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Termination of a plan without sufficient assets to pay all benefits


smm

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ok - here is my question. What is a plan document allows an employer to termate the plan in connection with a change in control, etc....but the employer does not have sufficient assets (or will not receive sufficient assets in the deal) to pay all benefits due under the plan. Under the exception in the final regs. allowing termination of a plan in connection with a change in control, all amounts under the plan must be paid with 12 months, etc. In a perfect world, this would not be a problem. But we live in an imperfect world. There is another provision of the regs. that says there is no 409A violation when an employer doesn't pay provided that the employees basically sue the employer. What if the individuals entitled to the benefits make up the board, etc. Any thoughts?

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I am assuming from your post, particularly the information provided near the end, that the individuals who would be "shortchanged" are happy to do whatever needs to be done to close the deal. In other words, they won't sue because they are not getting their full benefits. Have you considered amending the Plan(s) to say that the participants will be entitled to benefits only to the extent the money is available, and that they waive any claims to anything more? The consideration is that they have their own personal interests in getting this deal done. Reduction of benefits is not a problem under 409A.

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SMM: you need to review the merger documents to see what liabililities of the acquired company will be assumed by the acquiring co and what are the employees rights under the NQDC plan. Liabilities just dont disappear when a company is acquired. If the employees' benefits are vested under a NQDC plan they cannot be unilaterally reduced by the plan sponsor since the employer is contractually obligated to pay the sums and may be able to sue the acquiror. The plan will probably provide that in the event of a cinc the employees will be paid the fmv of their vested benefit b/c no one trusts the acquiring company to pay the promised benefits. There is case law under ERISA that would enforce the employees rights to vested NQDC benefits. Directors who are not employees can enforce their rights under state contract law.

You need to consult with counsel to find out the terms for paying the benefits in the NQDC plan under the plan for merger.

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I don't think 409A requires per se that employer meet the obligations of a plan, but only that there is no money left on the table that can be paid later. So the employees either have to agree to take less money or the acquiror should pick up the remaining liability. It might be kind of tough to rely on ERISA here since many courts don't apply ERISA's remedies in this situation--the participant's are thought to have only contract rights (depending on the jurisdiction you are in). If they don't want to sue, then the plan should be amended, each participant should agree to take what is available and they should sign a release and waiver. Otherwise, you'd think the buyer would be willing make the participants whole if they want the deal to go through.

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SF: Top hat plans are subject to ERISA (See 201) but are exempt from the fiduciary provisions and Fed cts will apply ERISA to enforce the contractual rights of employees to plan benefits. See Kemmerer v. ICI Americas Inc. 70 Fed 3d 281. Top hat plans are subject to the claims procedures of ERISA 503. State laws are preempted from applying to an ERISA plan. Excess benefit plans are subject to state law since they are exempt from ERISA.

Every deal I worked on had explicit provisions of what liaibilities would be assumed by the buyer and what would be the disposition of the any NQ plans of the seller b/c no one wanted to assume undisclosed liabilities. What is the fmv of the NQCD benefits?

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SF: Top hat plans are subject to ERISA (See 201) but are exempt from the fiduciary provisions and Fed cts will apply ERISA to enforce the contractual rights of employees to plan benefits. See Kemmerer v. ICI Americas Inc. 70 Fed 3d 281. Top hat plans are subject to the claims procedures of ERISA 503. State laws are preempted from applying to an ERISA plan. Excess benefit plans are subject to state law since they are exempt from ERISA.

Every deal I worked on had explicit provisions of what liaibilities would be assumed by the buyer and what would be the disposition of the any NQ plans of the seller b/c no one wanted to assume undisclosed liabilities. What is the fmv of the NQCD benefits?

I don't have citations, but I recall some court opinions that do not enforce ERISA claims procedures/remedies for top hat plans--I think it would depend on what circuit you are in and how the plan is drafted.

I agree that the acquisition agreement should address this, but what if the buyer doesn't want to assume the liability and it isn't a merger of equals (which is rarely the case). Wouldn't that mean the participants have to agree to accept less and use it as leverage in negotiating a higher sale price? Otherwise, if the buyer wants the deal to go through shouldn't they agree to assume the liability?

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I would be interested in seeing the cites since top hat plans are subject to ERISA and participants in a top hat plan can bring a civil action under the enforcement provisions of Section 503 of ERISA to recover benefits. Barrowclough v. Kidder Peabody & Co, 752 F2d 923.

I dont understand your statement of what if the buyer does not want to assume the liability of the DC plan. In that case the deal would be structured as an asset sale where no liabilities are transfered to the buyer and seller would still be obligated to pay benefits to the employees under its NQDC plan. Or the buyer could purchase a majority interest in the seller and the seller could continue as a subsidiary of the buyer with a continuing liability to the employees under the NQDC plan. Finally the seller could assume the liability to pay the NQDC plan benefits by reducing the sales price to the buyer in an amount equal to the FMV of the benefits.

