1. Duty trumps loyalty?

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1 1. Duty trumps loyalty? Facts: Trump Corp has 245 employees, 225 of whom are eligible for its 401(k) plan. The plan is ADP-tested. It provides a match equal to 50% on the first 10% of compensation deferred. It also provides for a discretionary profit sharing contribution. Annual PS contributions have averaged 3% per year. Booze Cruz has 32 employees, 30 of whom are eligible for the 401(k) plan, which is a safe harbor plan. Booze Cruz s plan matches 100% on the first 5% of compensation deferred. It allows for a discretionary profit sharing plan but the company has not made that type of contribution in several years. Trump has purchased the assets of Booze Cruz (tangible and intangible, although goodwill has been valued at zero). The acquisition, which is effective August 1, 2017, involves the following terms. Trump agrees to hire all of the Booze Cruz employees, 2 of whom are the owners of the business. They are hired effective August 1, Trump does not want to take over the Booze Cruz plan. Both plans are on a calendar year Booze Cruz wants to make sure its employees do not experience an interruption of retirement savings. a. Discussion #1. Coverage of Booze Cruz employees in the Trump Plan. Discuss the following issues. i. How the Trump plan should cover the Booze Cruz employees so that they have uninterrupted coverage in a 401(k) plan. ii. What the ramifications are to the Cruz safe harbor plan for the 2017 plan year. iii. How ADP-testing is addressed in the Trump plan for the 2017 plan year. iv. How is the HCE test applied to the former Cruz employees under the Trump plan? v. Distributions to Cruz employees from the Cruz 401k plan. vi. The coverage transition rule under IRC 410(b)(6)(C) and how that applies to the Trump plan if the plan is amended to grant prior service to the Cruz employees or to identify the Cruz employees as a separate class of eligible employees who are exempt from the plan s eligibility requirements. vii. Application of the IRC 402(g) and IRC 415 limits by the Trump plan with respect to the former Cruz employees. b. Discussion #2. Trump and Cruz negotiate an arrangement where the Trump plan will be amended to provide the greater of the matching formula under the two plans to a former Cruz employee, but only for the 2017 plan year. What issues does this scenario present? 1

2 c. Discussion #3. Suppose instead that Cruz convinces Trump to takeover its plan. Discuss issues relating to the following scenarios, including, if applicable, the issues addressed in a. above. i. Trump takes over the Cruz plan but freezes contributions. Cruz employees become participants in the Trump plan effective August 1, ii. Trump maintains the Cruz plan as an active plan. It amends the Trump plan to provide that employees who are eligible for the Cruz plan are excluded from the Trump plan. iii. Trump merges the Cruz plan into its plan, but on a post-august 1 basis, the Cruz employees are only entitled to the Trump match going forward. iv. Trump agrees to turn its plan into a safe harbor 401(k) plan, identical to the Cruz plan, and merges the two plans. v. Trump maintains the Cruz plan as a separate plan for the remainder of the 2017 plan year. Effective January 1, 2018, the plans are merged and the Trump plan is amended into a safe harbor 401(k) plan. The plan uses the safe harbor nonelective contribution approach, but leaves its matching formula as 50% on the first 10% of compensation deferred. d. Discussion #4. Assume the Cruz plan has a June 30 plan year end. The Cruz plan is merged into the Trump plan effective August 1, What effect would this transaction have on the two plans? Would it matter if both plans were ADPtested? Would it matter if the transaction occurred a month earlier and the merger took effect on July 1, 2017? 2

3 2. Orange you glad I didn t say merger? Facts: Orange Prisons is a private corporation that provides prison facilities for contracting local and state governments. It maintains a safe harbor 401(k) plan for it employees. It provides for a safe harbor match of 100% on the first 6% deferred. It also provides for a discretionary profit sharing contribution with a permitted disparity formula. Orange purchases the stock of another private prison provider, Black Correctional Works, on March 18, Black Correctional is a small company, with only 25 employees. The 100% owner of Black Correctional is Piper. Her stock is acquired by Orange in exchange for cash and a 2% stake in Black Correctional. Black also maintains a safe harbor 401(k) plan. The plan provides for a match of 100% on the first 3% deferred, plus 50% match on the next 2% deferred. It also provides for a discretionary match. a. Discussion #1. As of March 18, 2018, Black becomes the wholly-owned subsidiary of Orange. Both companies continue to maintain their respective plans without change. Discuss the following issues relating to this scenario. i. Distribution rights of the Black employees under their 401(k) plan. ii. Catch-up contribution rights (e.g., only the Orange plan has a catch-up feature and the Black plan does not). iii. Status of safe harbor provisions during the 2018 and 2019 plan years, assuming no changes are made to the coverage of the respective plans, or the plan allocation formulas. iv. Determination of HCEs. v. The effect of a discretionary match declared by Black for the 2019 plan year. vi. Effect of different benefits, rights and features (BRFs) under the two plans. vii. The application of the top heavy rules if, as of the end of the 2017 plan year, the Orange plan was not top heavy but the Black plan had a top heavy ratio exceeding 60%. viii. Plan design options for the 2020 plan year. b. Discussion #2. Instead of maintaining the respective plans, Orange decides that it will have the Black subsidiary merge its plan into the Orange plan. It does so on June 30, Discuss the following issues relating to this scenario. i. Design of the merged plan to provide for the two separate matching formulas through the end of 2018, and then adopting the Orange formula for all covered employees effective January 1, ii. Pursuant to the merger, application of the Orange matching formula to all covered employees, effective July 1, 2018, including the Black employees who become eligible for that plan as of the merger. iii. Contribution of a discretionary match under the merger plan for the 2018 plan year, pursuant to the formula that was in the Black plan prior to the merger. 3

