As with otherbenefit plans, the buyer should compare its health plans to theseller's and consider whether adjustments should be made to reduceany discrepancies. (Image: Shutterstock)

Integrating the employee benefits of the acquired employees following an acquisition isof critical importance, but it can be a difficult task for a buyerof a business from legal, administrative and employee relationsperspectives. When buyer and seller wish to combine operations,assimilating the newly acquired employees into the new environmentrequires coordination with payroll, HR and other components of the buyer'sbusiness.

Making the transition a smooth one requires carefulconsideration and planning. Below are some importantbenefits issues that organizations should consider in connectionwith an acquisition.

401(k) plans

When the buyer and seller both sponsor a 401(k) plan, a commonintegration strategy is for the buyer to continue its plan for bothits employees and the employees it acquires in the transaction.This strategy is often used where there is a desire to make theemployees of the seller feel comfortable about their integration asemployees of the buyer and can be especially effective if thebuyer's retirement benefits are more robust than the seller'sbenefits.

There are two different ways to accomplish this result. Thefirst is for the seller to terminate its plan. Terminationstriggers full vesting of any unvested amounts held in an employee'saccount and a distribution of the plan account to each planparticipant. Each participant may then retain his or her planbalance, transfer it to an IRA or transfer it to the buyer's plan.Most participants seeking continued tax deferral will transfertheir account into the buyer's plan.

Related: 4 keys to effective 401(k) plandesign

The second way is for the buyer to assume sponsorship of theseller's plan. The buyer can either maintain the seller's plan as aseparate plan or merge it into their own. Maintaining the seller'splan as a separate plan provides continuity for the seller's formeremployees, but is costly and complicated for the seller, asseparate plans require separate plan documents, nondiscriminationtesting and Form 5500 filings. As a result, maintaining separateplans usually does not make sense unless the seller's operationsare separate and two plans are more appropriate from an employeerelations perspective.

Merging the seller's plan into the buyer's plan simplifiesadministration but can have a significant downside: if the seller'splan has compliance issues, it will “infect” the buyer's plan. Thismeans that if the IRS or DOL audits the merged plan and finds adefect attributable to the seller's plan, the penalty may be basedupon the total assets in the merged plan. Also, the buyer's plan isusually more complex post-merger, as any “protected” benefits underthe seller's plan must be maintained. For these reasons, the buyershould conduct a compliance review of the administrative andfiduciary operations of the seller's plan prior to the merger.

Given the drawbacks of assuming sponsorship of the seller'splan, many buyers prefer plan termination with distribution ofparticipant accounts (rather than plan-to-plan transfers), whichlimits the liabilities assumed by the buyer and is usually thesimplest approach from an administrative perspective. However, thebuyer must decide what to do about loans if the seller's planpermits them. In order to avoid putting outstanding loans intodefault (which generally occur automatically when employment isterminated or accounts are distributed), buyers often makearrangements to transfer the loans to the buyer's plan. The buyershould also be certain that the seller's former employeesunderstand the tax implications of their distributions and know howto roll over their distributions into the buyer's plan.

If the transaction is an asset acquisition, the buyer and sellermay provide for a transition period during which the seller'sformer employees continue to participate in the seller's plan. Thisarrangement may be desirable if the buyer does not have time toestablish the administrative structure necessary to enroll theseller's former employees in the buyer's plan right away. BecauseInternal Revenue Code rules prohibit the termination of a 401(k)plan (and consequent distribution of accounts) if an employermaintains more than one 401(k) plan, this strategy does not work ifthe transaction is a stock acquisition.

Where there is a transition period after the closing, theparties should enter into a transition services agreement outliningtheir rights and responsibilities during the transition period. Insome instances, the seller provides all payroll and benefits duringthe transition period while it “leases” its former employees to thebuyer.

Once a decision about whether to maintain, merge or terminatethe seller's plan is made, the buyer should notify its 401(k) planservice providers as soon as possible (and before any applicabledeadlines specified in the service agreements) and begin planningfor the administrative mechanics of the transition, includingdetermining what resolutions and plan amendments are necessary.

As discussed above, if the buyer has decided to merge its planwith the seller's, it should perform due diligence on the seller'splan (or review an already-prepared diligence report) and correctany compliance issues before the merger. If compliance issuesemerge during that diligence (as they often do), the buyer may havesome recourse via representations and warranties insurance or thepurchase agreement's indemnification provisions, assuming that theagreement included a representation that the plan was in materialcompliance with applicable law.

Buyers should also review the benefits provided by the seller'splan and consider the employee relations consequences of anydifferences between the two plans. If the seller's plan is moregenerous, adding a matching or profit-sharing contribution to thebuyer's plan or the merged plan at the time of the transition maymake sense. Whether benefit levels will be adjusted or not,employees on both the buyer and seller side will have questionsabout the transaction's impact on their benefits. Employeecommunications explaining the transition should be prepared inadvance, if possible, and sent soon after the transaction isannounced.

2. Health benefits

The seller's former employees are usually transferred to thebuyer's health plans effective upon the closing. Therefore, buyersshould notify their insurers (for plans that are insured) or claimsadministrators and stop-loss insurers (for plans that areself-insured) about the transaction as early as possible. Often,the purchase agreement provides that the buyer will credit theseller's former employees with any spending they have already donetoward plan deductibles and out-of-pocket expense limits for theyear. In order to accomplish this, buyers should require the sellerto transfer the appropriate records to the insurer or claimsadministrator.

The buyer should also require that the seller provide completerecords with respect to its compliance with the Affordable CareAct. In particular, the buyer should obtain the informationnecessary to fulfill ACA reporting requirements for the next yearas well as the data necessary to transition the seller's formeremployees onto the buyer's hours tracking system for purposes ofACA's “pay or play” employer mandate.

When the seller sponsors a flexible spending account (FSA), theparties must decide whether the buyer will transmit contributionsto the seller's plan for the remainder of the year or transfer theseller's employees (along with their elections and accountbalances) to the buyer's plan.

As with other benefit plans, the buyer should compare its healthplans to the seller's and consider whether adjustments should bemade to reduce any discrepancies. The buyer should also prepareemployee communications explaining the transition and the benefitsprovided under its plans.

It is also critically important for buyers to understand if anyretiree medical or other post-termination health benefits have beenpromised to employees. If such commitments have been made, then itis key to understand whether they will be transferred to the buyerand, if so, the extent to which the buyer will be obligated tocontinue providing the benefits.

3. Executive compensation

Executive compensation arrangements vary widely, as do theissues encountered in integrating them following a transaction, butthe first task for every buyer is understanding exactly whatdeferred compensation, equity awards and perks have been promisedto executives. This task is difficult but important, as executivecompensation arrangements are frequently unfunded. The buyer shouldconsider how its executive compensation package compares to theseller's and whether changes are necessary or appropriate. Thecomparison should also be taken into account in negotiating theemployment terms of the seller's executives.

There are a multitude of factors relating to benefits that mustbe taken into account when a business is acquired. Careful planningand knowledge of the acquired business's benefits plans arecritical to accomplishing a smooth transition and the successfulintegration of acquired employees.

Read more:

• Mergers and acquisitions 101
• 5 things most brokers don't know about agencyacquisitions
• Strategic objectives should drive mergers,acquisitions

Emily A. Meyer is an associate andSteven J. Friedman and Robert C.Long are shareholders at Littler Mendelson, P.C.in New York, where they advise employers on a variety ofaspects of employee benefits law.