There is a wide variety of regulatory considerations in a merger or acquisition, with most of them falling into one of two categories: (1) general regulatory issues affecting all types of transactions, and (2) industry-specific regulatory issues that affect only certain types of transactions in certain industries. The general regulatory considerations include issues such as antitrust, environmental, securities, and employee benefits matters, which are discussed in this chapter. There are also industry-specific regulatory issues, with federal and/or state regulators exercising rights of approval over those transactions that involve a change in ownership or control, or that may have an anticompetitive effect on a given industry. Any transaction in the broadcasting, health-care, insurance, public utilities, transportation, telecommunications, financial services, or even defense contracting industries should be analyzed carefully by legal counsel to determine what level of government approval may be necessary in order to close the transaction. Regulatory agencies such as the Federal Communications Commission (FCC) and the Pension Benefit Guaranty Corporation (PBGC) have broad powers to determine whether a proposed transaction will be in the best interests of the consuming general public or, in the case of the PBGC, the employees and retirees of a given seller.
In certain regulated industries, these government approvals are needed in order to effectuate the transfer of government-granted licenses, permits, or franchises. These may range from the local liquor board approving the transfer of a liquor license in a small restaurant acquisition to the need to obtain FCC approval for the transfer of multibillion-dollar communication licenses, such as the transaction between Verizon Wireless and Alltel.
Prior to the 1970s, sellers normally had little or no legal obligation to disclose information concerning the presence or use of potentially hazardous substances on their premises, nor to report the release of such substances into the environment to the potential buyers of their business. What obligations did exist were imposed by state or local governments regulating public nuisances or engaging in emergency planning.
In the 1970s and early 1980s, as the federal government passed new laws concerning health and the environment, it created new obligations to report on the presence, use, and release of hazardous substances under certain circumstances. The Clean Water Act (CWA), the Toxic Substances Control Act (TSCA), the Resource Conservation and Recovery Act (RCRA), and the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA or Superfund) all contained provisions requiring notification of government authorities in the event of chemical releases and other emergencies. In addition, TSCA and regulations promulgated pursuant to the Occupational Safety and Health Administration (OSHA) required chemical manufacturers and others to compile and report information on the presence and use of certain chemicals on their premises. Each of these laws had a unique, limited scope—for example, covering some substances but not others—and the result was a patchwork of different but sometimes overlapping reporting requirements.
In 1986, Congress enacted the Emergency Planning and Community Right-to-Know Act (EPCRA), found in Title III of the Superfund Amendments and Reauthorization Act of 1986 (SARA). Subchapter I of EPCRA creates a framework for state and local emergency response planning, and in that setting imposes on companies two types of reporting obligations: (1) the obligation to provide information about the presence of extremely hazardous substances so as to facilitate emergency planning, and (2) the obligation to notify authorities immediately in the event of a release. Subchapter II of EPCRA requires companies to file additional reports on the presence of hazardous substances at their facilities, and also to report on the periodic release of toxic chemicals. Unlike the information required by other federal laws, much of the information that is reported under EPCRA is available to the public.
Not only did EPCRA not completely supersede other federal reporting provisions, but it also did not preempt state law. Several states have passed right-to-know or other reporting and disclosure laws, the most aggressive being California’s Proposition 65. However, because EPCRA’s reporting requirements are fairly extensive and because they are implemented largely by the states themselves, the importance of state reporting laws has generally been diminished.
In 1990, Congress amended the Clean Air Act of 1970 (CAA), revising section 112. The CAA regulates any emissions, either stationary or mobile. This revision imposed significant enhanced air quality standards for emissions of hazardous air pollutants, whereas prior to 1990, the CAA only mandated a risk-based program with very few standards.
Any company that makes, uses, or otherwise is involved with potentially hazardous substances may be required under federal law to notify authorities of a release of such a substance into the environment. In many cases, a company’s obligations will be satisfied by reporting under EPCRA and CERCLA, but in some cases the CWA, TSCA, RCRA, or CAA might be applicable. This complex web of federal and state environmental laws creates legal issues for both the buyer and the seller in a proposed merger or acquisition, usually surrounding the problem of allocating liability for environmental problems under federal laws such as RCRA and CERCLA and state laws that address hazardous waste discharge and disposal. The seller should have its legal counsel obtain an environmental audit from a qualified consulting firm prior to the active recruitment of potential buyers in order to assess its own liability under federal and state laws. Nonetheless, it is very likely that the buyer and its counsel will want to do their own independent review and assessment of the seller’s sites, insurance policies, and possible areas of exposure.