4 iv. Existing participant loans in the Black plan. Include in the discussion the issue of payroll deduction on loan repayments being suspended during a transition period when the plans are being merged. v. Differences in investment options under the two plans. c. Discussion #3. For this discussion, assume the plans remain separate at least for 2018 and Discuss how IRC 401(a)(4) testing is applied to the allocation formula under the Orange plan. What additional issues arise if, effective January 1, 2019, the Orange plan is amended to adopt a new comparability formula. What effect on the 2018 plan year if the amendment is adopted on October 15, 2018, and made effective for the current plan year (plan includes a last day employment requirement for allocations). d. Discussion #4. Suppose the plans are not safe harbor 401(k) plans. Discuss the approach that would be taken to ADP and ACP testing under the two plans if they remain separate for the remainder of the 2018 plan year. Different approach if merged during the 2018 plan year? e. Discussion #5. For this discussion assume the plans remain separate. As part of the acquisition negotiations, the parties agreed that Orange would amend the Black plan to adopt the enhanced matching formula that is contained in the Orange plan. Discuss the following scenarios. i. The Black plan is amended on June 15, 2018, to adopt the enhanced formula that is in the Orange plan, effective prospectively for elective deferrals made on or after July 1, ii. The Black plan is administered by Crazy Eyes & Associates. It was directed by the Orange management that, pursuant to the acquisition agreement, the Black plan was to be amended to provide for the same enhanced match that is provided by the Orange plan. The change in the match is communicated to the Black employees, but it is discovered in September 2019, that the amendment has not been prepared and executed by the Black corporation. f. Discussion #6. Instead of continuing the Black plan, as in the prior discussion, the parties decide in their negotiations to terminate the Black plan. Discuss the following issues. i. Timing of the termination. ii. A decision is made to cover the Black employees in a stand-alone profit sharing plan after the acquisition. Does it matter whether this is accomplished by: (1) amending the 401(k) arrangement under the Black plan and adding a PS contribution going forward, or (2) terminating the 401(k) plan before the acquisition date, and have Orange establish a new profit sharing plan sometime after the acquisition? iii. Coverage of the Black employees in the 401(k) plan maintained by Orange. 4

5 3. Breaking plans Facts: Mr. White owns Heisenberg Inc., which maintains a safe harbor 401(k) plan and a defined benefit plan. Jesse, who is one of Heisenberg s top managers, has decided to form a separate company, Blue Sky Corporation. Mr. White agrees that the line of business that Jesse manages should be sold to Blue Sky. Blue Sky buys the assets of that line of business on May 1, The Heisenberg plans are on a calendar year. Discuss the following issues. As part of the asset acquisition, Blue Sky hires 40 of the 250 employees who work for Heisenberg. These employees currently participate in the safe harbor 401(k) plan and in the cash balance plan. Discuss the issues presented by the following scenarios. a. Discussion #1. Blue Sky establishes a new safe harbor 401(k) plan effective July 1, It provides for immediate eligibility so the acquired employees will be immediately eligible. b. Discussion #2. In September 2018, a new deal being negotiated by Jesse indicates that it will be doing a significant amount of new hiring over the next 12 months. Blue Sky amends its safe harbor 401(k) plan to require one year eligibility effective October 1, c. Discussion #3. Blue Sky decides to adopt both a 401(k) plan and a defined benefit plan and agrees to have the account balances and accrued benefits of the acquired employees under the Heisenberg plans to be directly transferred to the respective plans. Note: For Discussions #4-#7, do NOT assume Blue Sky agrees to transfer of benefits. d. Discussion #4. The cash-out of the benefits of the Heisenberg employees who go to work for Blue Sky and the determination of their vested interests in the 401(k) and DB plan. Consider the effect of their immediate participation in the Blue Sky 401(k) plan. e. Discussion #5. Heisenberg s liability for safe harbor contributions under its 401(k) plan and the accrual of additional benefits under the defined benefit plan with respect to the employees who transfer to Blue Sky. f. Discussion #6. Heisenberg pays out mid-year bonuses on June 30, Some of those bonuses are paid to employees who went to work for Blue Sky. The Heisenberg plan allows for deferrals out of bonuses. Also consider the effect of the bonuses being paid on January 20, 2019, instead, but some of those bonuses are still paid to employees who went to work for Blue Sky. g. Discussion #7. The effect of IRC 436 distribution restrictions under the Heisenberg defined benefit plan due to an AFTAP below 60%. 5

