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Corporate Mergers, Acquisitions, & Spin-Offs Tuesday, April 30, 2013

Ilene H. Ferenczy, Esq., APA, CPS,

Ferenczy + Paul LLP

Donald Kieffer, Esq., IRS

Agenda

• Coverage Issues

• Plan Mergers

• Crediting Service

• Determining HCEs

• Dispositions

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M&A BASICS

Understanding the Deal

• Three types of transactions:

• Stock purchase

• Asset purchase

• Merger

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Stock Purchase

• Buyer purchases a majority of

the shares of stock of the target

• If buyer is a company, target becomes a subsidiary

• Transaction does not change which benefit plans are

sponsored by the target (except to the extent that the

target participates in the seller’s plans)

• To get rid of the target’s plans, generally must terminate

the plans

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Stock Acquisition

Asset Purchase

• Buyer purchases all or some of the

target’s assets and assumes all or some

of the target’s liabilities

• Stock remains owned by the sellers: if all

assets are sold, company is a shell with just the

“consideration” for the transaction

• Seller/target remains the sponsor of all plans unless

buyer affirmatively adopts them

• Employees are terminated by seller and hired by

buyer (to the extent desired)

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Asset Acquisition

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Asset Purchases • Employees will generally be eligible for

distributions from the seller’s plan

• Concern for seller: partial plan termination

• Undefined in statute, but applies when a large enough

percentage of participants’ employment is terminated

• Rule of thumb: 20% decrease

• Result: full vesting

• (Can apply in stock sale setting, too, if

employees no longer participate in seller’s

plan)

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Asset Acquisition

Mergers • Two companies combine and one of them – or a

new company – survives the transaction

• The survivor owns and owes all of what either

company owned or owed before the transaction

– by operation of law

• The survivor sponsors all employee benefit

plans sponsored by either company before the

transaction – by operation of law

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Company Merger

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What Do We Suggest?

• Make sure to understand the transaction and to

communicate it to the various service providers

• Be sure that service contracts survive the transaction

• Be sure that everyone knows the new structure so that

they can help you with the post-transaction transitions

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Company Merger

COVERAGE ISSUES

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Issue #1: Plan of Purchased Company

• What is going to happen to their plan after the

acquisition?

• Continue indefinitely

• Continue for a limited time

• Terminate immediately

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Option #1: Continue Purchased Plan Indefinitely

• Best Bait, Inc. (B) purchases all of the stock of

Spectacular Sushi, Inc. (S)

• Both companies sponsor a 401(k) plan

• The companies desire to keep their benefits

separate indefinitely

• Question: Can the two companies continue their

separate 401(k) plans?

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Option #1: Continue Purchased Plan Indefinitely

• Question #1: What do the plans say?

• If the plan documents cover employees of all

members of the controlled/affiliated service group,

then the other company’s employees will enter the

plans regardless of desire

• Need to make sure that plans read the way we want

(i.e., exclude nonadopting members of the controlled/

affiliated groups)

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Option #1: Continue Purchased Plan Indefinitely

• Question #1: What do the plans say?

• If amend the plans after the acquisition to eliminate

participation of the other entity, the amendment will

terminate the transition period for that plan

• Therefore, if such an amendment is needed, it must

be done before the transaction

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Option #1: Continue Purchased Plans Indefinitely • Question #2: Can the plans pass §410(b)?

• To maintain separate plans indefinitely, each plan

must separately meet the coverage rules

• There is a “transition period” for this: from date of

acquisition to the last day of the plan year following the

year of acquisition

• To maintain the transition period:

• Plans must have met coverage rules before the

acquisition

• No amendments may be made to the plans during

the transition period 15

Option #1: Continue Purchased Plans Indefinitely

• Question #2: Can the plans separately pass

§410(b)?

• If the plan is amended, transition period terminates

immediately and both plans must meet §410(b)

• Therefore, plans must go into transition period covering

the desired group

• Amendments made before the transition period begins

(i.e., before the transaction) are safe

• Do all amendments terminate the transition period?

