Leaving A Controlled Group

[MTWeeks]

I have a group of three companies all previously owned by the same family (three brothers, owning all three companies jointly), that have operated a single 401(k) Plan as a controlled group. Now they have sold 49% of one of these companies to an unrelated outside individual. They are asking if they now have the option to kick the 51% owned company out of the Plan. I believe they can, but also think the successor plan rule would apply since they maintained the 401(k) after the acquisition. Does anyone here have any thoughts?

[Bri]

I'm curious on this, because I want to hear more about the concept of kicking out a sponsoring employer....

[Doc Ument]

There is nothing to preclude a document from stating that the employer that "starts" the plan can choose whether other companies may adopt the plan, and to impose conditions on such adopting employers joining or staying on the plan.  For example, a plan that does not contain any provisions for unrelated employers might require that any adopting employer continue to be a member of a controlled group or affiliated service group.  That is why the attorneys who structured this deal should have read the document before proceeding with the transaction. That is why no such divestiture should occur without all the plan's advisors providing advice before the transaction takes place.  

I am not an expert on such matters, but it sounds to me like this group is still a controlled group (since 5 or fewer persons together own presumably equal shares that combine to a percentage over 50%).   Even if I am wrong, it could be an affiliated service group.  So, even if the plan is designed only to be a "single" employer plan, you might still have a single employer plan (i.e., a plan that is adopted only by related employers within the meaning of IRC 414(b)(c) and (m)).   So you would need to look at the document to see if there are any other less common restrictions on the degree of "permission" that exists for adopting employers to remain an adopting employer.  Probably not.

Or, if the brothers have non-uniform ownership among the three companies, and it is not a controlled group for that reason (see IRC 1563(a)(2)), and is not an affiliated service group, then yes, you should make sure the plan contains provisions for unrelated employers, i.e., a multiple employer plan (MEP).  If not, that could be a reason to expel an unrelated employer, though I could argue it means only that the plan should have been amended to accommodate the unrelated employer.

In any event, the deal that was struck should have specifically addressed this situation and not left it up to the advisors to try to figure out once the deal was done.  Did the deal contain a contractual commitment that the 49% company give up the plan?   If so, then the brothers have a contractual remedy outside the plan to force the company to un-adopt the plan. 

The successor-plan rule is generally meant to mean the restriction of the distribution of deferral-related accounts upon a plan termination.  So far, I haven't hear anything about the plan terminating.   Nor have you said that any employees are terminating, so I don't even see any distributable event (an employer un-adopting a plan is not, in itself, a distributable event, except I suppose it could be for some types of funds).   So I don't think anyone reading this has enough facts to make an educated guess as to what options the employers have.

Accountant:  "So, I assume nothing major changed with your tax situation during 2018 or I would have heard from you."

Client:  "No, not really.  Not that I can recall.   Unless you mean that I got divorced, sold the house, bought a condo rental unit that I will live in until my new business (I told you about that, right?) takes off, and then I will rent it out.   Why do you ask?  Isn't that why we have these annual interviews on April 14th?"

[QDROphile]

In addition to Doc Ument's comments, I would embellish the following one:  "That is why the attorneys who structured this deal should have read the document before proceeding with the transaction."

Even if the document did not provide for what was to happen under the circumstances, the plan document could have been amended before closing to provide for the desired outcome (and forced the parties to think in advance about what the desired outcome should be).  Corporate transactional lawyers and advisers have a very bad habit of not including someone with ERISA expertise in the structuring and execution of a sale/reorganization, or at least not doing so in a timely manner before all that can be done is either hold your nose or pick up the pieces as well as possible.

Also, the mentality of not thinking beyond pre-approved documents contributes to the problem.  A pre-approved document is almost certain to fail to serve the needs of complex corporate organizations and transactions.  They are designed based on LRMs and IRS approval rather than the tax-qualification needs of the employer.  Even the exercise of filling out the adoption agreement of pre-approved documents is usually a missed opportunity to think deeply about what the employer(s) is/are all about and what they are trying to accomplish both by way of benefits and by way of administration.  Adopting a benefit plan has become an exercise in buying a mass-produced commodity, designed as a loss-leader for the business of selling investment management services.  It is not surprising the a lot gets lost in the process of both design and implementation.  Cheaper, yes.  But sometimes there is a painful lesson about getting what you pay for.