M&A Retirement Plans: Reducing Buyer Exposure with Due Diligence

Retirement plans amidst M&A can have serious flaws, protecting buyers. In a merger or acquisition, due diligence is the buyer’s second line of defense.

Due diligence exposes M&A retirement plan flaws, thus protecting buyers. In a previous article on fiduciary and plan sponsor concerns in mergers and acquisitions, we addressed buyer concerns about key provisions in an M&A purchase agreement. This article focuses on the buyer’s second line of defense: due diligence.

Magnifying Glass and a Calculator resting on a desk

M&A Purchase Agreement and Due Diligence: The Buyer's Lines of Defense

In a merger or acquisition, the purchase agreement is the buyer’s first line of defense. Buyers should require the seller to provide all plan and related documentation for full transparency. After conducting a thorough review of representations and warranties, buyers will gain assurance regarding the plan's prior operation. Depending on the type of M&A transaction, buyers can also insulate themselves by limiting or excluding liability for the seller's benefit plans and include those limitations in the purchase agreement.

Performing due diligence is the buyer’s second line of defense. However, the type of due diligence analysis will vary depending on the M&A transaction. For instance, if the buyer is only purchasing the seller's assets, they may conduct a limited review or forego it entirely, merely relying on the seller's representations and warranties. However, in a stock deal where a full or partial equity interest is purchased, the buyer will often conduct an extensive due diligence analysis that includes a detailed review of the seller's plan documentation and operational diligence. More commonly, due diligence falls between these two approaches.

Documentation and Operational Diligence Protect the M&A Buyer

Robust documentation and operational diligence review will help the buyer determine if they should maintain the seller's plan as a separate plan or merge it into the buyer's plan. Due diligence analysis reveals if there are operational defects or fiduciary breaches when performed by a qualified fiduciary, which can taint the buyer's plan's qualification status.

Documentation and Operational Diligence in M&A
Documentation diligence includes a review of plan documents and the summary plan description (SPD) to ensure they are current and consistent, have all required amendments, and are compliant with applicable laws. Documentation diligence includes examining required filings (i.e., 5,500 annual reports), notices, federal regulator correspondence, and related documents.
Operational diligence evaluates the plan’s compliance with applicable laws and the plan document terms. One key area includes assessing whether the seller allocated participant’s deferrals to their plan accounts on a timely basis. To determine how quickly these amounts were allocated, fiduciaries will examine payroll registers and allocation reports to ensure the seller has managed the plan in a compliant manner.

In M&A, Terminating a Retirement Plan is Tricky

After documentation and operational diligence are complete, the buyer’s fiduciaries will recommend the buyer maintain the seller's plan or terminate it before closing the M&A deal. If the buyer retains the seller’s plan, they can operate it as a free-standing plan or merge it into the buyer's plan. However, every deal has unique facts and concerns, and there is no one-size-fits-all answer.

For example, in a simple asset deal where the seller sponsors only a defined contribution retirement plan such as a 401(k) or profit-sharing plan, benefits counsel usually advises the seller to terminate the plan the day before closing the M&A deal. First, the buyer benefits from being insulated by any existing defects in the seller’s plan. Second, the law permits 401(k) distributions at termination that are not permitted when the plan is terminated after closing, allowing plan participants to rollover account balances to the buyer's plan or an IRA. Finally, the buyer's plan's fiduciaries are not legally involved in the disposition of the seller's plan, nor do they become fiduciaries of the plan.

Terminating a defined benefit plan is complex and includes notice provisions, IRS and Pension Benefit Guaranty Corporation (PBGC) filings, complicated actuarial work, and a host of other tasks.

There are instances when terminating a plan before close is not practical, especially if the seller sponsors a defined benefit plan. If there are thousands of active participants or the plan has a complicated design, it may not make sense to terminate the seller's plan. Also, defined benefit plans must be fully funded at termination, making it an expensive proposition for some companies.

The buyer may choose to continue the seller's defined contribution plan and possibly merge it into their existing plan. Prior to the close, fiduciaries must understand their level of responsibility for the seller’s plan after closing, which will establish expectations and ensure a smooth transition. If the buyer’s fiduciaries have post-closing responsibility for the plan, they should ensure that participants’ account balances are accurate and operations move forward unimpeded.

If the buyer has an active investment or plan committee, they should be fully informed of the seller's defined contribution plan. This helps ensure a seamless administration of the company's plan, allowing the advisory committee to view all the buyer’s retirement plans in their entirety.

M&A Buyers Limit Liability Using Both Defenses

Buyers can use their two defenses, the purchase agreement, and due diligence, to limit liability and ensure compliance while still providing valuable retirement benefits to employees. While each M&A scenario is unique, buyers will improve their outcomes by working with reliable, independent advisors, competent ERISA counsel, and expert fiduciaries. This team of professionals will help buyers navigate even the most complicated retirement plan due diligence challenges.

Your Employees Depend on their Retirement Plans

M&A transactions present unique challenges for buyers. Due diligence is a critical way to prevent firms from taking on unnecessary liability and confusion for administrators and employees. Woodruff Sawyer provides a nationally recognized retirement plan team with deep M&A experience. In addition to making sure your plans are competitive and compliant, they can partner with you when you have M&A on your radar to help you address potential pitfalls and identify opportunities you should consider during the transaction. For more information, reach out to your Woodruff Sawyer advisor.



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