When businesses are bought, sold, merged, or reorganized into or out of existence, qualified retirement plans must be dealt with. This article provides an overview of some of the most common decisions faced by both buyers and sellers, acquirers and target companies; that is, what to do with the retirement plans of the company being acquired.
What Are The Objectives?
In any form of acquisition transaction, there are fundamental desires of the companies involved. Acquirers want to seamlessly integrate the target company's employees into their retirement plan. The acquirer does not want problems with the target's plan, if there are any, especially if they could taint or disqualify its own. On the other hand, the seller wants to preserve its plans, if it can, or to obtain benefits that are at least as good for the employees that are absorbed by the acquirer. In some situations, although not the norm, a buyer may wish to isolate the company it is acquiring, as a separate division or subsidiary. A separate plan or a different rate of participation in its retirement plan may be possible, subject to coverage and discrimination testing requirements.
An M & A Partner
For our readers who are neither investment bankers, attorneys nor CPAs, it may help to have a basic understanding of the universe of business acquisitions and sales. It often is referred to as mergers and acquisitions, or M & A, which encompasses many different types of transactions. In simplest terms, the world of M & A is roughly divided into two types of transactions. The first type is transactions in which the assets of the target company are acquired (i.e., an "asset purchase"). The other type is every other form of "entity" acquisition. This can include purchases of stock or partnership interests for cash; mergers in which the target company is absorbed by the acquirer and becomes part of the acquirer; or various forms of tax-free "reorganizations" in which entities are formed or combined, or interests in companies are exchanged to accomplish the absorption of the target company into the acquirer's structure.
The fundamental distinction between asset purchases and entity acquisitions is that in the former, the acquirer generally does not have to acquire any undesired assets or liabilities. This includes the retirement plans of the target. On the other hand, in an entity acquisition, the usual presumption is that the acquirer will be a successor to all the assets and liabilities of the seller, which would include the retirement plans of the target company.
The Results Of Inaction
If nothing is done with the retirement plan of a target company in an asset acquisition, it will be left with the target company which ultimately may be terminated, or wound up, when the target company is terminated and wound up after the asset sale. If all the assets of the target are sold and the target is abandoned, in theory, this could result in an abandoned plan or "sponsorless plan." As a practical matter, this is not a frequent occurrence.
If nothing is done in the context of an entity acquisition, then the acquirer could wake up the morning after the acquisition date and find that it has a new retirement plan. The unintended result is that, due to the Code's requirements, the terms of the plan may require coverage of all the acquirer's employees and vice versa; the plans of the acquirer may also require coverage of the target's employees! Hooray! Double the benefits, double the fun … for the employees, that is. At a minimum, therefore, in an entity acquisition, the issues of who the employer is, who is eligible, who receives credit for prior service, and who receives compensation as of the acquisition date all must be dealt with in the acquirer's plan and the target's plan.
To Merge Or To Terminate - Look Before You Leap
The most common choices (but not the only choices) for an acquirer in dealing with the target's plan are either to require that the plan be terminated prior to the acquisition date, or to merge the target's plan into its own retirement plan.
The Plan Merger Route
The merger of the target's and acquirer's plans is often perceived by human resources departments as the simplest procedure. This is because the legal act of a merger of plans can be as straightforward and simple (from a documentation standpoint) as the board of directors, or controlling parties of the acquirer, taking formal action to merge the plans by board resolution or otherwise. The merger is viewed by the IRS as an "amendment" of the target's plan to be combined with the acquirer's plan under its terms. Therefore, an anti-cutback analysis must be performed and the features and protected benefits that cannot be eliminated must be preserved, at least as to benefits accrued up to the date of merger. These balances, features, and benefits must be tracked and administered and cannot be forgotten.
The trusts and the assets and the participant account balances of the target's plan are then combined in a plan merger with the acquirer's plan and the employees continue to participate in the plan hopefully in a seamless and uninterrupted fashion. There are, of course, the practicalities and nuts and bolts issues of changing investments and permitting participants to make investment elections under the acquirer's investment delivery system.