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Why would a buyer pay the seller more to induce the seller to terminate the seller's NQ plan that has no additional value to the buyer? NQDC plans in the acquired employer are usually terminated as part of the acquisition and benefits are paid by the seller from the sale proceeds or cash reserves. If the participants have vested in the benefits the seller will have to pay them out regardless of the higher stock price because seller cannot cancel the employees' rights to vested benefits under a top hat plan.

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Why would a buyer pay the seller more to induce the seller to terminate the seller's NQ plan that has no additional value to the buyer? NQDC plans in the acquired employer are usually terminated as part of the acquisition and benefits are paid by the seller from the sale proceeds or cash reserves. If the participants have vested in the benefits the seller will have to pay them out regardless of the higher stock price because seller cannot cancel the employees' rights to vested benefits under a top hat plan.

I'm not saying the seller can cancel anyone's rights, but the employees can agree to take what's available for the sake of the deal--they are all presumably shareholders. A buyer may not want to maintain a seller's plan and may not want to merge the plan, so they would want it terminated to get it off the books. This can happen in the qualified plans arena as well. As consideration, the buyer might pay a higher price.

I disagree that plans are usually terminated. Most employees will have their account balances transferred to the buyer's plans because they don't want to recognize income. In the normal course, plans usually merge. In OP, there is obviously a funding problem; the money has to come from somewhere or participants have to take less. Every executive lives with the risk that the company may not be able to pay its liabilities under a NQDC, do you think that just because they are vested means that money will fall from a tree?

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I disagree that plans are usually terminated. Most employees will have their account balances transferred to the buyer's plans because they don't want to recognize income. In the normal course, plans usually merge. In OP, there is obviously a funding problem; the money has to come from somewhere or participants have to take less. Every executive lives with the risk that the company may not be able to pay its liabilities under a NQDC, do you think that just because they are vested means that money will fall from a tree?

Acquiriors do not like to add liabilitites for the predecessors NQDC on their books after an acquisition for which the acqurior is now obligiated to pay out with its own assets and it is difficult to merge NQ plans (Why would the acquiror go to the expense and trouble of merging plans with no assets?) Employees prefer to receive the funds and pay taxes to the uncertainty of dealing with the acquiror when payment is due. Since tax rates at this time will be lower than tax rates after 2010, employees will accept the opportunity cost of receiving benefits instead of waiting until retirement.

The risk that the employees assume in a NQDC plan is that creditors of the employer will claim the funds needed to pay benefit in the plan, since the employees are last in line as unsecured creditors, not that the employer will renege on its obligation to pay deferred comp. It would be a great opportunity if corporations could avoid paying amounts due under binding obligations by merging with or being acquired by another entity. The participants can sue their employer to collect benefits owed under NQDC.

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The OP is saying the company can't pay, not that they won't pay. That suggests insolvency to me.

In my experience, plans don't terminate on merger because all benefits have to be paid out--especially now with 409A's strict rules on termination it is rarely practical, and you definitely can't do it after merger. People who terminate at CIC can usually be paid out so termination is too drasic and unneccessary in the normal course. The employees who continue on in employment typically want the status quo to continue. I don't see why you say it is hard to merge NQ plans. Seems much harder to merge qualified plans with assets and 411(d)(6), etc. But at any rate, in the business I work in, the acuirors usually either merge or take on the prior plan as successor.

As to the previous issue--some cases to chew on:

Amending or terminating a top hat plan is different from amending a broad-based ERISA plan because top hat plans are not subject to the anti-cutback, non-forfeiture provisions, as are broad based plans.

Courts have found top hat plans are analogous to unilateral contracts and have used contract law analysis when looking at decisions to amend or terminate plans Goldstein v. Johnson & Johnson, Carr v. First Nationwide Bank.

Although claims for benefits are governed by ERISA, an employer's decision to terminate or cut back a benefit is analyzed under contract law. Thus, the real question here is probably whether or not the company can contractually terminate the plan. If the seller is essentially insolvent how can they "force" the buyer to bail the plan out? I can't imagine why they don't want to but, assuming the plan can be terminated, I don't see why the buyer couldn't make the deal contingent on termination of the plan. Again, I'm not sure what reasons would justify such a condition.

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ok - here is my question. What is a plan document allows an employer to termate the plan in connection with a change in control, etc....but the employer does not have sufficient assets (or will not receive sufficient assets in the deal) to pay all benefits due under the plan. Under the exception in the final regs. allowing termination of a plan in connection with a change in control, all amounts under the plan must be paid with 12 months, etc. In a perfect world, this would not be a problem. But we live in an imperfect world. There is another provision of the regs. that says there is no 409A violation when an employer doesn't pay provided that the employees basically sue the employer. What if the individuals entitled to the benefits make up the board, etc. Any thoughts?