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Option #1: Continue Purchased Plans Indefinitely

• Question #2: Can the plans pass §410(b)?

• If B bought S in November 2012, and the two

companies’ plans had calendar plan years, the

transition period would run through December 31,

2013

• Plans would need to be tested for coverage as of

January 1, 2014

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Option #1: Continue Purchased Plans Indefinitely

• Can meet coverage:

• 70% test

• Average benefits test

• QSLOB filings

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410(b)

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Option #2: Continue Purchased Plan for a Limited Time

• If the desire is to continue the

purchased plan just long enough

to get things set up for a merger, usually the

transition period will take care of everything

• Make sure plan documents exclude other employees

• Make sure that no amendments are made to the

plans until the merger is ready to occur (but what

about EGTRRA restatements?)

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Option #3: Terminate the Purchased Plan • If terminate the purchased plan after acquisition,

the 401(k) plan of the buyer will be an “alternate

defined contribution plan”

• That will prevent the payout of 401(k) deferrals and

QNECs upon plan termination

• Will need to merge at least that part of the plan, or

maintain purchased plan as frozen plan

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Option #3: Terminate the Purchased Plan • If maintain the purchased plan as a frozen plan:

• Be sure to amend to stop deferrals in that plan

• Amend buyer’s plan to cover acquired employees

after freeze date

• Can distribute profit sharing, matching contributions

so long as they are not QNECs or QMACs

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Option #3: Terminate the Purchased Plan

• If action is taken to terminate the purchased plan

prior to the acquisition, okay to distribute

deferrals and QNECs

• “Alternate DC plan” is judged at date action is taken

to terminate the plan

• If that action was taken prior to the acquisition,

buyer’s plan was not alternate DC plan, so no

limitations on distributions if handled expeditiously

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What if Asset Acquisition??

• In an asset acquisition, the seller maintains the

plan (i.e., the buyer only is buying stuff, not

stock)

• Result: if the buyer wants to continue to

maintain the prior plan for the acquired entity, it

must adopt it as a successor employer

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Example

• Best Bait, Inc. (B) buys all the assets

of Terrific Trout, Inc. (T) from its 100%

shareholder, Tom Terrific

• After the transaction, Tom still owns 100% of the

stock of T. The only asset in the company is the

money that B paid to purchase the assets

• All employees have gone to work for B

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Example

• The plan sponsored by T is still so sponsored

• All of its participants have terminated employment

and may be paid out

• If B wants to maintain that plan for the employees

who used to work for T, it can do so by adopting

the plan as a successor employer (and being sure

to fix the eligibility section)

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Issue #2: Plan of Buyer

• Need to make sure that Buyer’s plan does not

cover acquired employees

• If it does, need to amend plan prior to the

transaction to maintain the transition period

• If plans to be kept separate indefinitely, need to

meet coverage in buyer’s and acquired plan

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Buyer’s Plan

• If Buyer’s plan is going to cover the acquired

employees:

• Need to enroll the employees

• Timing may be a challenge – see next section for

ideas

• If acquired plan will be merged into buyer’s plan,

need to do so

• See next section for ideas

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MERGER OF PLANS

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Merger of Plans

• Best Bait, Inc. (B) purchased all the stock of

Spectacular Sushi, Inc. (S)

• B wants to merge the 401(k) plan of S into B’s

401(k) plan

• What concerns do we have?

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Question #1: Timing

• There is generally some time lapse between the

acquisition and the merger of the plans

• What do you want to do with the plans in the

interim?

• Freeze the S plan immediately, and enroll the

acquired employees in the B plan? OR

• Keep the employees in the S plan until the merger

of the plans is possible?

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Getting the S Employees into the B Plan Immediately

• There is nothing that compels the merger of the

plans to occur at the same time as the acquired

employees begin to be covered by the buyer’s

plan

• Can freeze the acquired plan to new

contributions, and start new contributions going

into the buyer’s plan as of the acquisition

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Getting the S Employees into the B Plan Immediately

• Big consideration: How quickly can you get the

acquired employees enrolled?