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7 4. We are never getting back together Taylor and Calvin are owners of two corporations: Red Lipps, Inc., and Dee J Musicworks. Due to irreconcilable differences the two decide to buy each other out and maintain separate companies. Accordingly, effective August 1, 2018, Taylor becomes the 100% owner of Red Lipps and Calvin becomes the 100% owner of Dee J. At the time of the split, the companies jointly maintained a 401(k) plan. Discuss the following issues. a. Discussion #1. Continue maintenance of the plan by the two corporations. Consider both if the plan is ADP-tested and if the plan is a safe harbor 401(k) plan. b. Discussion #2. A decision by Dee J to adopt a new defined benefit plan. Consider the effect of counting prior service to determine a participant s benefit, including average compensation, under the new defined benefit plan. c. Discussion #3. A decision to split the 401(k) plan into two separate plans effective August 1, 2018, with each company maintaining its respective spinoff 401(k) plan. The terms of the plan remain identical at least through the 2018 plan year. Take into account the differences (if any) if the plan is ADP-tested or a safe harbor 401(k) plan. d. Discussion #4. A decision by Dee J, following the division of the plan, as described in c. above, to terminate the 401(k) plan in conjunction with adopting the defined benefit plan described in b. above. 7

8 Reference materials The following material is taken from Section VII of Chapter 15 of The ERISA Outline Book. It is a checklist on merger and acquisition issues and should be used in conjunction with the discussion of the case studies above. * * * This section provides reference tools for dealing with the following transactions: merger of two or more qualified plans, a spin-off of part of a qualified plan into a separate plan, or a transfer of assets between plans. This section also address the effect of company-level transactions (e.g., corporate merger, asset acquisition or stock acquisition) that may or may not result in plan-level changes or a modification of the way the qualification requirements are applied to the plans maintained at the time of the company-level transaction. Part A. of this section provides definitional information, including definitions of plan-level and company-level transactions, definitions of stock acquisition and asset acquisition, and definitions of plan merger, plan spin-off, and a direct transfer of assets. Part B. of this section is a checklist of issues to consider when these transactions occur. Part A., Definitions of merger, transfer and spin-off for qualified plan purposes The resolution of the qualified plan issues addressed in this section may be affected by whether a plan transaction is involved, a company transaction is involved, or both types of transactions are involved. Plan transactions include a merger of two plans, a spin-off of assets from a plan to form a new plan, or the direct transfer of assets from one plan to another. See 1. below. Company transactions include a change of ownership in one or more businesses, the acquisition of all or part of the assets of a business, or the merger of two businesses. See 2. below. 1. Plan transactions. A merger is a consolidation of two or more plans into a single plan. A spin-off transaction is the splitting of a plan into two or more plans. A direct transfer of assets or liabilities from one plan to another, is a direct transfer of the assets or liabilities attributable to one or more participants in the plan to another plan. The IRS views a direct transfer as a twostep transaction: first a spin-off of the assets and liabilities being transferred from the first plan, and then a merger of that spin-off into the second plan. See Treas. Reg (l)-1(o). Any of these transactions must satisfy the requirements of IRC 414(l). A participant's benefits cannot be reduced because of a merger, transfer, or spin-off transaction. The employer(s) sponsoring the plans involved in these transactions may unilaterally decide to enter into the transaction, without obtaining the consent of the employees participating in the plans. 1.a. Merger transaction. Before merger: Plan #1 and Plan #2 exists 8

9 After merger: There is only one surviving plan, with the assets of Plan #1 of Plan #2 transferred to the surviving plan. The surviving plan might be identified as Plan #1 or Plan #2, or it might be identified as a new plan (Plan #3). 1.b. Spin-off transaction. Before spin-off: Plan #1 exists After spin-off: Part of Plan #1 is transferred out of the plan. The transferred assets constitute a spin-off. Spin-off becomes Plan #2, either as a newly-established plan, or through a merger with another existing plan. 1.c. When does a merger or transfer actually occur? When assets of a plan are being merged or transferred into another plan, a legal issue may arise as to when that merger or transfer has actually occurred. Here's where the legal documents are so important. Good plan practice is to draft a written merger/transfer document executed by both plans involved in the transaction. This document should include an effective date for the merger/transfer. As part of any merger or transfer, the assets of the transferor plan must be re-titled in the name of the transferee plan. In some cases, that re-titling process may extend beyond the effective date of the merger or transfer. Nonetheless, from a legal standpoint, the effective date of the merger or transfer will usually control. For example, suppose on May 1 two plans enter into a merger agreement in which Plan #1 is merged into Plan #2 effective as of the close of business June 30. This means the assets of Plan #1 must be retitled in the name of Plan #2. The trustees then proceed to retitle the assets of Plan #1. However, some of Plan #1's assets are not retitled until sometime after June 30. Nonetheless, from Plan #1's prospective, it should show its assets transferred as of the close of business June 30, and reflect a zero balance as of that date. As of July 1, the trustees of Plan #1 are merely holding title to assets that now legally belong to Plan #2. This issue can have important consequences for Form 5500 filing purposes, for example. If the re-titling of the assets extends beyond the close of the plan year, one might argue that the transferor plan has entered a new plan year and must file another Form If the effective date of the merger is the legal date of the transaction, then a new Form 5500 filing would not occur. In our example, if Plan #1's plan year ends June 30, a final return could be filed for that plan year, even if some of the assets have not been formally retitled as of that date. 1.c.1) Prospective effective date. This effective date issue for the merger or transfer assumes the effective date is prospective. Such a transaction should be prospective anyway because of the potential 30 days' advance notice requirement (see Form A). From a legal standpoint the transferor plan should be considered to own the assets at least through the date the transaction documents are executed and become legally binding. 9

