M&A attorneys and advisors come to us for guidance on protecting their clients – buyers and sellers – from millions of dollars of employee benefits plan risk. They need practical solutions that avoid costly post-closing surprises. We support successful closings by bringing specialized experience in benefits due diligence to the transaction process.
The stakes are often high and time is usually short. So we focus on real, big picture risks. We work with deal counsel to efficiently quantify benefit plan risks and offer practical solutions to correct issues we identify and minimize the risk. We don’t hang up the deal with hyper-technical nit-picking.
Here are examples of what can go wrong during a merger or acquisition and how we can help.
An Efficient Approach to Due Diligence
Our phased due diligence approach puts business owners and their counsel in control of the process. Buyers need to identify material risks in an acquisition. Sellers need to identify benefits issues that may present material risks and provide solutions to those issues. This due diligence keeps the focus on real, big-picture risks and won’t bog you down with unhelpful technical details.
Underfunded or Unfunded Defined Benefit Retirement Plans
Underfunded or unfunded pension plans are among the most expensive problems to acquire. Not only must funding be made up, but there may be penalties involved. An underfunded multiemployer (union) pension plan could trigger withdrawal liability for the seller or the buyer. Single employer pension plans can surface with their own particular shortfalls. It may be that plan contributions didn’t meet minimum IRS requirements or worse that the contributions were never made. Both parties benefit from uncovering these problems early. The seller may be able to resolve the issue before the transaction. If not, due diligence provides an opportunity to negotiate a solution and avoid costly post-sale litigation.
Who has to provide COBRA coverage? That’s a question we often hear from transaction lawyers and their clients. The answer depends on a variety of factors. Was there a qualifying event? Is it a stock sale or an asset sale? Will the buyer continue the business operations associated with the assets without interruption or substantial change? Can the buyer and seller negotiate COBRA responsibility? These are just a few of the questions we’ll answer before you pick up COBRA as part of your next deal.
The Affordable Care Act (ACA)
There’s a mistaken notion that the ACA no longer applies to employers. But, the ACA is still in force and in 2018 the IRS started sending out noncompliance letters for plan years back to 2015. We’ve seen proposed assessments with six-figure penalties. We can work with buyers and sellers to make sure this problem doesn’t sink the deal.
Withdrawal Liability and Union Pension Plans
Withdrawal liability is a critical area of focus if the seller contributes to a union pension plan. Many union pension plans are seriously underfunded putting employers at risk of owing the plan hundreds of thousands or millions of dollars if the transaction triggers a withdrawal. It’s an issue that’s easy to get wrong due to misunderstanding, misinformation, and miscommunication. We guide our clients through the withdrawal liability rules to a solution that makes sense from structuring the transaction in a way that doesn’t trigger a withdrawal to negotiating indemnification provisions.
Plan Eligibility Mistakes
Retirement plan eligibility mistakes are third on the IRS list of the most common benefit plan errors. These errors are incorrectly excluding or incorrectly including employees. According to the IRS, this mistake most often occurs as a result of a merger or acquisition. The worst case scenario in a M&A deal is that employees of both buyer and seller become eligible for both sets of plans. The ambitious serial entrepreneurs we work with are almost always shocked to learn that these controlled group rules exist and that they apply to them. They’re also shocked to learn how expensive oversight eligibility errors can be.
Imprudent or Illiquid Retirement Plan Investments
Problems can lurk in 401(k) or other retirement plans that are invested in unusual or illiquid investments. We’ve uncovered incorrect ERISA bond amounts where investments were difficult to value, seen plan terminations that caused transaction delays because investments couldn’t be quickly cashed out, and other delays caused by incorrect Form 5500 due to additional reporting requirements for nontraditional assets. These types of last minute snags can all be cost-effectively avoided through routine due diligence.
Adverse Claims Experience in Self-funded Health Plans
An estimated 100 million American workers and their dependents are covered by a partially or fully self-insured company health plan. These plans are more common in larger companies but about 13% of employees covered under a self-insured plan work for companies with fewer than 200 employees. Because the employer bears the risk of unexpected employee healthcare costs, due diligence of a self-funded health plan is critical. An employee group with above-average injuries and illnesses can result in higher healthcare expenses than a buyer might anticipate. Several years of claims data surveyed during due diligence can help a seller and buyer gauge expected costs going forward so they can address issues in deal pricing and terms if needed.
Late Contributions to Retirement Plans and Miscalculated Matching Contributions
Contributions that are even a few days late and calculation errors in matching contributions can add up. These amounts must be deposited to the plan, including any missed earnings, and IRS penalties may apply. Late plan contributions can lead to an excise tax on the seller or on the buyer in a stock sale where the buyer takes on the seller’s plan. We can surface this issue if it exists and give the parties cost-effective options for resolving the problem.
Noncompliant 409A Deferred Compensation Plans
Most of the due diligence process centers on company-wide retirement plans such as the 401(k) and the healthcare plans. But nonqualified deferred compensation plans with 409A problems can have drastic tax consequences for executing, prompting some to take legal action against their employer.
The 409A rules are complicated to say the least and easy to get wrong. The draconian consequences of 409A errors can create a very unhappy executive team. Some errors can be corrected with little or no negative impact to the plan participants, but only if they’re found early. If 409A errors exist, we’ll identify them during due diligence and correct them before a seller loses out on a transaction or a buyer inherits a problem.
Missing, Inapplicable or Incorrect ERISA Reps and Warranties in the Purchase Agreement
“Copy and paste” ERISA reps and warranties are not okay. Your client deserves to have ERISA counsel review the purchase agreement in the context of their particular transaction. Here are some of the more common plan drafting issues we see in the ERISA reps and warranties.
- Representations that there have never been any mistakes made in any of the seller’s employee benefit plans are extremely unlikely and your client shouldn’t promise it. It’s better to include a defined materiality qualifier.
- Failure to directly address what will happen with the seller’s employee benefit plans or who will pay for COBRA. It’s better to document these points upfront so there is no confusion post-closing.
- Failure to accurately list the seller’s plans in the disclosure schedule.