• Because they are participating in a different plan,

they have no salary deferral elections for that

plan

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Creative Solution?

• Can amend the buyer’s plan to provide for

automatic enrollment of the acquired employees at

the rates shown on attached schedule

• Put prior deferral rates on the attached schedule

• Effect: maintain the deferral rates from the other

plan while enrollment is pending

• Negative: will have all money go into default fund?

• Note: Not an EACA, because rate of auto

enrollment is not uniform and does not apply to all

employees 33

Keeping S Employees in Own Plan

• See prior section:

• Amendment to plans may be necessary

• Need to meet coverage or maintain the transition

period during the time that the plans are kept

separately

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Issue #2: Merger Processing

• Need to ensure that the process is organized

• Want to ensure that no unreasonable delay

occurs as this could result in a fiduciary breach

that causes losses

• Want to reduce stress on client and participants

to the extent possible

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Merging Plans

• Need to be very organized in preparation

process

• Coordinate with fundholders and recordkeepers

for both plans

• Do high quality employee communications

• Remember need for blackout notices 30-60 days in

advance

• Remember need for 204(h) notices if MP plan is

involved

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Merging Plans

• Need to be very organized in preparation

process (cont’d.)

• Will the prior fundholder do cashouts where

possible prior to merger?

• Need to provide enough time for notices to be

given and responses received

• Will a final mailing be made to terminated

participants for whom cashouts are not available,

soliciting distribution authorizations?

• Mapping of investments

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Merging Plans

• Need to be very organized in preparation

process (cont’d.)

• Identification of new QDIA

• Who will prepare final Form 5500 for

disappearing plan?

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Merging Plans

• Use a merger agreement to help

identify and determine the answers

to issues that will arise

• Vesting issues

• Accounts to be kept separate and accounts to be

merged

• Forfeitures from disappearing plan

• Elimination or preservation of distribution options

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Merging Plans

• Use a merger agreement to help identify and

determine the answers to issues that will arise

(cont’d.)

• Eligibility differences

• Crediting service for eligibility and vesting

purposes

• Special contributions for merged-in participants?

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Merging Plans - Testing

• If prior year testing, need to do adjustment to prior

year ADP and ACP

• Example: Plan B and Plan T are merged

• Plan B had 300 NHCEs with prior year ADP of 6%

• Plan T had 100 NHCEs with prior year ADP of 4%

• The prior year ADP for the NHCEs is the weighted

average of the two groups:

• (300/400 x 6%) + (100/400 x 4%) = 5.5%

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Merging Plans - Testing

• If both plans are current year and merger is mid-

year, three possible options:

• Test everything in the surviving plan for the year

• Test both plans through merger date, then

surviving plan from merger through end of plan

year

• Test disappearing plan for part of year before

merger, then test surviving plan for the full year,

reflecting merged-in people as new entrants

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Merging Plans - Testing

• If plans are not the same testing method:

• Can change acquired plan to match buyer’s plan

regardless of normal current year/prior year

limitations

• Do so before the merger

• Last day to do so: end of transition period

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CREDITING SERVICE

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Asset Purchase

• Acquired employees are new employees

• Do not credit service unless plan so provides:

• Specifically discusses crediting of service for

acquired employees; or

• Plan is amended in connection with acquisition to

credit service with predecessor

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Stock Purchase or Merger

• No guidance

• Argument for crediting service in buyer’s plan

• Could not exempt service for eligibility if new

subsidiary adopted new plan (consistency)

• Argument against crediting service in buyer’s

plan:

• Prior service with acquired entity was not with this

controlled group

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DETERMINING HCES

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Asset Acquisition

• Best Bait, Inc. (B) acquires the assets of

Spectacular Sushi, Inc. (S)

• All of S’s employees go to work for B

• None of S’s employees own stock in B

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Asset Acquisition

• Acquired employees are new

• Not 5% owner unless they are given stock in the

buyer

• No compensation during prior year

• Result: no HCEs in year of acquisition (and

possibly in year after acquisition, depending on

how much compensation is earned in year of

acquisition)

