Employee benefits and business combinations.

When acquiring a business, companies need to consider numerous employee benefits issues. Although these issues can be crucial to a merger's success, they typically do not receive attention until after the primary feasibility studies are completed and the price negotiated. Before final negotiations, companies should identify potential payroll tax liabilities and any obligations under existing health and retirement plans.

If companies buy stock in a corporation, they are, in effect, "stepping into the shoes of the seller." In other words, the buyer can be a potential target for any claims that arose while the seller was in control of the corporation. These include unpaid wages and employment taxes, missed IRS filings, funding deficiencies in the pension plans, etc.

An asset purchase (rather than a stock purchase) can avoid some claims, but full immunity is not guaranteed. Recent court cases have held a new employer liable, even when only assets were purchased.

What about Health Plans?

If a buyer purchases a company and retains most of the existing employees, the buyer has to extend Consolidated Omnibus Reconciliation Act of 1985 (COBRA) rights to the employees who lose their old coverage. Under COBRA, terminated employees have the right to purchase continued health coverage for a limited time. While this right normally applies to the health plan the employee had until he was terminated, it can also apply to the new owner's health plan if the original plan was dropped in favor of the new one.

A buyer should conduct a due diligence review and search for potential health coverage issues or COBRA violations. By including comprehensive and strong representations, warranties and indemnification provisions, the buyer will be protected from potential COBRA violations.

An important issue for self-insured heath plans is determining who is liable for claims incurred but not reported. A buyer will want to take a look at the history of a company's health claims to evaluate the probability of incurring a major uninsured claim in the near future. An increase in stop-loss coverage may be warranted.

A buyer should scrutinize all plans for any postretirement and postemployment benefits and properly record any liabilities discovered.

The concern that comes with acquiring a company with a defined benefit plan is whether the plan has been properly funded. Defined benefit plans are designed so the plan's assets will equal the promised benefits when an employee retires. There are no requirements, however, that the assets must equal the benefits earned to date. If the plan has more assets than benefit liabilities, a buyer could receive a windfall; however, there are penalties if that money is used in any way other than to pay plan benefits. Therefore, this is not a convenient source of working capital for a business. A buyer could convert those assets to working capital if it is possible to merge the plan with another plan and the excess assets lower the buyer's required future contributions. More often than not, the assets in these plans are less than the actuarially determined accrued benefits. If both companies voluntarily agree to terminate the plan, the sponsor has to fund the plan at a level equal to the calculated plan benefits owed to the participants. For ongoing plans, the Code determines the level and timing of the funding. Penalties apply for each year the plan is underfunded.

Buyers should also be aware of benefits payments owed to employees of the acquired company who remain after an acquisition.

A buyer's existing employees might not experience "separation from service" (a trigger for benefit payments), unless the buyer purchased at least 85% of a new company's assets. Likewise, employees who come to work from the new company might not experience separation from service either, due to the "same desk" rule.

Under the same desk rule, employees doing the same job at the same place are not separated from service for plan purposes, even when an employer actually changes through a business acquisition.

Scrutinize Compensation Plans

It is not uncommon to terminate employment agreements with executives in connection with a business acquisition or restructuring.

Because of this, a buyer should scrutinize executive employment agreements and stock option agreements to determine whether it will owe the executive additional compensation when stock options mature, vesting is accelerated, stock restrictions lapse or an organizational change occurs.

If a buyer's organization is publicly traded, the "golden parachute" rules must be evaluated. Also, existing stock option plans must be examined, and the decision whether to continue or immediately terminate them must be made.

A buyer should look closely at accrued vacations, sick leave' and severance pay plans. Outgoing management has been known to adopt generous severance pay packages as a final goodwill gesture.

Another important detail is checking for provisions or separate agreements that may give severance pay packages in the event of a change in control. If these exist, a buyer should determine which events trigger the payments.

Purchase agreements are often silent as to which employer will be responsible to pay transferred employees' accrued vacation and sick leave.

Given the issues involved, employee benefits advisers are necessary when a company considers expanding its business through acquisitions.

FROM JULIE ROEHRICK, CPA, APPLETON, WI