Legal review of employee benefit plan issues represents a key opportunity for private equity funds to protect and enhance the value of their investments. Below are some important considerations to bear in mind when structuring and negotiating transactions.
Potential Areas of Non-Compliance
Dealing with historical benefit plan non-compliance can be costly and distracting to a new management team. An effective review of a target company’s employee benefit plans can foster a successful execution of a fund’s business plan by reducing ongoing risks, saving costs, helping to ensure a smooth transition for employees, and better positioning portfolio companies for future add-on acquisitions and the private equity fund’s eventual exit.
Potential Areas of Joint and Several Liability
Certain employee benefit plans carry unfunded liabilities that are joint and several liabilities of the sponsoring employee or participating employer and each member of that employer’s “controlled group.” The controlled group generally consists of all entities, whether or not incorporated, that are connected through common ownership of 80 percent or more by vote or value. Under some theories, the entire private equity fund and its portfolio companies may be deemed to be part of the controlled group and thus jointly and severally liable for such liabilities.
Single-employer defined benefit pension plans often carry significant unfunded termination liabilities that can adversely affect the plan sponsor’s balance sheet. Private equity funds should be cautious of rules that impose joint and several liabilities for unfunded termination liabilities and annual minimum funding contributions among members of the controlled group.
A private equity fund acquiring a direct or indirect interest in 80 percent or more of the target may be liable for any withdrawal liability or missed contributions. Many U.S. multi-employer defined benefit pension plans assess significant liabilities against employers that cease participation in such plans (referred to as “withdrawal liability”). A key consideration for multi-employer plans is identifying and managing potential (and often significant) withdrawal liabilities in due diligence. In addition, multi-employer defined benefit pension plan liabilities can be deemed to be joint and several liabilities of the entire controlled group. Further, in an asset transaction, withdrawal liability is automatically triggered and assessed on the seller and its controlled group. Private equity buyers should be aware that sellers sometimes may seek to shift such burdens to the buyer in the purchase agreement.
Positioning for the Future – Structuring the Post-Acquisition Entity
The definitive purchase agreement should contain provisions to manage the benefit plan obligations of the private equity fund and its target. After closing, acquisition targets typically must establish and administer new employee benefit plans. This is particularly relevant in carve-out scenarios where the target had been participating in the employee benefit plans of a much larger parent company. Proper documentation and corporate governance is key to ensuring compliance with relevant rules and regulations. In particular, sellers often seek to require that buyers replicate current employee benefit plans at the seller. However, a replication of such plans may not make business sense for the size and cash flow of the target. In the welfare area, the most costly plans to establish are retiree welfare benefit plans. In the pension area, typically defined contribution, rather than defined benefit, plans are established.