The issue of potential liability under federal and state environmental laws is typically one of the broadest areas of coverage requested by buyers under the representations and warranties, such as those set forth in Figure 7-1.
(a) Hazardous Material. Other than as set forth in Schedule, (i) no amount of substance that has been designated under any law, rule, regulation, treaty, or statute promulgated by any governmental entity to be radioactive, toxic, hazardous, or otherwise a danger to health or the environment, including, without limitation, PCBs, asbestos, petroleum, urea-formaldehyde, and all substances listed as hazardous substances pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, or defined as a hazardous waste pursuant to the United States Resource Conservation and Recovery Act of 1976, as amended, and the regulations promulgated pursuant to said laws (a “Hazardous Material”), and (ii) no underground or aboveground storage tanks containing Hazardous Material, are now or at any time have been present in, on, or under any property, including the land and the improvements, groundwater, and surface water thereof, that Seller has at any time owned, operated, occupied, or leased. Schedule identifies all underground and aboveground storage tanks, the proper closure or removal of such tanks, and the capacity, age, and the contents of such tanks, located on property owned, operated, occupied, or leased by TCI.
(b) Hazardous Materials Activities. Seller has not arranged for the transport of, stored, used, manufactured, disposed of, released or sold, or exposed its employees or others to Hazardous Materials or any product containing a Hazardous Material (collectively, “Seller’s Hazardous Materials Activities”) in violation of any rule, regulation, treaty, or statute promulgated by any governmental entity.
(c) Environmental Permits and Compliance. Seller currently holds all environmental approvals, permits, licenses, clearances, and consents (the “Environmental Permits”) necessary for the conduct of Seller’s Hazardous Material Activities and the business of Seller as such activities and business are currently being conducted. All Environmental Permits are in full force and effect. Seller (i) is in compliance in all material respects with all terms and conditions of the Environmental Permits and (ii) is in compliance in all material respects with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules, and timetables contained in the laws, rules, regulations, treaties, or statutes of all governmental entities relating to pollution or protection of the environment or contained in any regulation, code, plan, order, decree, judgment, notice, or demand letter issued, entered, promulgated, or approved thereunder. To the best of Seller’s knowledge after due inquiry, there are no circumstances that may prevent or interfere with such compliance in the future. Schedule includes a listing and description of all Environmental Permits currently held by Seller. For purposes of this Agreement, knowledge of Seller includes the knowledge of the persons who, as of the Closing Date, were its officers, directors, and stockholders (including the trustees, officers, partners, and directors of stockholders that are not natural persons).
(d) Environmental Liabilities. No action, proceeding, revocation proceeding, amendment procedure, writ, injunction, or claim is pending or, to the best knowledge of Seller, threatened against Seller or the business of Seller concerning any Environmental Permit, Hazardous Material, or the Seller’s Hazardous Materials Activity or pursuant to the laws, rules, regulations, treaties, or statutes of any governmental entity relating to pollution or protection of the environment. There are no past or present actions, activities, circumstances, conditions, events, or incidents that could involve either Seller or any person or entity whose liability Seller has retained or assumed, either by contract or by operation of law, in any environmental litigation, or impose upon Seller (or any person or entity whose liability Seller has retained or assumed, either by contract or by operation of law) any material environmental liability including, without limitation, common law tort liability.
Mergers and acquisitions among small and growing privately held companies do not generally raise many issues or filing requirements under the federal securities laws, specifically the Securities Act of 1933 and Exchange Act of 1934. Privately held companies may utilize the 1933 SEC private placement exemption, commonly known as Regulation D Safe Harbors. Privately held companies, however, may be subject to the obligations of the 1933 Act if the transaction involves a public offering. Regulation D sets the standards in determining whether a transaction involves a public offering. In addition, where one or both of the companies are publicly traded and therefore have registered their securities under the Securities Act of 1933, a host of reporting obligations are triggered.