Even though the target's plan may be merged out of existence in the transaction, it still is possible for the IRS to audit a qualified plan up to three years after the plan's final Form 5500 is filed. Records for the target's plan should be maintained and the acquirer should be prepared to deal with the eventuality of an audit in any merger situation. We have even seen audits of retirement plans, including defined benefit plans, occur where the plan has been completely terminated and wound up, and a determination letter has been obtained upon final determination. Even after the plan is gone, the IRS reserves the right to audit the plan for open taxable years.
So, before taking the seemingly simple steps to merge the target's plan, the acquirer needs to perform a certain amount of due diligence on the condition of the target's plan to ensure that there are no qualification, administration, or fiduciary problems under ERISA that can come back to haunt it. This is similar to performing the due diligence on the business to determine that there are no hidden liabilities in the assets or enterprise being acquired.
How does one perform due diligence on the target's plan? Do you merely ask the TPA, "how's the plan?" We think not. Our firm, of course, has developed comprehensive lists of issues and compliance items that should be examined prior to the merger of any retirement plan. Our approach is to have the plan administrator produce the records that support each item on the applicable checklist with a fiduciary signing off as to the completeness of the data or documentation. The gathering process, like the due diligence documentation process at the company level, will result in files being produced in a fashion that prepares the acquirer for the eventuality of any audit. Better yet, it allows the target or the acquirer to deal with the retirement plan representations and warranties in the transaction documents intelligently. One such approach is to take the defects (if any) that are uncovered and resolve them in the appropriate fashion, such as through one of the IRS's or the DOL's corrective compliance programs.
Terminating The Target's Plan
The other common alternative is to terminate the target's plan. This may sound like the more attractive option after having read our checklist for plan due diligence or the prospect of disqualifying the acquirer's plan if something is missed in the due diligence process and the two are combined. However, it is not without its own thorns. Some of you may be wondering why, in the context of an asset acquisition, it is even necessary to terminate the target's plan. After all, the acquirer is not assuming that plan and all (or most) of the employees will terminate from its payroll and become employees of the acquirer. Doesn't the target plan simply make pay outs to the terminated employees which they have the option of rolling over to the acquirer's plan? Of course, life is never this simple.
The first issue, of course, is whether the plan can be terminated. In this regard, we have to pay heed to the predecessor/successor plan rules for Code section 401(K) plans. If the acquirer wants the target to terminate its 401(k) plan, and distribute the assets to the participants, permitting them to roll over their account balances to the acquirer's plans, these special 401(k) plan termination rules must be taken into account.
In this regard, timing is almost everything. This is because the Code and Treasury regulations provide that a 401(k) plan may not distribute amounts attributable to a participant's cash or deferred elections until either: (i) the employee's separation from service, or (ii) the termination of the plan without the establishment or maintenance of a "successor plan" by the employer. Therefore, whether employees will be able to take distributions from the target's 401(k) plan depends upon whether either of those conditions is satisfied. So the art of the termination alternative is to do so before the acquirer and target become one employer, and to do so properly, before the transaction closes.
This notion that a plan can be terminated by the target prior to the closing date, and then have the target employees covered by the acquirer's 401(k) plan immediately after the closing date, is not without risk. This position requires the IRS to respect the distinction that the employer, at the time of plan termination, was the target, by itself, and that the employer, after the consummation of the acquisition, is a different employer. This may be difficult or strained if it is an acquisition of an entity that joins the acquirer's controlled group. In an asset acquisition, it may appear more straightforward. However, since there are no formal rulings upon which an employer can rely in support of this position, employers are forced to rely on informal comments from IRS officials that this approach is valid. Fortunately, the informal statements private letter rulings of the IRS appear to coincide with the common business sense notion of the distinction between pre- and post-transaction entities. Unfortunately, in some entity acquisitions, such as the more complex "reorganizations" that are specified in the Code, these acquisitions are structured specifically for the sake of maintaining continuity of interests, and actually may be an appealing basis for the IRS to consider the pre- and post-transaction entities to be the same employer. In particular, some reorganizations involve "spin-offs" of entities and it is not always clear just who was the predecessor employer. Each acquisition, therefore, must be viewed carefully. The pension lawyers and the deal makers must communicate well in advance.
