for acquired
employees?
Buyer B wants to maintain the existing Seller S welfare benefit plans for acquired S employees.
Answer depends on form of transaction and terms of the applicable plans and arrangements. Review welfare plan documents.
Stock sales – automatic transfer of ownership of policies and sponsorship of plans. Check coverage terms for both B and S plans.
Asset sales – transfer sponsorship of plans. Can the insurance policies / services agreements be assigned? Check for notice requirements. Check coverage terms for both B and S plans.
FAQ #13 – Can We Convert Seller
Stock Plans to Buyer Stock Plans?
Facts:• Public Client A purchasing Public Seller S. • Both companies have stock-based plans (e.g., ISO,
NSO grants to employees).
• A wants to convert S stock arrangements into A stock arrangements without adverse tax consequences. Answer: Possible to achieve this goal. Tread
carefullythrough Code (ISO/NSO/409A) and securities requirements.
Special conversion formulas, etc.
Also applicable in spinoff/reorganization transactions.