10-Q and 10-K reports. The Exchange Act of 1934 imposed periodic reporting requirements on issuers of securities. A discussion of the proposed transaction may need to be included in either or both of the acquiring company’s and the target’s quarterly and annual filings with the SEC. The acquiring company will usually be obligated to include the information in its scheduled SEC reports if the acquisition is deemed to be “significant.” A significant acquisition is typically defined as one where the target’s assets or pretax income exceeds 10 percent of the acquiring company’s assets or pretax income.
Registration statements. If the acquiring company plans to issue new securities as part of the consideration to be given to the target’s shareholders, then a registration statement should be filed with the SEC. For a negotiated merger or acquisition transaction, the registration statement filed with the SEC is a form S-4, which contains details relating to the share distribution, amounts, terms, and other information related to the consolidation. Additionally, a prospectus must be provided to shareholders who will receive the securities, detailing specific disclosure requirements based on the business and financial affairs of the issuer.
Proxy information. If the proposed transaction must be approved by the shareholders of either the acquiring company or the target, then the SEC’s special proxy rules and regulations must be carefully followed.
Tender offers. When a buyer of a publicly held company elects to make a tender offer directly to the shareholders of the target, rather than negotiating through management, then the filing requirements in the Williams Act must be followed. This includes the filing of the SEC’s Schedule 13D whenever the purchaser becomes the beneficial owner of more than 5 percent of the target’s equity securities, which gives notice of the buyer’s intentions to both the SEC and the target company’s officers and directors.
Antifraud Liability. The 1933 and 1994 Acts create liability for fraud in the offer, purchase, or sale of securities. Both parties must be careful, and should consult with counsel to ensure avoiding any material misrepresentation or omissions of material facts in connection with the sale.
The central concern of federal government policy is with those acquisitions that increase the danger that companies in a particular market will have market power—the power to raise prices or limit production free from the constraints of competition. This danger increases when a market is dominated by a few large firms with substantial market shares. Federal antitrust laws prohibit any acquisition of stock or assets that tends to substantially lessen competition. Acquisitions of the stock or assets of a competitor or potential competitor (“horizontal acquisitions”) are most likely to raise antitrust concerns, especially if they occur in markets that are already dominated by a few firms. Acquisitions involving companies in a supplier–purchaser relationship (“vertical acquisitions”) can also raise antitrust concerns, but in general, vertical transactions are less of a concern from an antitrust perspective.
The DOJ and the FTC may seek to halt, delay, or modify the terms of those acquisitions that they consider likely to significantly lessen competition. Furthermore, the Hart-Scott-Rodino Act generally requires that the FTC and the DOJ be given advance notification of mergers and acquisitions involving companies and transactions above a specified minimum size, the details of which are discussed here.
The principal responsibility for enforcing antitrust laws with respect to business combinations continues to be exercised by the DOJ and the FTC. These agencies have jointly issued their own set of merger guidelines to help businesses assess the likelihood that their specific business transactions may be challenged under the federal antitrust laws. These federal agencies will consider a number of factors in assessing the legality of acquisitions involving companies competing in the same geographic market and offering competing products or services to generally the same targeted customers. However, the respective market shares of the combining companies, as well as the degree of “market concentration,” continue to be the starting point for the government’s analysis. Transactions that result in the combined company having a large share of the relevant market may raise antitrust concerns.
Because of the importance of market concentration, the definition of the relevant geographic and product market is critical. Among other things, the guidelines take into account reasonable product substitutes, production facilities that may be easily converted to making a particular product, and entry barriers. Once the market is defined, the guidelines seek to measure the extent to which the proposed transaction increases market concentration. While various tests are available, the guidelines measure concentration using the Herfindahl-Hirschman Index (HHI). The HHI is calculated by adding the squares of the individual market shares of all competitors in the market. For example, a market consisting of four competitors, each of which has a 25 percent share of the market, has an HHI of 2,500 (252 + 252 + 252 + 252 = 2,500). Under the guidelines, markets with HHIs below 1,500 are presumed to be unconcentrated, HHIs between 1,500 and 2,500 are presumed to be moderately concentrated, and HHIs over 2,500 are presumed to be highly concentrated. The competitive significance of particular acquisitions is then examined in terms of both the level of the market’s HHI following the acquisition and the extent to which the acquisition increases the HHI. In general, the higher the increase in the post-merger HHI, the higher the probability the DOJ and FTC will raise potential anticompetitive concerns.
