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Mergers & Acquisitions, Employee Benefit Services

Retirement Plan Considerations in Mergers and Acquisitions

When one business is considering acquiring or merging with another, careful consideration must be given to the existing employee benefit programs in each company and the impact of the transaction on the employees. Special attention must be paid to the qualified retirement plans maintained by each entity. Failure to do so can result in significant unintended consequences to the buyer, and issues that arise as a result of the transaction can be difficult to correct. With proper due diligence and planning, employee benefit programs can be transitioned smoothly to the new combined organization with minimal impact to employees.

Types of Transactions
The type of transaction greatly affects plan benefits and the status of employees. The nature of the transaction will set the course for the due diligence process.

  • Stock Sale – When one company acquires another, the seller’s shareholders receive cash or other consideration in exchange for their shares. The buyer takes over as the employer and assumes all liabilities of the seller, including responsibility of the retirement plan. The employees have continuous employment with the company, and do not experience any separation from service.
  • Asset Sale – When only the seller’s assets are purchased, the seller’s entity continues as before, and the buyer is not responsible for the liabilities of the seller, including the retirement plan. Employees continuing with the buyer are considered new hires and typically as terminated employees of the seller.
  • Disposition Transaction – A disposition transaction is a subset of an asset sale where the buyer purchases only a portion of the seller’s business. Often, the affected employees’ benefits are “spun-off” into a separate plan established by the buyer to provide continuity of employment and retirement benefits.

Retirement Plan Options
There are three options to consider when a company is being acquired. As with most issues, the determination of the appropriate option is best made well before the close of the transaction. Addressing retirement plan issues after the transaction can provide unintended participation rights to employees or lead to an expensive correction procedure.

The first option is to maintain the plans of both employers. In a stock sale (absent a pre-closing termination of the plan), the buyer will automatically become the sponsor of the seller’s plan. In an assets sale, the buyer has the option of adopting the seller’s plan post closing. Continuing the seller’s plans may be desirable for continuity of benefits or if the acquired entity will be continued as a separate operation of the buyer. The disadvantage of this option is the cost of maintaining separate plans and benefit structures. All plans of the employer must be tested together for coverage and nondiscrimination testing, although there is generally a transition period before these requirements apply to the acquired employees.

A second option would be to merge the plan of the buyer into the seller’s existing plan. A plan merger is done post transaction and can only occur if the plans are the same type (such as two 401(k) plans). The advantage of the plans merging is that vesting of benefits is maintained for the acquired employees and they are rapidly integrated into the buyer’s plans and benefits. A downside is that any qualification defects associated with the seller’s plan could jeopardize the tax-qualified status of the buyer’s plan.

The third option is to terminate the seller’s plan, typically prior to the close of the transaction. This is a common course of action in a stock sale, to avoid any transfer of liability to the buyer. Plan termination fully vests all participants, and they would be able to receive distribution of their plan benefits. The employees would then be integrated into the buyer’s plan.

Other employee benefit determinations
There are other employee benefits that must be reviewed prior to the purchase transaction. A review of the qualified retirement plans from both organizations should be conducted to determine whether they contain incompatible features that would prevent a plan merger. For example, the seller’s plan might contain a safe harbor or auto enrollment feature that is not part of the buyer’s plan. This may lead to a decision to either continue or terminate the seller’s plan.

The seller’s welfare plans should be reviewed to determine compatibility with the buyer’s programs. These benefits include health, dental, disability and other programs. Cafeteria programs and employee co-pay levels can greatly affect an employee transition to the buyer’s plans. The programs must also be reviewed for compliance with COBRA and HIPAA regulations.

Another important area is that of nonqualified plans offered by the seller to key executives. The benefits under such plans are often triggered by a “change in control” of the company, which may lead to unexpected tax burdens for employees or obligations by the buyer. All deferred compensation agreements should be thoroughly reviewed prior to the transaction.

Due diligence
In order to properly consider all of the available options and avoid unintended liabilities, buyers must perform a careful analysis of all the seller’s employee benefits and deferred compensation contracts. Vetting these issues during the due diligence and planning phase will provide the best chance for a smooth transition for employees and avoid costly post-transaction corrections.

There are many qualified plan materials and practices that need to be reviewed as part of the due diligence process:

  • Plan Documents – All plan documents must be reviewed for compliance with current law and to ensure they have all the required compliance amendments. Provisions should also be reviewed for compatibility with the buyer’s current plan.
  • Defined Contribution Plans – 401(k), profit sharing and ESOPs each have their own unique attributes that should be reviewed for their impact on the employees and the transaction. Non-discrimination testing results should be analyzed for potential liability. If the buyer is contemplating a change in the investment platform for the acquired employees, plans should be made for that transition, including the required blackout notice and enrollment meetings.
  • Defined Benefit Plans – These plans must be reviewed for the promised benefits and funding levels. A buyer assuming responsibility for the seller’s pension plan must be aware of required contributions and any long-term obligations, such as post-retirement medical benefits.
  • Fiduciary Obligations – The seller’s fiduciary practices should be reviewed for any errors or poor practices. These include investment committee minutes and policies, bonding levels, and timing of employee contribution deposits. Any errors or issues are best addressed pre-transaction.
  • Plan Operations – Similarly, all plan operations should be reviewed, such as loan and distribution practices and compliance with governmental reporting requirements. How a plan is operated will influence the decision on whether to maintain or terminate the seller’s plan.

The due diligence process is critical in determining potential barriers to the purchase transaction and to secure seller representations and warranties in order to protect the buyer from future liability. With a thorough discovery process and proper planning, any issues can be addressed and corrected prior to the transaction.

The purchase of a business is a complicated and involved undertaking, and the retirement plan considerations are only one part of the overall transaction. With careful planning and analysis, the buyer can avoid unexpected complications and delays that may negate the value of the transaction. To assist our clients, we have developed an introductory checklist to begin the due diligence process. It is available on our website at the link below.

Therese Cheevers
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