10 2. Company transactions that might trigger plan issues. This section will also deal with company transactions that may trigger plan issues. For example, when one company (buyer) acquires another (seller), the acquisition might trigger the merger of seller's plan into buyer's plan, the spinoff of a portion of seller's plan into a separate plan maintained by the buyer or into the buyer's existing plan, or the termination of a plan maintained by the seller. Employee benefit plan issues will rarely make or break a company transaction. But the employee benefit plan considerations may affect how the company transaction is structured and may affect the purchase price for the company (or portion of a company) being sold. The following company transactions are considered in these materials. 2.a. Change in related group members/acquisition of stock or other equity interest. Previously unrelated companies become part of a controlled group (as described in IRC 414(b) or (c)), or affiliated service group (as described in IRC 414(m)) because of a change in ownership of the businesses involved. For example, the stock of a company might be purchased entirely by another company, or by the controlling owner of another company. Companies are "previously unrelated" even if they had some common ownership or a prior business relationship, so long as the common ownership or business relationship did not rise to the level of a controlled group or affiliated service group. Example - new subsidiary. Corporation X buys 100% of the stock of corporation Y from an unrelated third party. Immediately prior to the transaction, X and Y were not part of a controlled group. Immediately after the transaction, X and Y constitute a parentsubsidiary group under the controlled group definition. Example - brother-sister relationship is created. Jason owns 100% of corporation W and 20% of corporation Z. The other 80% of Z is owned by an unrelated person. W and Z are not controlled group members because the common ownership is not enough to satisfy the definition of a controlled group. Jason purchases the other 80% of the stock in corporation Z. After the transaction, Jason is the 100% owner of both companies, so W and Z constitute a brother-sister group under the controlled group definition. Example - formation of affiliated service group. Five independent medical practices are each owned by a different physician. Each practice is a separate professional corporation. The five corporations form a partnership. After the transaction, a partnership exists, which employs the employees of the five corporations. Each physician continues as the employee of his or her respective corporation, but now each corporation is a partner of the partnership. The transaction results in an affiliated service group relationship among the five professional corporations and the partnership. The professional corporations are "A-Organization" of the partnership (as the "First Service Organization") under the affiliated service group definition described in IRC 414(m)(2)(A). 10

11 2.a.1) Plan issues. By virtue of an acquisition of ownership (e.g., stock), the buyer automatically assumes the seller s plan. In the first example above, X assumes the responsibilities of any plan maintained by the newly acquired subsidiary (Y). In the second example above, Jason, as the new 100% owner of Z, assumes the responsibilities of Z s plan. In addition, after the transactions described in the first two examples, the companies involved are now members of a controlled group which may assume joint and several liability with respect to certain plan liabilities. These issues are addressed later in these materials. In the third example above, the partnership is now part of an affiliated service group with five other companies, and any plan continued by the separate professional corporations are now plans maintained within that new affiliated service group. 2.a.1)a) Negotiation. Because of the related group liabilities resulting from the above transactions, the buyer may negotiate with the seller to have the selling company terminate its plan before the acquisition. Usually a termination before the company transaction will be necessary to eliminate (or minimize) potential liabilities to the buyer (or to the new related group members). 2.a.1)b) Less flexibility when addressed after the transaction. If the employee benefit plan issues are addressed after the transaction closes, there may be less flexibility in dealing with certain issues, including the distribution of benefits with respect to the plan maintained by the acquired company, the funding of benefits accrued prior to the transaction, and the crediting of service earned prior to the transaction. These issues are addressed later in these materials. 2.b. Acquisition of the entire assets of a business. In these transactions, a business purchases the assets of a business. After the purchase, the company being purchased is liquidated. Example. Corporation A and corporation B are independent businesses, separately owned, and are not part of the same controlled group or affiliated service group. A purchases the assets of B. After the transaction, the B employees become employees of A. B liquidates. In these transactions, what should be done with the qualified plan maintained by B? If A is not willing to assume sponsorship of the plan, the plan will generally terminate. A can assume sponsorship one of two ways: (1) merge B's plan (or the portion of B's plan that covers the acquired employees) into a plan maintained by A, or (2) become the successor sponsor of B's plan and continue to maintain it as a separate plan. Under (2), 11