In addition to market shares and market concentration, federal enforcement agencies consider the degree of ease of entry into the market. The presence of barriers that would prevent a new competitor from entering a market—such as patents, proprietary technology, know-how, and high “sunk” capital investments—increases the likelihood that the agencies will seek to block the transaction. However, if the agencies conclude that it would be relatively easy for new competitors to enter a market within a relatively short time if prices rose to noncompetitive levels, it is unlikely that they will consider a merger in that market to be anticompetitive, even though it produces a high post-acquisition HHI. Other factors that will be given varying degrees of weight under the guidelines are changing market conditions that might undermine the significance of market shares, such as rapidly changing technology; the financial condition of a company, which might affect its future competitive significance; characteristics of a product that make price collusion difficult or unlikely; and efficiencies resulting from the combination.
Acquisitions involving suppliers and their customers could raise questions under the antitrust laws. Courts, as well as earlier federal enforcement policies, have expressed concerns that such acquisitions could foreclose access by competitors to necessary suppliers or distribution outlets. The foreclosure effect was measured by reference to the share of the market held by the supplier company and the share of purchases of the product made by the customer company. Current federal enforcement policy is somewhat skeptical about claims that vertical acquisitions produce anticompetitive effects. It limits the inquiry primarily to the question of whether such an acquisition is likely to create unacceptable barriers to entry by making it necessary for any new entrant to enter at both the supplier and purchaser levels in circumstances where it is difficult to do so, and thus insulates concentrated markets at either level from new competition.
The premerger notification requirements of the Hart-Scott-Rodino Act (H-S-R) can have an important impact on an acquisition timetable. Under H-S-R and the regulations issued under it by the FTC, acquisitions involving companies and transactions of a certain size cannot be consummated until certain information is supplied to the federal enforcement agencies and until specified waiting periods elapse.
The premerger notification program was established to avoid some of the difficulties that antitrust enforcement agencies encounter when they challenge anticompetitive acquisitions after they occur. The enforcement agencies have found that it is often impossible to restore competition fully because circumstances change once a merger takes place; furthermore, any attempt to reestablish competition is usually costly for both the parties and the public. Prior review under the premerger notification program has created an opportunity to avoid these problems by enabling the enforcement agencies to challenge many anticompetitive acquisitions before they are consummated.
The Hart-Scott-Rodino Antitrust Improvements Act requires that persons contemplating proposed business transactions that satisfy certain size criteria report their intentions to the antitrust enforcement agencies before consummating the transaction. If the proposed transaction is reportable, then both the acquiring business and the business that is being acquired must submit information about their respective business operations to the Federal Trade Commission and to the Department of Justice and wait a specified period of time before consummating the proposed transaction. During that waiting period, the enforcement agencies review the antitrust implications of the proposed transaction. Whether a particular transaction is reportable is determined by application of the act and the premerger notification rules (see Figure 7-2).
Figure 7-2. Hart-Scott-Rodino Act Reporting Rules
On January 25, 2005, the Federal Trade Commission announced that it had authorized the publication of a Federal Register Notice, required by the 2,000 amendments to the act, revising the notification thresholds and limitations in the act and rules. The new rules and regulations regarding increased notification thresholds took effect on March 2, 2005, and the new rules and regulations amending the reporting rules for unincorporated entities took effect on April 6, 2005.
Size of Transaction
There are two basic tests to determine whether a transaction will be reportable. The first test is known as the “size of transaction” test. The minimum required value for any reportable transaction is $53.1 million (as adjusted), and this value is adjusted on an annual basis based upon changes in the GNP during the previous year. The size of transaction test is satisfied if, after consummation of the transaction, the acquiring person will hold voting securities or assets of the acquired person valued at $53.1 million (as adjusted) or more. Rather than amend the rules annually, each dollar threshold will be listed “as adjusted,” which term is defined in the HSR rules. Certain of the exceptions and exemptions to the reporting requirements are discussed in paragraphs (a) and (d) under “Miscellaneous.”
