Top Ten Retirement Plan Issues in Mergers & Acquisitions (United States)

By Gia Norris, Attorney Editor, Practical Law Employee Benefits & Executive Compensation, Practical Law

Overview

Companies that are parties to a corporate merger or acquisition must consider legal and practical issues under the Internal Revenue Code (IRC) and the Employee Retirement Income Security Act of 1974 (ERISA) relating to the qualified retirement plans involved in the transaction. Significant liabilities on both the buyer and seller side of a transaction can result if the parties do not:

• Consider the scope of these issues and the potential impact on the purchase price of the transaction during due diligence. Protect their interests when negotiating the underlying agreement. Determine the appropriate post-transaction plan design. Provide employees and government agencies with required notices.

This article highlights the top ten legal and practical issues that practitioners should consider in dealing with qualified retirement plans in mergers and acquisitions. For an in-depth look at retirement plans in mergers and acquisitions, see Practice Note, Qualified Retirement Plans in Mergers and Acquisitions.

1. Controlled Group Liability

Under ERISA, assets of any member of a controlled group can be applied toward liabilities of any employee benefit plan within the controlled group on a joint and several basis. The buyer should be aware of whether the target company or any of its controlled group members contribute to any single employer defined benefit plans, multiemployer plans and multiple employer plans because many significant potential liabilities are joint and several among the employer and its controlled group members, including:

• Funding obligations. Multiemployer plan withdrawal liabilities. Termination liability.

The seller or target, or both, will typically be required to make representations that there are no material controlled group liabilities. For more information about controlled group liability for retirement plans, see Practice Note, Qualified Retirement Plans in Mergers and Acquisitions: Controlled Group Liability. For more information on controlled groups generally, see Practice Note, Controlled Group and Affiliated Service Group Rules.

2. Multiemployer Plan Withdrawal Liability

Multiemployer plan withdrawal liability has traditionally been one of the most complicated issues for the parties to a transaction to handle.

In a stock sale, a complete withdrawal does not typically occur because the employer doesn't change. However, the buyer succeeds to the entire contribution history of the target company, which will be used to calculate its liability if it withdraws from the plan any time after closing.

In an asset sale, a complete withdrawal occurs if the target makes no additional contributions to the plan after closing and a partial withdrawal will occur if the target continues making some contributions to the plan.

In any transaction involving multiemployer plans, the buyer must determine how the plan assesses withdrawal liability and determine the extent of its potential liability. It should also be aware of the following exceptions:

• In asset sales, a seller can avoid withdrawal liability if the transaction is structured to comply with ERISA Section 4204 (see Practice Note, Qualified Retirement Plans in Mergers and Acquisitions: Avoiding Withdrawal Liability in Asset Sales: ERISA Section 4204). If the transaction involves a party in the construction, trucking, entertainment or retail food industries, special withdrawal liability rules under ERISA Sections 4023 and 4205 may apply. Withdrawal liability may be reduced or waived for smaller employers under ERISA Section 4209's "de minimis" rule.

For more information, see Practice Note, Multiemployer Pension Plans.

3. Single-employer Defined Benefit Plan Liabilities

The buyer's counsel should determine if the target company sponsors or contributes to any defined benefit plans. Defined benefit plan issues are difficult to address because:

• The assumptions used to determine plan liabilities vary depending on the purpose. Minimum funding standards, Pension Benefit Guaranty Corporation (PBGC) premiums and termination liabilities are joint and several liabilities of the plan sponsor and each member of its controlled group. How plan assets and liabilities are divided among the parties has a significant impact on future plan funding requirements and financial accounting costs that may apply after the transaction. The Pension Protection Act imposes additional funding requirements and benefit restrictions for certain underfunded pension plans. (See Practice Note, Qualified Retirement Plans in Mergers and Acquisitions: Single-employer Defined Benefit Plan Liabilities).

The PBGC monitors certain companies with underfunded defined benefit plans and has the ability to impose liens or force plan terminations if it determines that a transaction could significantly increase the PBGC's risk of loss.

4. Partial Terminations

If an entire business unit, division or subsidiary is being sold and a significant number or percentage of employees participating in the target company's qualified plan are terminated and no longer eligible to participate in the plan, a partial termination may occur.

If a partial termination occurs, the affected plan participants must be fully vested under IRC Section 411(d)(3). If the likelihood of a partial termination of a plan is significant, the seller may agree to fully vest the affected participants to avoid this issue.

Parties to a transaction should keep in mind that a partial termination can also occur due to:

• Plan amendments that adversely affect participants' vesting rights or exclude a group of employees who were previously covered under the plan. The reduction or cessation of future benefit accruals, which may also result in a reversion to the employer.

5. ERISA Reportable Events

Sponsors of defined benefit plans are required to provide the PBGC with written notice of certain "reportable events" under ERISA Section 4043 within 30 days after the event. Advance 30-day notification is required for certain non-public plan sponsors.

The PBGC may assess penalties of up to $1,100 per day that the notice should have been provided. The parties to a transaction involving a defined benefit pension plan:

• Should consider whether the transaction itself is a reportable event under ERISA Section 4043. May be concerned if the reportable events are so significant that they may cause the PBGC to terminate the plan (or may signal financial difficulties for the company).

