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Liability for Prior Plan Sponsor's Errors


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The buyer in an asset sale is contemplating adopting a 401(k) plan maintained by the seller. The buyer will inherit all of the seller's employees (plan participants) in the transaction. The plan is a prototype sponsored by a payroll processing company and has only been in existence 3 years. Presuming that there were procedural errors during one or more of those years, what is the extent of the buyer's liability for the prior plan sponsor's errors? Other than correcting the procedural error and paying any applicable penalties and interest, would the buyer still have exposure if it did not take a tax deduction for the year in which the error took place? Are there any ramifications for the seller, if the seller still exists? Does it make a difference if the seller does not exist after the asset sale?

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I am not a lawyer, but it is my clear understanding that the buyer instantly assumes all liability for all past errors upon the moment the buyer adopts the seller's plan. I have seen payment holdbacks as part of the sales contract to cover unknown contingencies such as this. Obviously the plan must be fixed. It is immaterial whether a deduction has been taken, operating a plan correctly is a fiduciary requirement and the buyer just became a fiduciary.

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Since it was an asset deal, I assume the seller remains the sponsor. If your focus is on protecting the interests of the buyer, then you might consider requesting the seller to terminate the plan, obtain an IRS determination letter regarding plan termination and distribute the accounts, including direct rollovers to the buyer's plan, under Reg. Sec. 1.401(k)-1(d)(3). Presumably, the process of obtaining the determination letter will require the seller to clean up the problems, which may require the seller to utilize the VCR or Walk-in CAP programs initially, before requesting a letter of determination. If the seller will terminate the plan but doesn't want to request a determination letter or utlize the IRS resolution programs, then you could consider having the seller's shareholders indemnify the buyer for any claims, damages, liabilities, etc. to the buyer or the buyer's plan from accepting direct rollovers. If the seller cannot be persuaded to terminate the plan, you might consider asking the seller to approve a merger with the buyer's newly established plan on the condition that the seller's shareholders similarly indemnify the buyer. Of course, this may be a very slender reed for the buyer, if the shareholders' indemnification is not worth much.

The strategy of having the buyer "adopt" the seller's plan is probably the most suspect, if for no other reason, because the prototyple plan may not permit the substitution of an unrelated employer as plan sponsor by a simple amendment of the adoption agreement. But assuming that it did, I don't see how the buyer would be exposed to adverse tax consequences even if the plan is retroactively disqualified, although as an employee relations matter, it may take the brunt of the employee's dissatisfaction with such an outcome. While the buyers will have fiduciary liability on an ongoing basis, they will not be exposed to liability for the breaches of the prior fiduciaries. Nonetheless, they have a duty to take legal action to recover any lost profits or restore losses that were the result of such breaches, which come to their attention.

[Edited by PJK on 08-16-2000 at 03:01 PM]

Phil Koehler

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