The second test is known as the “size of person” test. This test applies only to transactions that are valued at between $53.1 and $212.3 million (as adjusted). Deals that exceed $212.3 million (as adjusted) are reportable without regard to the size of the parties. If a transaction falls within the $53.1 to $212.3 million (as adjusted) range, in order for the transaction to be reportable, one party must have at least $106.2 million (as adjusted) in annual net sales and/or assets. Total assets and total annual net sales of a person are determined by reference to the last regularly prepared balance sheet and annual income statement. When calculating the total assets and net sales, all entities that are controlled by such person must be included.
Filing Fee
As of late 2017, the fees for filing a premerger notification with the FTC and DOJ are staggered as follows:
Deal value in excess of $80.8 million but less than $161.5 million—$45,000
Deal value at least $161.5 million but less than $807.5 million—$125,000
Deal value $807.5 million or more—$280,000
The regulations provide for such fees to be paid by the acquiring person; however, parties often agree to share such fees.
The parties to a reportable transaction may not consummate the transaction until the statutory waiting period detailed in the H-S-R Act has expired. The waiting period begins on the date that the FTC and DOJ receive the completed notification forms. The waiting period will end on the thirtieth day following such receipt (for cash tender offers and bankruptcy transactions, the waiting period is fifteen days). If any waiting period would expire on a Saturday, Sunday, or legal holiday, the waiting period shall extend to the next regular business day. Parties can request “early termination” of the waiting period at the time of filing at no additional cost, but it is not guaranteed (although early termination is granted in most cases). When early termination is granted, it is usually within two weeks of the initial filing. It is important to note, however, that early terminations are reported in the Federal Register, listed on the FTC website, and listed in the FTC’s public reference room; therefore, parties seeking to maintain the nonpublic nature of a transaction should not request early termination.
During the waiting period, a transaction raising competitive concerns will be reviewed by only one of the agencies—assigned to either the DOJ or the FTC through a clearance procedure. Prior to the expiration of the waiting period, either the FTC or the DOJ can issue a “second request” for additional documents and information, but second requests are not common.
The issuance of a second request extends the waiting period until thirty days after the date when the parties certify that they have substantially complied with the second request (the extension for cash tender offers and bankruptcy transactions is ten days). Responding to a second request will often take between sixty and ninety days, depending on the size of the companies, the number of product markets, and the amount of material to be reviewed. During this time, the responsible agency will be evaluating the relevant markets and interviewing suppliers, customers, and competitors to learn more about the anticompetitive effects of the transaction.
As a general matter, the act and the rules require both parties to file notifications under the premerger notification program if the following conditions are met:
1.One person has sales or assets of at least $161.5 million.
2.The other person has sales or assets of at least $16.2 million.
3.As a result of the transaction, the acquiring person will hold a total amount of stock or assets of the acquired person valued at more than $80.8 million, or, in some stock transactions, even if the stock held is valued at $15 million or less, if it represents 50 percent or more of the outstanding stock of the issuer being acquired and the issuer is of a certain size.
4.As a result of the transaction, the acquiring person will hold a total amount of stock or assets of the acquired person valued at more than $200 million, regardless of the sales or assets of the acquiring persons.
The first step in determining reportability is to determine what voting securities, assets, or combination of voting securities and assets are being transferred in the proposed transaction. Then you must determine the value of the voting securities and/or assets or the percentage of voting securities that will be “held as a result of the transaction.” Calculating what will be held as a result of the transaction is complicated and requires the application of several complex rules. The securities held as a result of the transaction include both those that will be transferred in the proposed transaction and certain assets of the acquired person that the acquiring person has purchased within certain time limits. If the value of the voting securities exceeds $200 million and no exemptions apply, the parties must subsequently file notification and observe the waiting period before closing the transaction. If the value of the voting securities exceeds $80.8 million, but is $323 million or less, the parties must utilize the “size of person” test.
The first step in determining the “size of person” test is to identify who the “acquiring person” is and who the “acquired person” is. These technical terms are defined in the rules and must be applied carefully. In an asset acquisition, the acquiring person is the buyer and the acquired person is the seller. The rules require that a person who is proposing to acquire voting securities directly from shareholders, rather than from the issuer itself, serve notice on the issuer of those shares to make sure that the acquired person knows about its reporting obligation.