For a discussion of reportable events that commonly arise in transactions, see Practice Note, Qualified Retirement Plans in Mergers & Acquisitions: Reportable Events.

6. Plan Qualification Defects

A buyer will usually encounter and may become liable for qualification defects under IRC Section 401(a) in the target company's retirement plans. There are significant tax consequences if any plans sponsored or contributed to by an employer are disqualified under the IRC.

Typically, the only way the buyer may ensure that a plan is qualified in operation (absent conducting an audit, which is often not possible) is by requiring the seller to make representations and warranties in the purchase agreement to this effect. To the extent there are any qualification defects, the parties should determine if and when the defects should be corrected (see Practice Note, Correcting Qualified Plan Errors under EPCRS).

7. ERISA Fiduciary Issues

Fiduciary issues can be difficult to identify during due diligence but may represent significant potential hidden liabilities. Buyers should examine the target's plan documents and operations to ensure that there are no significant potential claims for a breach of fiduciary duty under ERISA, by:

• Identifying the plan's fiduciaries. Reviewing the plan's fiduciary liability insurance (see Practice Note, Insurance for ERISA Fiduciaries). Confirming that the necessary individuals are bonded (see Practice Note, ERISA Bonding Requirements). Reviewing the plan's investment policy statement (see Standard Document, Investment Policy Statement for Defined Contribution Plan). Confirming that there are no prohibited transactions among the plan, seller, target or plan fiduciaries (see Practice Note, Prohibited Transactions and Exemptions under ERISA and the IRC). Determining that the plan is not currently subject to an US Internal Revenue Service (IRS) or US Department of Labor (DOL) audit or any threatened, pending or filed fiduciary breach lawsuits.

The parties will typically include a representation in the purchase agreement that the seller or the target has complied with these laws.

8. Plan Loans

Many asset sales involve a buyer purchasing a business unit or subsidiary of a large company that maintains a 401(k) plan at the parent level that permits participants to take plan loans. The transaction generally triggers a termination of employment of the employees of that subsidiary or unit and, absent further action, the plan loans become immediately due and payable under the plan's loan policy (see Standard Document, 401(k) Plan Loan Policy).

In this situation, the buyer typically agrees to cover the transferred employees and transfer related plan assets (including outstanding plan loan balances) to its own defined contribution plan.

Trust-to-trust transfers may not be possible if the target's plan includes a distribution event or optional form of benefit which the buyer does not wish to include in its plan or if the plan vendor does not accept loans. In this case, the target company or the buyer can make a bridge loan to participants to permit them to repay their loan under the seller's plan before distribution.

9. Designing Post-Acquisition Plans

The parties to a corporate transaction have several options in connection with the target company's qualified retirement plans, including:

• Assuming the plan. A buyer is most likely to assume the target's plan in a stock sale. Merging plans. If the parties have similar qualified retirement plans and benefit structures, they may choose to merge the plans (see Standard Clauses, Board Resolutions, Approving Plan Merger (Buyer) and Approving Plan Merger (Seller)). Transferring assets to the buyer's plan. A trust-to-trust transfer of assets is often the least costly design option for a buyer dealing with defined contribution plans with similar features. Spinning off the target's plan to a new plan for transferred employees. This option may be used if the defined contribution plans are different enough to warrant creating a "cloned" plan. Distributing plan assets. In an asset sale, 401(k) plan benefits may only be distributed in limited circumstances under IRC Section 401(k)(2) on a severance of employment with the target. Terminating the plan. A plan can be terminated if the buyer determines the target plan's potential liabilities are too great or the benefits are not sufficiently similar. Freezing the plan. A target's plan may be frozen because the buyer:
  • does not want to adopt the plan because of unfunded liabilities or varying benefit structures; is concerned about plan administration violations before the transaction; does not agree with seller regarding the amount of the plan's unfunded liabilities; or wishes to avoid the liability and complexity associated with terminating the plan.

(See Practice Note, Qualified Retirement Plans in Mergers and Acquisitions: Legal Options Available to the Parties).

10. Providing Required Notifications and Notices to Employees and Government Agencies

Once the buyer and seller agree on an approach to the qualified retirement plans at stake, they:

• Will each be required to execute plan amendments or board resolutions to implement the changes being made to their qualified retirement plans. May be required to negotiate a transition services agreement (see Standard Document, Transition Services Agreement) or retirement plan transfer agreement.

The parties may also be required to send required legal notifications before or after closing, such as a:

• ERISA Section 204(h) notice. This notice must be provided to participants (and, beginning in 2008, to contributing employers in a multiemployer plan) at least 45 days (15 days for plans with fewer than 100 participants) before the effective date of a plan amendment that ceases or significantly reduces future benefit accruals (see Standard Document, 204(h) Notice). IRS Form 5310-A: Notice to IRS of Plan Merger, Consolidation, Spinoff or Transfer. IRS Form 5310-A and an actuarial statement regarding IRC Section 414(l) compliance must generally be filed at least 30 days before the transfer of assets of a single-employer defined benefit plan. Reportable events notice. Defined benefit plans must typically provide written notice to the PBGC of certain "reportable events" under ERISA Section 4043 within 30 days after the event.