12 the separate plan could be a frozen plan (i.e., no additional benefits will accrue under the plan while it is maintained by A) or it could be an active plan (i.e., A will contribute to the plan). 2.b.1) Plan issues. When there is a complete asset sale, the seller remains responsible for the plan unless the parties in the company transaction negotiate otherwise. There are the following possibilities. 2.b.1)a) Seller might terminate its plan. This may trigger certain liabilities, distribution issues, and other issues that are considered in these materials. When there is a complete asset sale, the seller s plan will usually terminate unless the buyer agrees to sponsor the plan. If the buyer maintains a plan, but does not assume sponsorship of the seller s plan, the buyer must decide whether its plan will credit the acquired employees with their service with the seller, and whether (and, if so, when) the acquired employees will be eligible for its plan. 2.b.1)b) Seller might continue the plan. The seller might decide to continue the plan, at least during the period that the seller winds up its business. Issues here include the disposition of the benefits held for the employees who no longer work for the seller because of the sale, whether distribution is available with respect to those benefits, whether a partial termination has occurred for vesting purposes. These issues are addressed later in the materials. 2.b.1)c) Buyer might continue seller s plan. The buyer might agree to continue the seller s plan with respect to the employees now working for the buyer because of the company transaction. If all, or substantially all of the seller s employees now work for the buyer, the buyer might simply adopt the plan as a successor sponsor, or merge the entire plan into its plan. This triggers a number of issues with respect to the plan continued by the buyer, including the crediting of service with the seller under the buyer s plan, the protection of optional forms of benefit if plans are merged, and liabilities assumed by the buyer. These issues are addressed later in the materials. 12

13 2.c. Acquisition of a portion of the assets of a business. This type of transaction could take two basic forms: (1) the acquisition of the assets of a separate trade or business, division or operating unit within the company, or (2) the acquisition of the assets of a separate subsidiary corporation. Example - purchase of separate division. Corporation F operates three separate divisions (Division A, Division B and Division C). Each division has a substantially separate workforce and management structure, and is a separate profit center. Corporation L purchases the assets of Division B. After the transaction, Corporation L employs the employees of Division B, and Corporation F continues to exist, but now with only Divisions A and C. Example - purchase of assets of subsidiary. Suppose in the prior example that F is a holding company, and A, B and C are separate subsidiary corporations. L purchases the assets of Subsidiary Corporation B. After the transaction, Corporation L employs the employees of Subsidiary Corporation B. Corporation F liquidates Subsidiary B, and continues to exist as the parent company of Subsidiary Corporation A and Subsidiary Corporation C. 2.c.1) Plan issues. In these transactions, since only part of the seller is purchased, the seller usually continues after the transaction, but it no longer employs the employees who are transferred to the buyer as part of the transaction. Like the complete asset sales described in 2.b. above, in the partial asset sale the seller remains responsible for the plan unless the parties in the company transaction negotiate otherwise. What if Division B employees in the first example are covered under a plan? Similarly, what if Subsidiary Corporation B in the second example maintains a qualified plan that covers the acquired employees, or is a participating employer in a qualified plan that is jointly sponsored by all the controlled group members? The following possible scenarios may result in the above examples: 2.c.1)a) Buyer s plan accepts transfer. Corporation L might agree to have the benefits of the acquired employees transferred into its existing plan. This will transfer certain liabilities to L with respect to those benefits, will require L to credit service that the acquired employees earned with the seller, and affect the application of other qualification requirements under L s plan. These issues are addressed later in these materials. 2.c.1)b) Buyer sponsors separate successor plan for acquired employees. Corporation L might agree to have the benefits of the acquired employees spun-off into a separate plan, and L becomes the 13

14 successor sponsor of that plan. If the plan covering the acquired employees is already a separate plan, there will be no need for a spin-off. L will simply become the successor sponsor of that plan. In either case, the consequences to L are similar to those resulting from a merger of the seller s plan into L s plan. 2.c.1)c) Benefits not transferred to buyer s plan nor assumed by buyer in a successor plan. The benefits of the acquired employees might not be transferred to L's sponsorship under one of the two prior scenarios. In that case, the seller remains responsible for the plan. Where the acquired employees are part of a plan that covers other employees of the seller (Corporation F, or one of the F s controlled group members, in the case of the second example), those benefits might be distributed from that plan, but it must first be determined whether a distribution event has occurred under that plan. If the acquired employees are part of a separate plan, the seller might terminate or freeze the plan instead, or merge it into another plan maintained by the seller. 2.d. Two companies merge in a statutory merger. In a statutory merger, the surviving company after the transaction is the successor of the two prior companies. For plan purposes, a statutory merger is most similar to a stock acquisition. It s as if one company (the buyer ) acquired all the stock of another company (the seller ) and then merged the seller into the buyer. In these transactions, any plans maintained by the companies before the merger become the responsibility of the surviving company unless those plans are terminated before the merger. Following the merger, the surviving company might terminate one or more of the plans, merge one or more of the plans, or continue each of the acquired plans as a separate plan. Each of these possible scenarios comes with its own set of plan issues which are addressed in these materials. 2.d.1) Example. Corporation Q and Corporation R exist as two separate corporations. They are not part of a controlled group. Q and R merge to form Corporation QR. The employees of both businesses now work for QR. Both companies maintained 401(k) plans. After the merger, Corporation QR is now the sponsor of two 401(k) plans. From a plan perspective, this transaction has the same effect as if Q purchased all of R s stock, making R the subsidiary of Q, and then liquidated R by merging it into Q. Decisions regarding continued maintenance of plans. In the example, the merged company will have to make decisions about the maintenance of the plans. It might continue to maintain them as separate plans, particularly if QR will operate as two separate divisions, each reflecting the business activities and 14

