M&A: Reducing the Buyer's Retirement Plan Fiduciary Exposure

Fiduciaries Face Complex Challenges

Fiduciaries of plans maintained by plan-sponsor buyers involved in a corporate transaction—stock or asset sale or merger or similar corporate transaction—face many questions and challenges with respect to the disposition of qualified retirement plans involved in the corporate transaction. While every corporate transaction is unique and each deal can pose its own set of retirement-plan-related challenges, there are some recurring issues under the Employee Retirement Income Security Act (ERISA) and the US Internal Revenue Code with which plan sponsors and their fiduciaries should be familiar and ready to address when their companies are engaged in a corporate transaction.

The Purchase Agreement: The Buyer's First Line of Defense

The overriding concern for plan sponsors and plan fiduciaries when their company is the buyer in the transaction is to ensure that the company and the buyer's plan are: (i) insulated, to the extent possible, from exposure to any pre-closing plan-related costs or other liabilities and (ii) not taking on any defects from the seller's plan that would jeopardize the buyer's plan's qualified status.

The first line of defense is in the purchase agreement. Ideally the purchase agreement should specifically state that the buyer is not accepting any liabilities related to both the operation of the seller's retirement plan(s) and the funding of those plans, although this is very rarely acceptable. If this cannot be achieved the agreement should include a robust "representations and warranties" (reps and warranties) section addressing benefit plan operation. It is important that these reps and warranties cover all aspects of plan operation, including without limitation whether or not the plan is qualified and whether or not the sellers know of any operational or other impairment that could reasonably be expected to impair the qualified status of the plan.

Finally, most purchase agreements include an indemnity section. Among other things, indemnity provides protection from to buyer in the event that the seller's reps and warranties prove not to be true. There are three important concepts imbedded in indemnity sections: (i) duration of the indemnity, (ii) the threshold amount of losses and damages that a buyer must incur before it is entitled to any indemnification (a/k/a the basket) and (iii) the limit of the indemnity liability for the seller (the cap).

Another external line of defense is the use of a representations and warranties policy. If the buyer has done strong diligence on the plans and can demonstrate that then a representations and warranties policy would cover any breach of the representations given with regard to the plans along with almost all the other reps and warranties.

Indemnities Require Detailed Examination

As to the duration, buyers will attempt to make the benefits reps and warranties "fundamental reps." This means, among other things, that there is no time limit on the duration of the indemnity. If a benefits rep and warranties cannot be designated as fundamental, the duration of the indemnity should be at least three years (the period of time that tax years are deemed "open" for review by the Internal Revenue Service), but it would be better to have them survive for seven years (the general statute of limitations period for ERISA claims).

The basket is a threshold amount at which indemnity starts—think of it as a "deductible." Frequently, actual costs incurred in fixing operational mistakes are time consuming and annoying, but don't rise, on their own, to the level of the basket. It is worth discussing with deal counsel whether benefits claims can be carved out of the basket.

Similarly, the cap is not usually a significant issue for fiduciaries and plan sponsors, because they are often set at a high number (often a percentage of deal proceeds). However, buyers buying a company that has or has maintained in the past a pension plan or welfare retirement plan or has contributed to or contributed to in the past a multi-employer pension plan, should consider whether the cap is sufficient with respect to a worst-case scenario with those plans.

Also important in the purchase agreement is whether or not all plans providing possible exposure to liability are captured by the reps and warranties and are properly disclosed. For the most part, if the seller has only sponsored or maintained its own retirement plan, then this is easily achieved by identifying the plans to which the reps and warranties apply. More troublesome is when the buyer has subsidiaries or other related entities (so-called ERISA Affiliates) that may not be part of the deal.

Subsidiaries Can Include Hidden Liabilities

An ERISA Affiliate is a subsidiary or parent of the selling company and any other entity that will be considered to be part of a "controlled group of companies" under Code Section 414. In general, entities are considered to be in a controlled group if there is a parent-subsidiary relationship or a brother-sister relationship between two or more entities. (A full discussion of these rules is beyond the scope of this article.)

Under ERISA, members of a controlled group (and their assignees or transferees—like a buyer in an acquisition) can be joint and severally liable for claims related to certain types of benefit claims, which include:

• Funding obligations for a pension plan;
• Pension plan termination liabilities;
• Premiums owed to the Pension Benefit Guaranty Corporation (PBGC);
• Multiemployer (union) plan withdrawal liabilities;
• COBRA liabilities; and
• Liabilities related to health benefits provided to retirees.

Fiduciaries and plan sponsors may be surprised after a deal closes to find out that they have assumed liability for costs incurred in an ERISA Affiliate's plan and because the document was not drafted properly, they have no indemnity recourse against the sellers.

This means that an unknowing buyer may obtain costly liability for benefits and related costs for plans sponsored by members of seller's controlled group that buyer didn't even know existed. Careful drafting on the part of buyer's counsel will ensure that representations regarding the existence of these arrangements—and any liabilities related to them—will be addressed in the agreement.

M&A Agreements Require Skilled Expertise

Plan fiduciaries and plan sponsors—including benefits and human resources professionals—who work for acquisitive companies should take time to discuss these important issues with deal counsel to ensure that these types of concerns are addressed in the deal document.

Woodruff Sawyer is uniquely qualified to help you examine M&A agreements before you discover any surprises that may jeopardize your current plan. Aligning your retirement, stock-options, and employee benefit plans will help your M&A go smoothly and avoid any regulatory or financial misjudgements.