SF:

Q1 Ignoring for now that the OP did not state that the acquired company is insolvent, why would a buyer who acquires a controlling interest in an insolvent company not be liable for the liabilities of the insolvent company that it controls, incluidng deferred comp ? Are you saying that the acquiror can pocket the assets of the company that it controls and ignore the liabilities owed on the date of purchase? If a buyer wants to avoid acquiring liabilities of an insolvent company it purchases assets, not a controlling interest.

Q2 Why would a buyer give either cash or stock to purchase a controlling interest in an insolvent company that will have a value of 0 on the buyers book's after acquisition?

Q3 I dont understand what you mean by how can the seller force the buyer to bail the plan out. If the buyer purchases the seller why doesn't the buyer own the seller's liabilities as well as assets?

I dont disagree that courts use contract analysis to determine the rights of the employees and can terminate the plan in accordance withits terms. What the courts have held is that the employer cannot retroactively amend a top hat plan to reduce vested benefits or refuse to pay benefits on the grounds that the fiduiciary provisions of ERISA do not apply to a top hat plan. If the seller is insolvent after a cinc then it will file for bankruptcy which is why it make no sense for a buyer to purchase a controlling interest in such acompany.

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SF:

Q1 Ignoring for now that the OP did not state that the acquired company is insolvent, why would a buyer who acquires a controlling interest in an insolvent company not be liable for the liabilities of the insolvent company that it controls, incluidng deferred comp ? Are you saying that the acquiror can pocket the assets of the company that it controls and ignore the liabilities owed on the date of purchase? If a buyer wants to avoid acquiring liabilities of an insolvent company it purchases assets, not a controlling interest.

Q2 Why would a buyer give either cash or stock to purchase a controlling interest in an insolvent company that will have a value of 0 on the buyers book's after acquisition?

Q3 I dont understand what you mean by how can the seller force the buyer to bail the plan out. If the buyer purchases the seller why doesn't the buyer own the seller's liabilities as well as assets?

I dont disagree that courts use contract analysis to determine the rights of the employees and can terminate the plan in accordance withits terms. What the courts have held is that the employer cannot retroactively amend a top hat plan to reduce vested benefits or refuse to pay benefits on the grounds that the fiduiciary provisions of ERISA do not apply to a top hat plan. If the seller is insolvent after a cinc then it will file for bankruptcy which is why it make no sense for a buyer to purchase a controlling interest in such acompany.

Q1 You keep missing my point. It is commonplace for parties to negotiate the termination of a plan prior to a merger or acquisition because, for whatever reason, the buyer may not want to maintain the plan, or the seller, for whatever reason, may not want the buyer to maintain the plan. E.g., this was commonplace with 401(k)s until the IRS eased up on some of the rules. I never said the seller could avoid the liabilities after merger. IT HAS TO BE DONE BEFORE THE MERGER!

Q2 Many investors have made millions and even billions purchasing "worthless" stock, only to see the company come back. Kirk Kerkorian anyone? Old car company's, etc. Read the Wall Street Journal. The best time to buy can be when the company looks deadest.

Q3. See answer to Q1.

Wouldn't a buy out be intended to save a potentially insolvent company? Enron was desperately seeking a buyer when the sh!t started to hit the fan.

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BTW Insolvency is defined a financial condition experienced by a person or business entity when their assets no longer exceed their liabilities, commonly referred to as 'balance-sheet' insolvency, or when the person or entity can no longer meet its debt obligations when they come due, commonly referred to as 'cash-flow' insolvency.

The term insolvency is often incorrectly used as a synonym for bankruptcy, which is a distinct concept. Under the Uniform Commercial Code, a person is considered "insolvent" when the party has ceased to pay its debts in the ordinary course of business, or cannot pay its debts as they become due

Under that definition the company could be insolvent. The OP said "the employer does not have sufficient assets (or will not receive sufficient assets in the deal) to pay all benefits due under the plan".

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The term insolvency is often incorrectly used as a synonym for bankruptcy, which is a distinct concept. Under the Uniform Commercial Code, a person is considered "insolvent" when the party has ceased to pay its debts in the ordinary course of business, or cannot pay its debts as they become due

Under that definition the company could be insolvent. The OP said "the employer does not have sufficient assets (or will not receive sufficient assets in the deal) to pay all benefits due under the plan".

I dont see anything in the above statement that says the employer cannot it debts when due- the OP is that the employer does not have sufficient assets to pay all benefits due under the plan which can include the owner's desire to take money out of the company rather than not having enough assets to pay benefits. In order to answer the OP question it is necessary to know what will happen to the seller after the cinc- will the seller's co be merged into the buyer, continue as a separate subsidiary of the buyer or will the assets be sold and the the business liquidated.

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