Retirement plan issues should be looked at early in the transaction, McHugh said during the 2014 Plan Sponsor Council of America (PSCA) Annual Conference. “Far too often they come up later in the transaction, at times after the contract is drafted—considerations of whether assets will be transferred or whether plans will be terminated. A review of retirement plan issues can lead to significant contract provisions.” He added that if buyers and sellers do not solve issues early, it can lead to more costs later.
If the transaction is a stock purchase transaction, the buyer gets all of the retirement plans and all the problems that may go with them, McHugh said. In an asset transaction, the buyer may not get the retirement plans, and traditionally, it was believed the buyer would not get any problems related to the plans, but that is no longer true, he noted. The nature of considerations in the deal is affected by each party’s goals and the type of retirement plans involved.
Retirement plan-related contract provisions include seller’s representations, affirmative covenants, negative covenants and, perhaps, indemnification. McHugh said it is becoming increasingly important to add provisions by which the buyer is indemnified by the seller if anything goes wrong. His experience has been that, if asked, sellers are willing to give first dollar indemnification for benefit plans, but buyers often will not get that if they do not ask.
Sellers’ representations include a listing of retirement plans and their type. McHugh advised plan sponsors to ensure disclosure is not limited to benefit plans as defined by the Employee Retirement Income Security Act (ERISA); it should include plans that are not governed by ERISA—non-ERISA retirement plans, incentive plans and independent employment agreement obligations. A seller’s representation should affirm that the plan is in compliance with applicable federal and state laws and is currently funded, or it should identify any problems. McHugh said he includes in contracts a listing of operational codes and reporting obligations of the Internal Revenue Code (IRC) and ERISA for the representation by the seller that it is in operational compliance.
The seller should be asked to provide copies of all plans and related documents. The seller’s representations should include statements about continuing or potential termination of liability, including pension plan underfunding and multiemployer plan withdrawal liability. McHugh also suggested including representations of the disposition of welfare plan liability, including COBRA coverage, and the existence of any retiree obligations. “COBRA is especially important in a stock deal because the buyer may end up responsible for benefits for people the buyer never employed,” he noted.
According to McHugh, it is important to get these representations in the contract, but the buyer still has to do its due diligence. “For some companies, employee benefits are not a major focus, and some of the things they say are not true.”
Affirmative covenants are things people want to have happen after the transaction is completed, McHugh explained. These are the provisions that deal with what can be done with the benefit plans, as well as what should be done. This is the place where human resources (HR) or benefits staff have the most to contribute to deals, he said, because lawyers do not always understand retirement law. "The buyer may say, ‘I want you to transfer assets from your plan to my plans,’ or the seller may want employees protected and say, ‘You have to put our employees into your plans, you have to give them credit for past service, you have to offer them health care,’" McHugh explained. He added, “If the seller doesn’t offer health care benefits, the buyer’s employees may be able to elect COBRA on the seller’s plans, and this is expensive, so the seller will want to offer coverage.”
Negative covenants are usually limited, but include such things as a statement that the buyer does not want the seller to adopt any more plans before the transaction is complete and also cannot make any amendments to the plans before the transaction is complete. “The seller can’t do anything to make the plans more expensive or complicated,” McHugh said. “If you don’t have those provisions, you could end up taking on more than you want.” The negative covenants should say the seller can amend the plans to the extent the law says it has to, but otherwise the plans should be in the same condition as when the buyer did due diligence.
Generally, there is also an agreement at the closing of the transaction that everything attested about the plans in the beginning is still true at closing, he added.
What to Do with Retirement Plans
There are a number of ways to handle retirement plans in a merger or acquisition. If the buyer does not want the retirement plans, it can negotiate for a plan termination. McHugh said it is extremely important to remember to negotiate with the seller for it to terminate the plan prior to closing of the transaction. For defined contribution (DC) plans with a deferral feature, if the buyer inherits the plan, it cannot terminate it. It’s not required that termination be completed prior to closing, just that the termination process has started.