Once you have determined who the acquiring and acquired persons are, you must determine whether the size of each person meets the act’s minimum size criteria. This “size of person” test generally measures a company based on the company’s last regularly prepared balance sheet. The size of a person includes not only the business entity that is making the acquisition and the business entity whose assets are being acquired or that issued the voting securities that are being acquired, but also the parent of either business entity and any other entities that the parent controls. If the value of the voting securities exceeds $80.8 million, but is $323 million or less, the “size of person” test is met, and no exemptions apply, the parties must subsequently file notification and observe the waiting period.
In some instances, a transaction may not be reportable even if the size of person and size of transaction tests have been satisfied. The act and the rules set forth a number of exemptions, describing particular transactions or classes of transactions that need not be reported despite the fact that the threshold criteria have been satisfied. For example, the acquisition of assets in the ordinary course of a person’s business, such as new goods and current supplies, may be exempt. The acquisition of voting securities of a foreign issuer may be exempt if the foreign company’s sales into the United States were $50 million or less.
Once it has been determined that a particular transaction is reportable, each party must submit its notification to the Premerger Notification Office of the Federal Trade Commission and to the Director of Operations of the Antitrust Division of the Department of Justice. In addition, each acquiring person must pay a filing fee to the Premerger Notification Office for each transaction that it reports. The filing fee is $45,000, $125,000, or $280,000 depending on the value of the securities held as a result of the acquisition.
There is a wide variety of federal and state labor and employment law issues that must be addressed by the buyer and its counsel as part of its overall due diligence on the seller’s business. This includes a comprehensive review of the seller’s employment practices and manuals to ensure historical compliance with the laws governing employment discrimination, sexual harassment, drug testing, wages and hours, and so on, as well as its compliance with the Family and Medical Leave Act (FMLA), the Americans with Disabilities Act (ADA), and the Worker Adjustment and Retraining Notification Act (WARN), which governs plant closings and retraining requirements.
Where applicable, it will also be necessary to review collective bargaining agreements, with a particular focus on the buyer’s duty to bargain with the union as a “successor” employer.
The buyer must be aware of the wide range of potential ERISA liability issues that it may confront if the employee benefit plans established by the seller are not properly structured or funded. The buyer must also develop a strategy for the integration of the seller’s plan(s) into its own, which may involve transferring plan assets in whole or in part or the utilization of surplus plan assets. There are many different types of employee benefit plans, including a “qualified” plan (which currently provides certain favorable tax consequences, such as deductions for plan contributions and deferral of income for plan participants) and unqualified plans (such as deferred compensation arrangements, which currently do not provide favorable tax consequences). Retirement plans generally are either “defined-contribution plans” or “defined-benefit plans.” Defined-contribution plans include profit-sharing plans with or without a 401(k) feature, thrift or savings plans, money purchase pension plans, target benefit plans, stock bonus plans, employee stock ownership plans, simplified employee pensions (SEP), savings incentive match plans for employees (SIMPLE plans), and certain funded executive compensation plans. A defined-benefit plan is a retirement plan other than a defined-contribution plan. The traditional defined-benefit pension plan is one in which the employer takes financial responsibility for funding an annuity payable over an employee’s life or as a joint and survivor annuity to the employee and his spouse.
Employee benefit plans can represent one of the largest potential liabilities of a business enterprise. The types of employee benefit plans involving the greatest potential liabilities are defined-benefit pension plans, post-retirement medical and life insurance benefits, and deferred compensation programs for executives. In many cases, the liability for an employee benefit plan shown on the financial statements may not be an adequate portrayal of the true liability. A buyer is well advised to have an actuary compute the value of the employee benefits, both retirement plans and retiree medical plans, in order to be sure that the balance sheet provision is adequate.
