Built on the foundation of the Tax Management Portfolios™, Bloomberg BNA Tax & Accounting is a comprehensive tax research solution designed by tax practitioners for tax practitioners.
By Stephen R. Miller, Esq., Maureen O'Brien, Esq. and Joseph S. Adams, Esq.
McDermott, Will & Emery LLP, Chicago, IL
In M&A transactions, many lawyers (and clients) assume that employee benefits issues are tangential to the overall business deal and will "work themselves out" after the deal closes. However, employee benefit plans can represent significant liabilities that may affect the purchase price in any transaction. In addition, a smooth transition for employees can be a key component of the success for many transactions. The following are the five most frequent employee benefits and executive compensation issues that can materially affect a transaction and should signal the need for special attention by the parties most adversely affected.
1. Pension Plan Obligations
Single employer defined benefit pension plans often carry significant unfunded termination liabilities that can adversely impact the acquirer's balance sheet. In addition to the potential liabilities represented by unfunded benefits liabilities, the effect of required minimum funding contributions on a target's cash flow can be significant. Potential buyers should also be mindful about acquiring plans that are so under funded that they are subject to benefit restrictions under §436 of the Internal Revenue Code. These restrictions may be particularly burdensome in the context of the acquisition of a cash balance plan or other defined benefit plan that offers a lump-sum distribution option, which may be restricted. Typically, where assumption of single employer defined benefit pension plans cannot be avoided, the buyer should insist on a purchase price adjustment in the amount of the unfunded benefits liability measured on a basis agreed upon between the parties.
Furthermore, unfunded termination liabilities and annual minimum funding contributions are joint and several liabilities of the "controlled group" of the plan sponsor. The joint and several liability rule is particularly important when dealing with private equity or venture capital funds. If the deal is structured so that the private equity or venture capital fund will own 80% or more of the target, then the entire fund can be part of the target's controlled group and jointly and severally liable for the target's defined benefit plan liabilities.
Finally, multiemployer defined benefit pension plans (sponsored by union-affiliated trust funds and maintained pursuant to previous collective bargaining) can assess significant liabilities against employers that cease participation in such plans (referred to as "withdrawal liability"), in accordance with complicated federal and union rules. This potential withdrawal liability should be an important due diligence item in an equity transaction. As with single employer defined benefit pension plan liabilities, multiemployer defined benefit pension plan liabilities are also joint and several liabilities of the entire controlled group. Finally, in an asset transaction, withdrawal liability is automatically triggered and assessed on the asset seller unless the buyer agrees to certain statutory language regarding the buyer's commitment to continue contributions to the multiemployer plan and, in many cases, post a bond in the amount of the current withdrawal liability for a period of five years. In such situations, withdrawal liability will not be immediately assessed against a seller, but the seller will remain secondarily liable.
2. Retiree Welfare Benefit Obligations
Many companies subsidize health and life insurance benefits for retirees (and their dependants) after the employment relationship terminates. Such retiree welfare benefit obligations frequently are partially or wholly unfunded and any "FAS 106" liability associated with the plan must be reflected on the company's balance sheet. Many companies have seen retiree welfare benefit plan liabilities spiral out of control.
The most significant issue with respect to retiree welfare liabilities is the target's ability to reduce or terminate such liabilities in the present or future, which generally hinges on whether the target has reserved its right to unilaterally modify such benefits in the governing documents – a topic which has been the subject of significant class action litigation over the last 20 years. Any time retiree medical benefits are provided, due diligence should be performed to determine whether such benefits are unilaterally terminable by the target. If not, a purchase price adjustment for the buyer may be warranted.
3. Treatment of Defined Contribution Plans
Although defined contribution pension plans do not carry the significant liabilities associated with defined benefit pension plans, they frequently present issues in a transaction. In an equity sale, the defined contribution plan will enter the buyer's controlled group and, after a brief transition period, all defined contribution plans in the controlled group are required to be tested together for nondiscrimination purposes. In addition, once a seller's 401(k) plan enters the controlled group, it can be difficult to fully terminate that plan and move a seller's employees into a buyer's plan.
Further, some defined contribution plans contain onerous in-service distribution options that must be preserved if such plans are merged into a buyer's defined contribution plan. In an equity sale, often a buyer will request that a seller terminate any 401(k) plans immediately prior to closing. In an asset sale, a buyer can avoid these issues by not assuming the defined contribution plans. From a seller's perspective, the administrative burden of terminating or retaining the defined contribution plans, should be considered before an agreement to terminate or retain is reached with the buyer.
In any transactions in which the target defined contribution plans contain target stock as an investment fund, special considerations arise with respect to the valuation of the stock in the transaction and the fiduciary liability associated with maintaining the stock as an investment option.
Finally, in asset sales where the buyer is not assuming the target defined contribution plan, the treatment of participant loans under the target defined contribution plan can be problematic. Many buyers' plans' refusal to accept a rollover of outstanding participant loans from the seller's plan can result in seller's former employees (transferred to the buyer) being held in default on their outstanding loans from seller's plan, with adverse tax consequences to the former participants (the buyer's new employees). This is a matter for due diligence, negotiation and resolution before a purchase agreement is signed.
4. Executive Compensation Issues
In both asset and equity transactions, the treatment of equity plans, change in control agreements and other nonqualified deferred compensation arrangements can be the subject of significant negotiation. In addition to questions of compliance with the Internal Revenue Code's complex §409A, if the transaction triggers a change in control or a separation from service for the executive, executives can find themselves in possession of substantial payments earlier than desired, and the often unfunded nature of such plans and arrangements (with no associated "rabbi trusts") can result in significant payments being required from the target's general assets. Due diligence with respect to such plans, should focus on the terms and triggering payment events under such plans. Since noncompliance with §409A can result in substantial excise taxes being assessed upon executives, due diligence with respect to such plans should also focus on compliance with applicable law.
Finally, in certain change in control transactions, "parachute payments" to executives in excess of allowed payments under Internal Revenue Code §280G can result in non-deductibility by seller and substantial excise taxes assessed against executives. Shareholder approvals of said payments (if feasible) may preserve the corporate deduction and keep executives from incurring the excise taxes. All employment agreements and change of control agreements should be evaluated to determine if §280G issues are involved.
5. International Plans
Many transactions raise issues regarding the retention of employees and assumption of employee benefit plans in foreign jurisdictions. Foreign employee benefit and employment laws are often highly protective of a seller's employees and significantly different from comparable laws in the United States. Importantly, in some foreign jurisdictions, purchasing assets will not insulate a buyer from employee benefits liabilities nor from obligations to hire (or negotiate with employee representatives regarding hiring) large numbers of the target's employees. Thus, in any multi-jurisdiction transaction, thought should be given to the retention of local counsel in foreign jurisdictions with a significant number of employees.
These and other significant benefits-related issues can arise in the course of M&A transactions and, if overlooked until after the transaction closes, can cause substantial adverse consequences for the buyer or seller, such as restricted cash flow, and no longer avoidable costs, taxes and penalties.
For more information, in the Tax Management Portfolios, see Hildebrandt and McHugh, 364 T.M., Qualified Plans — Treatment in Mergers, Acquisitions and Other Corporate Transactions.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)