15 workforces of the previously separate companies. It might merge the plans together. 2.d.2) Change in form of entity. A similar issue arises when a business continues following a change of the type of business entity (e.g., a sole proprietorship incorporates, or a partnership becomes a limited liability company under state law). In most cases, the new business should be treated in all respects as the continuation of the old business. 3. What is the difference between an asset sale and a stock sale? Some of the company transactions described above involve a sale of the assets of a business (or a portion of a business' assets) to a buyer. Other transactions involve a sale of stock (or other equity interest, such as a partnership interest) in a company. How the company transaction is structured might impact how some of the qualified plan issues are applied, as will be discussed in the checklist in Part B. Therefore, it is important to understand the difference between an asset sale and a stock sale. 3.a. What is a purchase of assets? A purchase of assets is the acquisition by a company of the business assets of another company (e.g., equipment, building, accounts receivable, goodwill) in exchange for consideration, such as cash or stock in the purchasing company. The seller in this case is the company which is selling the assets and it is the company which receives the consideration for the sale. The shareholders of the acquired business retain their shares in the business that sells the assets. If all of the assets of the business are sold, the shareholders will usually proceed to liquidate the company. In redemption of his/her stock (or other equity interest), each shareholder receives a distribution of his/her share of the assets of the company (e.g., the cash received from the buyer in exchange for the assets). The business documents (e.g., sales agreement) will usually make clear what the nature of the transaction is. 3.a.1) Example - sale of 100% the company's assets. Lydia and Stanley own 100% (50% apiece) of Corporation X. A sale of 100% of X's assets is negotiated with Corporation W. After the sale, W owns X's assets and assumes responsibilities for conducting the business that X formerly conducted when it owned those assets. In exchange for the assets, X receives $800,000 in cash. X is then liquidated and Lydia and Stanley, in redemption of their stock in X, receive $400,000 apiece. 3.a.2) Example - sale of 100% of assets of a subsidiary. The Larson Company, a retail chain, owns 100% of a subsidiary, Morgan Apparel. Larson sells the assets of Morgan Apparel to an unrelated company. In exchange for the assets, Morgan Apparel receives $25 million. Larson, as the sole shareholder of Morgan Apparel, 15

16 then liquidates Morgan Apparel and the $25 million are distributed to Larson Company. 3.a.3) Example - sale of portion of assets. Suppose in the prior example that Larson Company sells only one division of Morgan Apparel. This division sells a line of teen clothing. The unrelated company, AberGap, purchases the teen clothing division for a price of $5 million. Morgan Apparel, as the seller, is the recipient of the cash. Morgan Apparel might use that cash to expand its remaining business, which is operated with the assets that were not sold, or to enter a different business line. In addition, some or all of the cash might be distributed to Larson Company, as the sole shareholder of Morgan Apparel. 3.b. What is a purchase of stock (or other ownership interest)? A purchase of stock is the acquisition by one or more companies or individuals of the stock of a company in exchange for consideration, such as cash or stock in the purchasing company. The sellers in this case are the owners of the company being purchased. They are selling their ownership interests and receiving consideration in return. After the sale, the business is owned by the buyers. In the case of a sale of stock, the stock certificates are reissued in the name(s) of the buyer(s). In a noncorporate equity sale, such as the sale of a partnership, the sale involves the transfer of partnership interests in accordance with the partnership agreement. The business itself continues unless the buyers decide to liquidate the business or merge it into another business that they own. The former owners of the acquired business now have cash (or other consideration) in exchange for their stock (or other equity) interest. The business documents (e.g., sales agreement) will usually make clear what the nature of the transaction is. 3.b.1. Example - stock sale by corporation. Let's compare a stock sale to an asset sale. Suppose in the example in 3.a.1) above that Lydia and Stanley sell their stock in Corporation X, rather than the assets of Corporation X. The buyer is still Corporation W. After the sale, W now owns 100% of the stock of X. X's assets, of course, come with the company, but instead of buying specific assets, W has become the parent company of X. In exchange for the stock, Lydia and Stanley are each paid $400,000 by W. X is not liquidated under this transaction (unless W, as the new owner, decides to liquidate it), but merely continues in existence as the subsidiary of W, rather than as a company owned by Lydia and Stanley. 3.b.2. Example - stock sale by individual. Consider the example in 3.a.2) above. If the sale were structured as a stock sale, rather than an asset sale, Larson would sell 100% of its stock in Morgan Apparel to the buyer. In exchange, Larson might be paid cash for its Morgan Apparel shares, or it might receive stock in the buyer, or a combination of cash and stock in the buyer. If Larson receives all 16

