Caveat Emptor – Employee Benefits Considerations in M&A Transactions (Part 1)

Employee Benefits & Executive Compensation Practice Briefs

Part 1 – Retirement Plan Issues


The first half of 2018 has seen a great deal of merger and acquisition (“M&A”) activity with hundreds of deals worth billions of dollars being closed globally.  There are no signs that this activity will slow down in the second half of 2018. While each transaction is different, a common thread in most, if not all, M&A transactions is that they are complex events involving a wide range of considerations, many moving pieces, and an army of professionals ranging from investment bankers, consultants and accountants to corporate and specialist lawyers, including those with employee benefits expertise.

In an M&A deal, an essential part of the due diligence process is identifying any employee benefit plan issues, which can present legal and operational challenges and potentially significant liabilities.  Issues can arise under the Employee Retirement Income Security Act (“ERISA”), the Internal Revenue Code (the “Code”), the Affordable Care Act and various other state and federal laws.  This is Part 1 of a Practice Brief which will examine retirement plan issues to be considered when reviewing employee benefit plans during the due diligence process and structuring a transaction. Part 2 will examine health and welfare benefit plan issues.

Transaction Structure

A buyer in any transaction, and each party in a merger, should conduct significant due diligence on the employee benefit plans and programs offered by the other party.  The depth of this review will depend on the type of transaction. An acquisition of a target company’s assets (an “asset deal”) generally will require less diligence as to plan operation and administration than an acquisition of a target’s stock (a “stock deal”) or a merger, provided that in an asset deal, the buyer is not assuming the target’s employee benefit plans and accompanying liabilities.

In an asset deal, the buyer chooses which of the target’s assets it will purchase and which liabilities it will assume. The target’s retirement plans generally remain under the sponsorship and control of the target post-closing, unless expressly assumed by the buyer in the asset purchase agreement.  Even if the buyer does not assume the target’s retirement plan liabilities, however, it still may be subject to some liability if, for example, the target had an underfunded “multiemployer” pension plan.

In a stock deal, the buyer assumes the target’s employee benefit plan liabilities as a matter of law.  Due diligence is, therefore, especially critical in a stock deal so the buyer is fully aware of any potential problems or hidden liabilities in the target’s benefit plans.

Target’s Retirement Plans

A buyer generally does not assume the target’s retirement plans in an asset deal unless (a) the buyer wants to continue the target’s plans either because (i) the buyer does not have any such plans of its own or (ii) the buyer wishes to provide the target’s acquired employees with the same benefits they had prior to the closing of the transaction; or (b) the buyer wants to merge the target’s plans into the buyer’s plans. Nevertheless, the buyer in an asset deal often agrees in the purchase agreement to provide substantially similar benefits to those provided by the target to its employees immediately prior to closing and to provide credit to the continuing employees for eligibility and vesting service. This permits such employees to participate in the buyer’s retirement plan immediately upon satisfying the buyer plan’s eligibility criteria. In addition, the buyer typically will facilitate a direct rollover from the target’s plan to the buyer’s plan.

The buyer becomes responsible in a stock deal (either directly or indirectly) for the retirement plans maintained by the target that are not terminated prior to the transaction. The sponsorship of the target’s retirement plans may have significant implications for the buyer because compliance of those plans with ERISA, the Code, and other applicable federal laws and regulations prior to the closing becomes the responsibility of the buyer after the closing. Consequently, a buyer in a stock deal typically will require the target to terminate its 401(k) or other retirement plans prior to closing.

A buyer also has the following options with respect to a target’s retirement plan:

  1. Continue the plan “as is” (buyer maintains two separate plans) – The target’s plan is maintained by the buyer and continues to cover the target’s acquired employees just as it had when they were employed with the target.
    • Advantage: Allows the buyer: (i) to provide different levels of benefits for buyer’s employees and target’s acquired employees, and (ii) a period of time to assimilate the new employees into the buyer’s plans. (Note: The IRS coverage rules do not apply until the first day of the second plan year following the transaction to allow time for a clean transition. Once this transition period ends, the two plans must be combined for non-discrimination testing to make sure one plan does not provide more generous benefits to highly compensated employees than the other plan.)
    • Disadvantage: The added cost of maintaining multiple plans, including plan reporting costs such as the Form 5500, plan audits, separate coverage and non-discrimination testing, maintenance of separate plan documents and potential ERISA or Code non-compliance liability for the target’s plan. These costs can quickly add up, especially if the buyer is an active acquirer of other businesses.
  1. Terminate/Freeze the plan – If the target’s plan is not terminated after the transaction closes, any qualified retirement plans must satisfy the coverage and nondiscrimination rules as part of the buyer’s controlled group (subject to the above transition rule). This strategy might be used if the buyer intends to set up its own plans but has not yet done so.
    • Advantage: Once terminated, the buyer would not have the added cost of maintaining two separate plans.
    • Disadvantage: If the terminated target plan is a 401(k) plan, and the assets are distributed to the plan participants, those participants cannot participate in another defined contribution plan of the employer for 12 months following the date of distribution. In addition, if the target’s plan is a defined benefit pension plan, termination of the plan can have unforeseen consequences on the buyer as plan sponsor. For example, while a pension plan may be fully funded on an ongoing basis, it could be significantly underfunded on a termination basis – thereby creating a potentially large immediate liability for the buyer that tries to terminate such a plan.
  1. Merge the target’s plan into the buyer’s plan – This strategy is typically used if the buyer wants to provide the same benefits to all employees. The buyer must be careful to preserve any “protected benefits” under the target’s plan (such as early retirement options and other optional forms of benefits).
    • Advantage: A plan merger eliminates the duplication of expenses associated with maintaining two plans.
    • Disadvantage: There is a possibility that the target’s plan could taint the surviving plan of the buyer if the target’s plan failed to comply with ERISA, the Code or other applicable federal law prior to the plan merger. Consequently, it is imperative that the buyer conduct an in depth operational review of the target’s plan for several years prior to the closing before deciding to merge its plan with the target’s plan.


Given the complexity of employee benefits issues, a buyer’s counsel should do more than simply review plan documents during the due diligence process and negotiations. Benefits counsel and advisors should be involved early in a transaction to assist with the transaction structure and to identify potential liabilities associated with the target’s employee benefit plans.

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Sanyam D. Parikh and H. Gray Hutchison, Jr. are attorneys in the Employee Benefits & Executive Compensation Practice Group, and Robert E. Futrell, Jr. is an attorney in the M&A practice group of Wyrick Robbins, which represents clients across a broad range of industries in connection with their significant corporate transactions. The M&A group publishes Practice Briefs periodically as a service to clients and friends. The purpose of this Practice Brief is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.