The plans of the seller can be merged with the plans of the buyer. The important things to remember in this situation is that plan benefits for participants cannot be cut back under ERISA, and if there is a compliance problem with the seller’s plan, it is now the buyer’s problem.
A plan-to-plan transfer of assets from the seller’s plan to the buyer’s plan often happens if the buyer is not taking the seller’s whole company. In this situation, ERISA’s anti-cutback rule also applies.
The agreement can offer the seller’s participants a chance to get a distribution of plan assets immediately after the close of the transaction. It may also offer participants the opportunity to roll their assets into the buyer’s plan. “That way, the buyer won’t get any problems of the seller’s plan; clean money is coming in,” McHugh noted. The issue is companies cannot control what participants will do; they may keep all their assets.
The buyer can continue the retirement plans of the seller. McHugh noted there is a special rule in the IRC that, in this situation, plan sponsors have a free pass on employee coverage rules until the end of the year following the year of the deal. He said this option works well in a situation where the buyer is not sure what they want to do with the plans. It can continue the plans for a period of time until it decides.
Finally, the buyer can take the seller’s plans and freeze them. “To me, this is the worst option because you’re adding administration and costs,” McHugh said. He noted, however, that some companies choose this option because they feel strongly that they do not want participants to take their retirement savings.
McHugh said buyers must be very proactive in their due diligence—get copies of plans, examine plans and look at Form 5500s. “In a stock sale scenario, every problem is yours after the close of the transaction, and case law is also now putting more liability on asset buyers.” He noted that lawsuits have looked at two issues: Did the purchaser have notice of problems or should it have known about them, and is there sufficient continuity between the buyer and seller? Under these two conditions, a court may find an asset buyer liable for problems of the seller. “Asset buyers can no longer walk away from a deal and not worry about the liabilities of the seller,” he warned.
One issue to consider is what to do with participant loans. Traditionally, if the seller’s participants had loans, the transaction would create a loan distribution and incur taxes on the participants. McHugh said buyers could allow participants to pay back the loan, but now the Internal Revenue Service (IRS) has made it clear loans can be transferred from the plan of the seller to that of the buyer. The buyer has to agree to assume the loan and administer the loan. A conference attendee said when her company acquired another, it paid the prior plan recordkeeper for the loans, transferred the assets, then set up loans under its recordkeeping system.
McHugh noted that upon a plan termination, all participants must be fully vested in all retirement accounts. Also, ERISA says if 20% or more of participants are leaving a plan, it is a partial termination and those participants have to be fully vested, so sellers may have a partial termination.
Buyers must coordinate salary deferral limits for each person that may move from the seller’s plan to the buyer’s plan. They also have to consider prior plan activity for coverage and nondiscrimination testing. Buyers should ask for partial-year deferral and compensation information from the seller, and for coverage rules, look at the features of the plan and who gets the benefit of it for coverage rules.
Buyers must understand liability for multiemployer pension plans. McHugh recommended they make sure they get an estimate from the sponsor of the plan as to unfunded liability and contribution requirements. There may also be collective bargaining concerns. If a seller is inheriting a collective bargaining agreement, it cannot just do whatever it wants to do, he said. Buyers should review agreements and understand their bargaining obligations.
McHugh noted the law permits a seller to ask a buyer to keep employees, and buyers often contract the employees until they decide what to do with the employees. Buyers must also decide what to do with plans for those employees. McHugh said he is seeing a greater frequency of sellers asking buyers to keep employees in their plans until a decision is made.
If a seller inherits a plan with operational defects, the parties have to determine who will pay for fixes. McHugh said the best thing to do is for the buyer to go to the IRS to fix the problem, but ask the seller to pay for it.
Finally, McHugh said, buyers need to understand where the assets of sellers’ retirement plans are invested. For example, if the buyer offers company stock in its plan, and the seller does not want that in its plan, the contract should provide for the company stock to be disposed of.