17 cash, after the transaction, the buyer is now the owner of all the shares of Morgan Apparel. Morgan Apparel is no longer part of Larson s controlled group. Larson might use the cash to expand its current business operations, or to form a new business, possibly even a new subsidiary corporation. 4. Documentation of the transaction. The plan issues involved in a plan transaction (i.e., the merger of two or more plans, a spin-off from a plan, or a transfer of assets and liabilities between plans) should be documented in a merger, transfer, or spin-off agreement, whichever is applicable. Where a company-level transaction is involved (e.g., acquisition of one company by another), the acquisition documents (i.e., agreements signed by the parties involved in the company transaction) should address the plan issues resulting from that acquisition including: (1) conditions, representations, warranties, and covenants regarding the plan liabilities, and (2) the responsibilities of each party to effect a plan transactions being negotiated as part of the sale. Representations and warranties are usually in the nature of guarantees that things have been done right. The seller is usually the one making these representations and warranties. Covenants are promises to take specific actions. The buyer and the seller are usually giving covenants (e.g., buyer promises to provide substantially similar benefits, seller promises to be responsible for maintenance and distribution of its plans). The buyer will want to consider the potential liabilities resulting from a stock sale or statutory merger, seeking a decrease in the sales price to cover these liabilities. If the buyer is not satisfied that it has been adequately protected, it may seek to negotiate an asset sale instead, or will need to follow up to make sure certain necessary actions have been taken (e.g., proper termination of a plan prior to the closing of the stock sale). The seller, conversely, may seek an increase in the purchase price to the extent the transfer of plan sponsorship through a plan transaction may represent a valuable asset (e.g., surplus assets in a defined benefit plan). The parties might negotiate an escrow agreement as well, to cover unexpected liabilities that were not considered in the negotiations. It is in the best interest of the parties to raise the employee benefit issues as early as possible. Corporate transaction documents can effect an amendment of a plan. In Evans v. Sterling Chemicals, Incorporated, 660 F.3d 862 (5 th Cir. 2011), an asset purchase agreement (APA) which contained provisions regarding ERISA plans maintained with respect to the employees of a line of business being acquired, was held to be a valid amendment of the affected plans. The APA was authorized by the boards of directors of all of the companies involved in the transaction, and was signed by the chairman of the purchaser and representatives of the seller. An earlier decision from the Fifth Circuit, Halliburton Co. Benefits Committee v. Graves, 463 F.3d 360 (5th Cir. 2006), established that a corporate agreement can amend an ERISA plan, whether or not the agreement was expressly intended to effect an amendment. As long as an agreement is in writing (the APA in this case), it contains a provision directed to an ERISA plan, and the plan amendment formalities are satisfied, such agreement or other document will constitute a valid plan amendment. The APA was approved by the appropriate boards of directors and signed by the chairman of each company. This approval satisfied applicable State law (Delaware in this case) regarding authority to amend the plans, which provides that a board of directors retains ultimate control over delegating authority and authorizing corporate actions. Even if the plan documents expressly authorized only the company s Employee Benefits Plans Committee to modify or amend the plan, the board of directors was empowered to revoke such delegation and authorize the chairman to amend the plan by signing the APA. 17

18 4.a. Identify plans and related documents in the negotiation phase. Parties in the transaction should identify existing employee benefit plans, as well as plans terminated in the recent past (e.g., last five years). Copies of summary plan descriptions and other relevant documents should be examined as well. Relevant documents include Form 5500s for at least the past three years, which will provide information about the plan s assets, highlight possible liability issues based on how certain questions are answered, and uncover any unresolved penalty issues for late filings or nonfilings. If the seller has any defined benefit plans, actuarial reports should also be requested. 4.a.1) Conflicting interests. Remember that the interests of the buyer and seller are usually in conflict, hence the importance of proper negotiations. The seller s primary focus is to dispose of the assets or stock interest being sold, at the best price, without retaining any liabilities with respect to the employee benefit plans, and by making the least number of representations, warranties and covenants possible. The seller also may be looking to the buyer to hire as many of the seller s employees as possible who are affected by the sale. On the other hand, the buyer usually wants the seller to retain employment and benefits liabilities with respect to activities occurring prior to the sale, wants the seller to be responsible for winding up existing benefit plans maintained by the seller, wants complete freedom in deciding which of the seller s employees it will hire, and wants to avoid responsibility for mistakes or hidden liabilities with respect to the seller s plans. Typical warranties and representations given by seller with respect to qualified plans. (1) Seller has complied with ERISA, the tax code, and other applicable laws. (2) There are no breaches of fiduciary duties, nor prohibited transactions. (3) All contributions and other funding obligations have been satisfied, including transmission of participant contributions made through payroll withholding. (4) In the case of a defined benefit plan, no Title IV liabilities (e.g., withdrawal liability from a multiemployer plan) and no reportable events under Title IV (or, if so, evidence that necessary notices have been given). (5) No pending or threatened litigation. (6) Employee data (including compensation data) are complete and correct. (7) No collective bargaining agreements other than any that have been disclosed. (8) No legal requirement to continue any plan (except as arranged with buyer as part of the sale) nor to continue anyone s employment. Typical covenants made by seller with respect to qualified plans. (1) Promise to make all contributions required through closing date of the sale. (2) Promise to pay all compensation, vacation pay, benefits, etc. through date of closing. (3) Promise to give buyer access to books and 18

