By Seth Gaudreau and Stephen Wilkes
In the context of mergers and acquisitions, an acquisition target’s qualified retirement plans, health plans, executive compensation arrangements, and benefit programs (referred to collectively as “benefit programs”) can all be a source of significant liabilities. These benefit programs are promises that the target has made to its employees, and the buyer must ascertain whether it is liable to fulfill them and, if so, the dollar value of those promises. Potential issues exist if the plans have been incorrectly drafted or operated. In order to avoid any complications and liabilities, the parties need to understand the best deal structure based on the benefit programs requirements and perform due diligence to carefully address any issues under both the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code early in the transaction.
Deal Structure
The transaction’s structure can determine the parties’ approach to the benefit programs and associated liabilities. Where the buyer intends to acquire the seller’s business through a stock sale or a merger, a myriad of issues must be addressed. Generally, in a stock sale or the merger of the target into the buyer, benefit liabilities remain with the target or are automatically transferred to the buyer or its acquisition subsidiary. In a merger, generally, the surviving entity assumes the target’s benefit programs liabilities, so it is imperative that the buyer knows what liabilities it is assuming. In either of the scenarios above, the parties need to understand their options, including but not limited to taking on the seller’s plan and operating it as a stand-alone plan, merging the seller’s plan into the buyer’s existing plan, terminating the seller’s plan, or freezing the plan. The forgoing options raise individual questions that need to be carefully analyzed and can change the structure of a deal and its terms.
Where the transaction is an asset sale, generally, the buyer only assumes benefit program liabilities if it takes affirmative steps to do so. An asset deal may require a less extensive due diligence review of a company’s benefit programs; however, concerns still exist with certain benefit programs regarding withdrawal liability and/or successor employer liability which courts and regulators may apply regardless of the deal structure.
Due Diligence
In order to consider all of the available options and avoid unintended liabilities, the buyer should review every current employee plan that makes up a benefit program. Whether looking at the overall value of a business or its benefit programs, the goal of due diligence is to vet all issues early in the deal, provide the best chance for a smooth transition, and avoid costly post-transaction corrections. The following are areas of consideration for due diligence review:
- The buyer should understand the seller’s corporate structure, affiliated entities, and potential controlled group issues.
- All benefit program materials must be reviewed to comply with current laws and ensure they have all required amendments. Further, whether the plan sponsor reserves the right to terminate or amend the plan and whether a plan provides for accelerated vesting or any other consequence resulting from the transaction that could increase liabilities should be determined.
- Whether the target has maintained proper fiduciary practices, including administering and operating the benefit programs accordingly, including whether the benefit programs been reviewed for qualification defects that may require corrections.
- Defined contribution plans have unique attributes that must be reviewed to determine the potential impact on the employees and the transaction. Aspects such as non-discrimination testing results should be analyzed for potential liability.
- Defined benefit plans promised benefits, obligations and funding levels need to be reviewed.
- In the case of a multiemployer pension plan, the buyer should determine if there is withdrawal liability based on the plan’s unfunded vested liability, and the portion of such liability allocable to the seller.
- All correspondence, inquiries, or examination notices to or from government agencies, such as the Internal Revenue Service, Department of Labor, or Pension Benefit Guaranty Corporation., and whether the target company is aware of potential regulatory audits.
- Review of health plan issues, including potential COBRA matters, as the Internal Revenue Service has regulations for determining the COBRA liabilities of buyers and sellers.
The preceding is an introductory discussion of selected matters that parties to a merger or acquisition need to consider. It is not intended to be a comprehensive review. Evaluating all the moving parts is critical when deciding how to proceed with a target’s benefit programs.
Our transactional capability and expertise extend not only to matters surrounding transaction execution (e.g., identifying plans and arrangements; identifying liabilities; evaluating and otherwise dealing with risk allocation; and attending to transitional matters) but also to adding value with creative approaches to complex questions involving employment contracts, severance agreements and equity-based and other executive compensation.