Health and Welfare Considerations in M&A Deal

By Stacey Stewart, JD
Senior Advisor
Stacey.Stewart@McGriff.com

What would happen if you arrived for work on Monday to find that your company is contemplating acquiring (or selling to) another company? Do you feel confident in your ability to guide your colleagues through the employee benefits aspects of the transaction? The acquisition process is fraught with traps for the unwary, especially when it comes to employee benefits. This article discusses some of the key considerations. It focuses on welfare benefits although many of the overall concepts apply equally in the retirement plan context.

This is one of the first and most important questions to ask about a proposed transaction because the legal form of the transaction will determine many of the benefits issues. This includes whether the benefit plans of the entity being acquired, which we refer to here as the “target,” are usually continued post-closing or terminated in advance of closing, what happens with target employees, and the like.

In a stock purchase, the buyer automatically becomes the sponsor of any plans not terminated by the target prior to closing. The buyer steps into the target’s shoes from a liability perspective so it needs to be very clear on compliance obligations and potential liability associated with these plans. Employees of the target business who continue will work for the same employer post-sale.

Contrast this with an asset purchase where the employees associated with the purchased assets who continue post-sale will have a termination of employment. The termination of employment has implications for various employee benefits plans. For group health plans in particular, COBRA liability and responsibility are a key concern.

The buyer will want to know about the target’s plans to assess potential liability. This is why the parties engage in the “due diligence process” where they ask each other to provide information on offerings and associated compliance risks. The transaction form determines how much importance the parties will place on past compliance. For example, past compliance is much more important in a stock or asset deal where the buyer will continue target plans post-closing versus in a stock deal where the target terminates all plans pre-closing or an asset deal where the buyer does not assume/continue any plans (and is not a successor).

The due diligence process also helps assess possible next steps for maintaining separate plans for acquired target employees or integrating their benefits with the buyer’s plans. Retiree medical, for example, can pose very significant challenges, both from a cost and a compliance perspective. Union plans also present their own unique set of considerations that are better addressed early in negotiations with the benefit of experienced counsel. In addition, to the extent the target offers a health FSA, DCAP or other “use-it-or- lose-it” account-based plan and the transaction will close mid-plan year, the parties must determine how/whether the account balances will transfer to a plan at the buyer, stay at the target, etc.

The purchase agreement often speaks to the parties’ intentions so it is vital to consult that agreement when discussing how to handle benefits on a going forward basis. For example, the purchase agreement may require the buyer provide past service credit for plan eligibility and credit toward deductibles or out-of-pocket maximums. It may also cover whether the buyer is required to offer certain benefits to all employees and/or particular benefits to executives.

Keep in mind that the purchase agreement may provide for employment or severance agreements for executives and these agreements may separately require the buyer to provide certain benefits to these executives (e.g., retiree health insurance, subsidized COBRA coverage).

You also want to know what the purchase agreement may say about COBRA obligations. It can, in some cases, shift COBRA liability away from the party otherwise legally required to shoulder it. It is important to understand the amount of expected COBRA liability and who will bear it. Equally important is whether this liability can and will shift from one party to the other.

The parties must assess the viability of the proposed strategy from both a practical and a compliance standpoint. For example, if the buyer wants to keep acquired target employees in their current group health plan after an asset deal, it generally will need to assume the plan or set up a mirror plan. Allowing these employees to stay on target’s plan post-closing creates a Multiple Employer Welfare Association (MEWA), which triggers additional compliance obligations. Benefits counsel may devise a creative approach to make this work (e.g., treat former employees as retiree class) or rely on an alternate theory to not treat temporary coverage as a MEWA. But the bottom line is that the buyer must evaluate the strategy on the front-end with counsel and be comfortable with any associated risk. They also must coordinate with applicable service providers to ensure they can accomplish the strategy in a timely fashion.

The ACA added a host of considerations in M&A transactions including the impact of applicable large employer (ALE) status and potential liability for ACA-related penalties (e.g., employer mandate penalties for ALE members, PCORI fees etc.).

Determining when the employer mandate and associated reporting rules apply (or cease to apply) is key. When an ALE buyer acquires a non-ALE member (or becomes an ALE due to the proposed transaction) statutory language indicates that the employer mandate may apply immediately. So the buyer may have an immediate need to provide affordable, minimum value coverage to all full-time employees including acquired target employees and to satisfy ACA Form 1094/5-C reporting.

Buyer must obtain hours of service and other relevant pre-transaction data from target to determine who is a full-time employee so it can make the necessary coverage offer (or understand potential penalties for failure to do so) and fulfill ACA reporting obligations. Also, the parties may use different measurement methods requiring the buyer sort through how to treat acquired employees post-closing under applicable IRS guidance.

The above discussion gives you a taste of the potential health and welfare issues that may arise in an M&A deal. The earlier you learn about a deal the better. Proper planning is key to avoid potential missteps both before and after the transaction.