19 records. (4) Promise to be maintain and distribute benefits under plans maintained by seller, unless sale providers for continuance of plan and assumption of responsibility for plan, by buyer (in latter situation, the seller should provide covenants regarding completion of its responsibilities through closing date). Typical covenants made by buyer with respect to qualified plans. (1) In the case of a defined benefit, a promise to credit service with seller, if that has been agreed to as part of the sale. (2) Promise to provide benefits to seller s former employees, as agreed to under the terms of the sale. 4.a.2) Due diligence is buyer s primary responsibility. The buyer, as the one potentially taking on liabilities it doesn t intend to, has a responsibility to perform due diligence with respect to the seller s plans. The warranties, representations, and covenants, as outlined above, may ultimately save the buyer from unintended liabilities, but at the time breaches of such warranties, representations and covenants are discovered, recovery from the seller may not be possible. Also, a warranty, representation, or covenant may not provide the protection the buyer thought it had. See the discussion in 4.e. below, for example. Particularly when the buyer is purchasing stock, due diligence is a critical part of the process because the buyer is assuming responsibility for the prior sins of the seller. In an asset sale potential liability is far more limited, unless the buyer is agreeing to assume responsibility for one or more of the seller s plans. 4.b. Retain actuary to review defined benefit plan liabilities. If the seller maintains a defined benefit plan that the buyer is considering assuming sponsorship of, or where the buyer is buying the stock of the seller so that the seller will become a member of the buyer s controlled group, the buyer should be assisted by a competent actuary to analyze the liabilities. 4.c. Surplus assets in a defined benefit plan. If the buyer will assume a defined benefit plan with surplus assets, the seller will want to seek compensation for the surplus in negotiating the sales price. On the other hand, if the defined benefit has an accumulated funding deficiency, or has had recent poor investment performance which will likely increase the funding requirements sharply in the near future, the buyer will want to reduce the sales price accordingly. 4.c.1) Reversion issue. If a buyer is assuming sponsorship of an overfunded defined benefit plan, and is looking to the surplus as a potential reversion in the future, make sure the plan permits a reversion. Under ERISA 4044, an 19

20 amendment to a defined benefit plan to add a reversion authorization cannot be effective for five years after the amendment is adopted. See 4.d.1) below regarding a case involving the right to surplus assets many years after the spinoff of a company 4.d. Asset acquisition creates lesser concerns for buyer. If the buyer is purchasing the assets of the seller, many of these concerns are irrelevant unless the buyer is assuming sponsorship of the plan or is agreeing to have the seller s plan merged into its plan. If the buyer is purchasing stock (or other equity interest) or is negotiating a statutory merger with the seller, the plan issues are a concern to the buyer regardless of whether the buyer will become the actual sponsor of the seller s plan. 4.d.1) Transaction documents important. In an asset acquisition in particular, the terms of the documents relating to the transaction can be critical in determining who is responsible for the continued maintenance of the plan after the transaction is completed. In Lockheed Martin Corporation v. Retail Holdings, 639 F.3d 63 (2 nd Cir. April 26, 2011), spin-off documents had to be analyzed by the court to determine whether the transferor or transferee company was responsible for a defined benefit plan. The issue arose many years later, when the plan was terminating, because the company in possession of the plan was entitled to millions of dollar of surplus assets. One section of the spin-off agreement (section 2.01) assigned to the spun-off company the complete and sole beneficial interest over all of the assets of the sewing and furniture lines of business. The definition of assets in the agreement referred to all rights under contracts relating to the sewing and/or furniture business. A similarly broad provision (section 4.02) provided for the assumption by the spun-off company of all of the liabilities of the sewing and furniture lines of business. Liabilities were defined to include all debts, liabilities and obligations arising under any contract, commitment or undertaking. Later in the agreement (section 8.02), however, the disposition of certain plans was discussed, but the terminating plan at issue was not discussed in that section. The spun-off company focused on the broad language of sections 2.01 and 4.02 to support its claim on the surplus assets. The transferor company focused on the specific language in section 8.02 to suggest that the document was ambiguous, and thus other factors had to be considered to determine the disposition of the surplus assets. One such factor was that the transferor company had continued to administer the plan in question subsequent to the spin-off transaction, which included the filing of Forms 5500, and the lower court agreed. The Tenth Circuit reversed the lower court and ruled that the expansive language in sections 2.01 and 4.02 clearly resulted in the assets and liabilities of the plan being transferred to the spun-off company. There was no ambiguity created by section 8.01 because it contained no language to suggest that its enumeration of certain plans was intended to be an 20