The treatment of employee benefit plans in corporate acquisition, merger, and disposition situations has taken on greater and greater importance since the passage of ERISA in 1974. The importance of employee benefit plans grows with each new development in the benefits arena, including the Multiemployer Pension Plan Amendments Act of 1980 (MEPPAA), Deficit Reduction Act of 1984 (DRA), Retirement Equity Act of 1984 (REA), Omnibus Budget Reconciliation Act of 1986 (OBRA), Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA), Single Employer Pension Plan Amendments Act of 1986 (SEPPAA), Tax Reform Act of 1986 (TRA 86), Omnibus Budget Reconciliation Act of 1987 (OBRA 87), Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Omnibus Budget Reconciliation Act of 1990 (OBRA 90), Tax Extension Act of 1991 (TEA ’91), Unemployment Compensation Amendments of 1992 (UCA), Omnibus Budget Reconciliation Act of 1993 (OBRA 93), Unemployment Compensation Act of 1992 (UCA), Retirement Protection Act of 1994 (RPA), Small Business Job Protection Act of 1996 (SBJPA), Health Insurance Portability and Accountability Act of 1996 (HIPAA), Taxpayer Relief Act of 1997 (TRA ‘97), Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA), Tax Relief Extension Act of 1999 (TRE ’99), Community Renewal Tax Relief Act of 2000 (CRTRA), Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Consolidated Appropriations Act of 2001 (CAA), Sarbanes-Oxley Act of 2002 (Sarbox), Job Creation and Worker Assistance Act of 2002 (JCWAA), Medicare Prescription Drug, Improvement, and Modernization Act of 2003, and the Pension Funding Equity Act of 2004 (PFEA), Statements 87, 88, and 106 132R of the Financial Accounting Board (SFAS 87, 88, and 106 132R), Worker Retiree and Employer Recovery Act of 2008 (WRERA), American Recovery and Reinvestment Act of 2009 (ARRA), Trouble Assets Relief Program under the Emergency Economic Stabilization Act of 2008 (TARP), and Patient Protection and Affordable Care Act of 2010 (PPACA).
Employee benefit plans can be the source of major off–balance sheet liabilities that have to be dealt with by the parties to the transaction. In some cases, employee benefit plans will dictate whether the transaction will be structured as a sale of stock or a sale of assets. In a few cases, employee benefit plans may result in the deal falling through. In still other situations, employee benefit plans can be utilized to accomplish the transaction.
Generally, employee benefit plan considerations do not dictate the structure of a corporate acquisition. There are, however, a few exceptions. A seller that faces a potentially large withdrawal liability with respect to a multiemployer pension plan may insist on a sale of stock rather than a sale of assets. On the other hand, a buyer that does not want to inherit a burdensome plan from the seller may insist on a sale of assets. In the case of a sale of assets, the buyer is not generally obligated to assume the plans of the seller. This decision will depend on the nature of the plans, their funding status, their past history of compliance with the laws, and the nature of the adjustment in the purchase price with respect to the plans.
The biggest difficulty related to employee benefit liabilities in a merger or acquisition is to determine the appropriate adjustment of the purchase price. Since the liabilities involve actuarial calculations, they are totally dependent upon the assumptions as to interest rates and life expectancies, the selection of mortality tables, and other factors that will affect the ultimate liability under the plan. The parties have to agree on these assumptions or on a method of arriving at these assumptions in order to calculate whether the plan is overfunded or underfunded. One such method for a pension plan would be to value the plan’s liabilities using the PBGC’s assumptions for terminated pension plans. While the PBGC rates are not the most favorable rates in the marketplace, they do represent the rates that will be utilized to determine whether the plan is underfunded in the event that the plan should terminate. Another approach is to value the liability on an ongoing basis rather than on a termination basis.
The most important aspect of the acquisition process for the buyer is to start its investigation of the employee benefit plans early and to do as thorough a job as possible. The buyer should be especially concerned with identifying items that are hidden liabilities. Obviously, a buyer should review the plans and their summary plan descriptions. Annual form 5500s for the last three years should be examined by professionals. To the extent that there are actuarial reports for the plans, the buyer should examine copies of them and make sure that they reflect any recent plan amendments increasing benefits. Collective bargaining agreements should also be examined to determine whether they provide for benefit increases that were not contemplated in the most recent actuarial report. With respect to welfare plans, buyers should determine whether they are obligated to provide for increases pursuant to “maintenance of benefit provisions” in collective bargaining agreements. If a union-negotiated plan bases benefits on the compensation of the employees, the buyer should check to see if large wage increases have been negotiated. Finally, the buyer should review any post-retirement medical or life insurance benefits provided by the seller.
The definitive Purchase Agreement should contain detailed and explicit provisions with respect to the handling of employee benefits. If responsibility for a benefit program has to be divided between the buyer and the seller, it is easier to have a fair division of the responsibility if it is negotiated in advance. Buyers rarely get significant concessions from sellers after the deal has closed. A set of sample representations and warranties to cover these issues is set forth in Figure 7-3.
(a) Definitions.