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Suppose B Wants to Give Special Contribution to Acquired Employees

• S sponsored a profit sharing plan to which they

generally contributed 10% per year

• Because S is not going to be in business at year-

end, it elects to make no contribution in the year

of the sale

• Former S employees are angry because they will

get no profit sharing contribution

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Solution

• B sponsors a 401(k) profit sharing plan to which

it normally contributes 5% of pay

• B amends the plan for the year of acquisition to

give former S employees a contribution that is

roughly equal to what they would have received

in S’s plan (but be careful: cannot exceed 100%

of the employees’ pay from B for the year, due to

415 limits)

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Asset Acquisition

• Why is this okay?

• Since none of the former S employees are HCEs

in the year of acquisition, the B plan can

discriminate in the former S employees’ favor

without violating nondiscrimination rules

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Stock Acquisition/Merger

• No guidance

• If plans of acquired entity and buyer are kept

separate, might determine HCEs based on pre-

acquisition situation

• If acquired employees enter buyer’s plan or vice

versa, need to decide how to handle

• If use top 20% rule, comingling HCEs may cause

former HCEs to cease to be HCEs

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DISPOSITIONS

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Asset Sale

• Sweet Sleepers (S) sells the assets

constituting its Phoenix facility to

Bountiful Beds (B)

• Can the Phoenix employees be paid out

of S’s plan?

• Yes, they have terminated employment

• Only exception: if S’s plan does not permit

distributions on termination of employment

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Stock Sale

• Sweet Sleepers (S) has a subsidiary, Terrific

Towels (T), that manufactures bathroom towels

• S sponsors a 401(k) plan in which T is a

participating employer

• S sells all of the stock of T to a third-party buyer

• Can the S 401(k) plan pay out benefits to the T

employees?

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General Rule

• If a subsidiary participates in a parent’s 401(k)

plan and the subsidiary is sold, can the plan pay

out subsidiary employees?

• Yes, if:

• Buyer is an unrelated company

• Subsidiary accounts are not transferred

to buyer’s plan (rollovers okay)

• Subsidiary employees do not participate in

parent’s plan after disposition

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Problem: How to Comply

• How does subsidiary participate in parent plan?

• Plan provides that it covers all employees of

related companies; or

• Subsidiary adopts the parent plan as a

participating employer

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Problem: How to Comply

• If parent plan provides that it covers all

employees of related companies, participation by

subsidiary terminates concurrently with sale (i.e.,

no longer related) – distributions okay

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Problem: How to Comply

• If subsidiary adopted the parent plan as a

participating employer, it must affirmatively act to

stop participation

• If not done prior to disposition, must wait for

employees to terminate employment with former

subsidiary to pay out of former parent’s plan

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Spin-offs • Disadvantages to distributions

• Participants get money out of plan and are less

likely to use it for retirement

• Participants are likely to be 100% vested due to

partial plan termination

• Therefore, some buyers prefer to have the part

of the prior parent’s plan that belongs to the

sold subsidiary or participants associated with

an asset sale spun off and merged with buyer’s

plan 61

Mechanics

• Documentation must be prepared to spin off the

portion of the seller’s plan

• Spin-off agreement is helpful

• Similar to merger agreement; outlines and resolves

significant plan issues

• Deals with: vesting, forfeitures, eligibility, distribution

rights

• Documentation is then prepared to merge the

spin-off portion into the buyer’s plan

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Issues

• What will happen to accounts for participants

who are no longer employed?

• Stay with former parent plan (last employer)

• Go to buyer’s plan

• How will forfeitures associated with this

employee group be used in the buyer’s plan?

• Black-out period, employee communications

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Questions?

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Ilene H. Ferenczy Ferenczy + Paul LLP

2200 Century Parkway, Suite 560 Atlanta, Georgia 30345

(678) 399-6602 ilene@ferenczypaul.com

Donald J. Kieffer Internal Revenue Service 200 Sheffield Street, FL 3 Mountainside, NJ 07092

(908) 301-2655 donald.j.kieffer@irs.gov