EMPLOYEE BENEFIT PLANS IN MERGERS AND ACQUISITIONS OF NATURAL RESOURCE COMPANIES

• Jurisdiction: United States

Mergers and Acquisitions of Natural Resources Companies
(Nov 1994)
CHAPTER 8B
EMPLOYEE BENEFIT PLANS IN MERGERS AND ACQUISITIONS OF NATURAL RESOURCE COMPANIES
R. Michael Sanchez
Kathleen A. Odle
Heidi J. Kesinger
Sherman & Howard L.L.C.
Denver, Colorado

I. QUALIFIED RETIREMENT PLANS

.A. TYPES OF PLANS

1. DEFINED CONTRIBUTION PLANS.

a. The Employer contributes an amount certain each year. No obligation to continue contributions in the future is required. These plans can be terminated or amended to reduce future benefit accruals upon short advance notice. Some defined contribution plans have completely discretionary contributions (e.g., profit-sharing and stock bonus plans).

b. The plan can be assumed or discontinued in an acquisition. If assumed, ongoing administration and compliance with IRS and DOL reporting requirements apply.

c. Examples of defined contribution plans are Profit Sharing, Target Benefit, 401(k), Money Purchase Pension, ESOP and Stock Bonus.

d. Employee Stock Ownership Plans are defined contribution plans, but if an ESOP is leveraged the repurchase liability and ESOP debt must be addressed before termination or assumption.

e. Defined Contribution Plans generally do not have material issues with respect to minimum funding requirements under IRC § 412. However, money purchase and target benefit pension plans do have minimum funding requirements and other defined contribution plans can have contractually mandated contributions.

f. Money purchase and target benefit pension plans can be frozen with respect to future benefit accruals (and to a lesser extent some past accruals) by giving participants and beneficiaries a 15-day 204(h) notice. ERISA § 204(h). If

[Page 8B-2]

the notice is given before any participant has accrued a benefit for the plan year (i.e., before completing 1,000 hours or before the end of year employment requirement is satisfied) then the contribution can be frozen retroactively to the beginning of the year. Prop. Treas. Reg. § 1.412(b)-4 .

2. DEFINED BENEFIT PLANS.

a. The employer is obligated to contribute the amount actuarially necessary to fund the benefits promised under the Plan. Enlisting the services of an actuary often is an important step to spot trouble areas.

b. With a few exceptions, the plan can be terminated only with approval of the Pension Benefit Guaranty Corporation and generally only if assets are sufficient to satisfy the Plan's obligations and benefits.

c. The plan can be frozen with 15 days' notice to participants and beneficiaries under ERISA § 204(h). Future accruals cease upon freeze but funding liability for past accruals continue.

d. The employer and other members of the controlled group are liable for the plan's unfunded liability even if they do not have employees who participate in the plan. ERISA § 4001(b).

e. A decline in investment performance can increase defined benefit liabilities quickly and materially.

f. A substantial difference can exist between an ongoing defined benefit plan's current funding status and its status on plan termination, particularly if the plan permits lump sum cash outs.

B. LIABILITY EXTENDS TO ALL TRADES OR BUSINESSES UNDER COMMON CONTROL.

1. Each member of controlled group is jointly and severally liable for liabilities arising from plan terminations whether or not they have ever maintained the plan. Treas. Reg. 1.414(c)-2.

2. A controlled group includes trades or businesses under 80% common ownership.

a. Parent/Subsidiaries

(1) 80% or more of each subsidiary is owned by parent or other subsidiaries.

[Page 8B-3]

(2) For corporations, ownership is voting stock or all stock outstanding; nonvoting preferred stock is not counted.

(3) For partnerships, ownership is measured by either profits or capital interests.

b. In a brother/sister company 80% or more of each trade or business is owned by the same five or fewer individuals, and more than 50% is owned by the same five or fewer individuals counting only the lowest percentage held by that individual in each entity.

3. For plan qualification, minimum funding and PBGC premiums, the controlled group includes affiliated service groups under Code Section 414(m) and employees of the employer may include leased employees.

C. TYPES OF LIABILITY.

1. PLAN TERMINATION LIABILITY.

a. ERISA imposes liability on the plan sponsor and members of the sponsor's controlled group for the plan's unfunded liabilities at the time of distribution.

(1) Unfunded liabilities can arise from poor investment performance, unexpected claims experience or liberal actuarial assumptions.

(2) After 1986, FASB 87 requires balance sheet reporting of a plan's unfunded liability. For plans of non-public companies with fewer than 100 participants, balance sheet reporting is required effective in 1988. ERISA liability is based on current accrued benefits while FASB 87 is based on projected benefits. A substantial liability difference can result.

b. The Pension Protect Act increased the liability to the PGBC to 100% of the plan's unfunded benefit liabilities whether or not vested.

c. If the plan is overfunded, the buyer may be able to terminate the plan and recover excess assets if:

(1) Plan assets exceed all benefits payable by the plan.

(2) Plan specifically allows for reversion of excess assets.

[Page 8B-4]

(3) After 1987, the plan generally cannot be amended to allow for reversion unless five years elapse between amendment and reversion. ERISA § 4044(d)(2)

(4) Collective bargaining agreements may preclude reversion of excess.

(5) Reversions are subject to excise tax unless contributed to replacement plan. The excise tax is 50% of the reversion if no replacement plan and is 20% if a replacement plan is adopted. IRC § 4980.

(a) The replacement plan must receive an amount equal to at least 25% of the maximum reversion amount.

(b) In lieu of a replacement plan, the accrued benefits of the participants under the terminated plan can be increased by at least 20% of the maximum reversion amount.

d. Final distribution of plan benefits generally relieves both the employer and the PBGC of liability; however, the purchase of terminal funding annuities is a fiduciary decision...