(i) “Benefit Arrangement” means, whether qualified or unqualified, any benefit arrangement, obligation, custom, or practice, whether or not legally enforceable, to provide benefits, other than salary, as compensation for services rendered, to present or former directors, employees, agents, or independent contractors, other than any obligation, arrangement, custom, or practice that is an Employee Benefit Plan, including, without limitation, employment agreements, severance agreements, executive compensation arrangements, incentive programs or arrangements, rabbi or secular trusts, sick leave, vacation pay, severance pay policies, plant closing benefits, salary continuation for disability, consulting, or other compensation arrangements, workers’ compensation, retirement, deferred compensation, bonus, stock option, ESOP or purchase, hospitalization, medical insurance, life insurance, tuition reimbursement or scholarship programs, employee discount arrangements, employee advances or loans, any plans subject to Section 125 of the Code, and any plans or trusts providing benefits or payments in the event of a change of control, change in ownership, or sale of a substantial portion (including all or substantially all) of the assets of any business or portion thereof, in each case with respect to any present or former employees, directors, or agents.
(ii) “Seller Benefit Arrangement” means any Benefit Arrangement sponsored or maintained by Seller or with respect to which Seller has or may have any liability (whether actual, contingent, with respect to any of its assets or otherwise), in each case with respect to any present or former directors, employees, or agents of Seller as of the Closing Date.
(iii) “Seller Plan” means any Employee Benefit Plan for which Seller is the “plan sponsor,” as defined in Section 3(16)(B) of ERISA, or any Employee Benefit Plan maintained by Seller or to which Seller is obligated to make payments, in each case with respect to any present or former employees of Seller as of the Closing Date.
(iv) “Employee Benefit Plan” has the meaning given in Section 3(3) of ERISA.
(v) “ERISA” means the Employee Retirement Income Security Act of 1974, as amended, and all regulations and rules issued thereunder, or any successor law.
(vi) “ERISA Affiliate” means any person that, together with Seller, would be or was at any time treated as a single employer under Section 414 of the Code or Section 4001 of ERISA and any general partnership of which either Seller is or has been a general partner.
(vii) “Pension Plan” means any Employee Benefit Plan described in Section 3(2) of ERISA.
(viii) “Multiemployer Plan” means any Employee Benefit Plan described in Section 3(37) of ERISA.
(ix) “Welfare Plan” means any Employee Benefit Plan described in Section 3(1) of ERISA.
(b) Schedule contains a complete and accurate list of all Seller Plans and Seller Benefit Arrangements. With respect, as applicable to Seller Plans and Seller Benefit Arrangements, true, correct, and complete copies of all the following documents have been delivered to Buyer and its counsel: (A) all documents constituting the Seller Plans and Seller Benefit Arrangements, including but not limited to, insurance policies, service agreements, and formal and informal amendments thereto, employment agreements, consulting arrangements, and commission arrangements; (B) the most recent Forms 5500 or 5500 C/R and any financial statements attached thereto and those for the prior three years; and (C) the most recent summary plan description for the Seller Plans.
(c) Neither Seller nor any ERISA Affiliate maintains, contributes to, or is obligated to contribute to, nor has either Seller or any ERISA Affiliate ever maintained, contributed to, or been obligated to contribute to any Pension Plan or Multiemployer Plan. Neither Seller nor any ERISA Affiliate has any liability (whether actual or conditional, with respect to its assets or otherwise) to or resulting from any Employee Benefit Plan sponsored or maintained by a person that is not a Seller or any ERISA Affiliate. Neither Seller nor any ERISA Affiliate has or has ever had any obligations under any collective bargaining agreement. The Seller Plans and Seller Benefit Arrangements are not presently under audit or examination (nor has notice been received of a potential audit or examination) by the IRS, the Department of Labor, or any other governmental agency or entity. All group health plans of each Seller and their ERISA Affiliates have been operated in compliance with the requirements of Sections 4980B (and its predecessors) and 5000 of the Code, and each Seller has provided, or will have provided before the Closing Date, to individuals entitled thereto all required notices and coverage under Section 4980B with respect to any “qualifying event” (as defined therein) occurring before or on the Closing Date.
(d) Schedule 3.19(d) hereto contains the most recent quarterly listing of workers’ compensation claims of the Sellers for the last three fiscal years.