Does This Matter?
It's difficult to say whether terminating the target's retirement plan makes a significant difference in terms of liability in an entity acquisition. As a practical matter, in most transactions, the target's retirement plans are terminated just before the completion of the transaction. The act of termination likely involves a formal act by a board of directors or the principals to "cease participation and accrual of benefits, accelerate vesting and terminate the plan." However, the act of filing for a determination letter and dealing with any asset/investment issues or administration concerns that come out of the woodwork, and are finally disclosed in the eleventh hour, always falls in the lap of the acquirer who is running the combined or acquired company after the deal closes. There is, therefore, no substitute for or way to avoid a certain amount of retirement plan due diligence in any business transaction. It may be necessary in an entity acquisition to have the acquirer specify that certain principals of the target remain in place as fiduciaries or plan administrators to oversee the "mop up" of the target's plan and to assume personal responsibility for what might be awry if there is good reason to impose personal liability. Therefore, our bottom line recommendation for all deal makers is that the plan due diligence be performed, the representations and warranties in the transaction documents be compared against the results of this due diligence, and responsibility for the cleanup of the plan compliance, fiduciary decisions, prohibited transaction, and even the minor and significant and operational defects be assigned and taken care of.
A Third Option?
In some situations, the form of transaction leaves no choice other than for the acquirer to maintain the target's plan and perhaps to combine the target's plan with the acquirer's plan some time after the acquisition. Sometimes, the qualified plan issues simply have to yield to the requirements of the transaction structure.
In these situations, however, all is not lost. Provided the necessary due diligence is done to identify compliance problems and the human resources departments of the companies can manage the delayed transition, it may be a palatable alternative. The Treasury regulations do provide transition rule relief from the Code's minimum participation and coverage requirements for the situation in which the target's plan must be maintained for a period of time. The regulations provide a special transition rule for a limited period of time for employers that have been involved in an asset or stock acquisition, disposition, merger or similar transaction. This special transition rule is available provided that: (i) plans of the parties to the transaction satisfied the coverage rules prior to the transaction; and (ii) there has been no significant change in either the terms of the plan or the coverage of the plans following the transaction (other than the inevitable transfer, hiring or termination of employees as part of the transaction).
But, what do these requirements mean? Once again, the facts of each plan situation vary, but we know them when we see them (or so we think). If these requirements are met, the affected plans are deemed to satisfy Code section 401(a)(26) (to the extent it is applicable) and Code section 410(b) and effectively, Code section 401(a)(4), for a transition period. The transition period extends from the effective date of the transaction until the last day of the first plan year beginning after the date of the transaction. So, for example, for a transaction which closes on January 2, 2008, the transition period for a calendar year plan would extend until December 31, 2009. The companies would have almost two years to deal with the eventual transition to a single plan. During that time, the employees can continue to participate in separate plans until all of the details are worked out, assuming the other issues in this article have been addressed.
What To Do?
At the risk of sounding like a broken record, mergers and acquisitions consultants and attorneys should start early to identify all of the qualified plans that may be affected by a proposed transaction. Can the parties really make those representations and warranties in the transaction agreement? What really is the condition of the plans? Don't kid yourself. Acquirers in any transaction are buying some retirement plan burdens, even if only administrative. The alternatives and tradeoffs involved in keeping and maintaining plans, absorbing plans, or eliminating plans must be carefully evaluated. Finally, competing priorities must be weighed against what might appear to be the most attractive alternative from a plan consultant's or plan attorney's perspective. Sometimes, the most desirable approach from a benefit planning perspective may have to yield to the requirements of the transaction. In either event, seek specialized assistance to ensure that all of the alternatives and tradeoffs are identified and evaluated.
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