Can the target corporation in a stock sale transaction transfer sponso

[Guest Davis McDonald]

Corporation A, a closely held corporation that sponsors a 401(k) plan, is being sold in a stock sale transaction (the corporation will be liquidated into a subsidiary of the acquiring company). The acquiring company does not want to assume any responsibility for terminating the 401(k) plan. Therefore, Corporation A is considering creating a new entity to assume sponsorship of the 401(k) plan prior to the sale. The new entity would be owned by the shareholders of Corporation A and its sole purpose for being would be to act as sponsor of the plan while it is being terminated. Is this permissible? For what liabilities of the 401(k) plan would the acquiring company potentially be liable? If it is permissible, what requirements would apply to the new entity in connection with acting as the new sponsor of the 401(k) plan? It is contemplated that the plan would be frozen and terminated prior to or on the closing date of the sale.

[pjkoehler]

Another approach would be to modify the acquisition agreement to provide post-closing covenants by the individuals who are currently Corp. A shareholders to: (1) exercise their best efforts to terminate the plan and obtain a favorable determination letter from the IRS and to report to the buyers' board on a regular basis concerning its progress, (2) to fully defray the cost of the plan termination and determination letter process, (3) to the extent they are plan fiduciaries, to remain in that capacity pending the receipt of a determination letter and complete distribution of all plan assets and filing of the final Form 5500 and (4) to indemnify and hold the the buyer harmless from any liabilities, damages, claims, etc. arising from the form, operation or termination of the plan. To further protect the buyer, the sales price could also provide for a special holdback or escrowed amount, that will not be released to the sellers until these post-closing covenants are fully performed and that may be drawn upon by the buyers in the event of the sellers' breach of such covenants or indemnification.

I think this is a better approach, because it gives the buyer more information about the progress of the plan termination and gives the selling shareholders a financial incentive to proceed rapidly. The approach suggested in this thread gives the buyer a false sense of security regarding the maintenance of the plan by a presumably thinly capitalized shell corporation, which exposes the buyers to the risk that selling shareholders would simply resign as fiduciaries, take the proceeds from the sale and disappear?[Edited by PJK on 09-06-2000 at 07:14 PM]

[Guest Davis McDonald]

PJK - Thank you for your comments. I think that the facts of the situation are consistent with what you recommend. The buy/sell agreement would obligate the owners of Corporation A to indemnify the acquiring company for any and all costs and liabilities that the acquiring company may incur because of the 401(k) plan (which would include all costs of terminating the 401(k) plan). It may also include a holdback. However, rather than let the acquiring company become the plan sponsor and be in charge of the termination, which would leave the current owners of Corporation A without any ability to control the costs incurred, the owners would like to set up an entity that they would own to retain sponsorship of the plan during the termination period. It does not seem to me that there is anything in the Internal Revenue Code, ERISA or other law that would prohibit the transfer of sponsorship to a shell corporation set up by and owned by the current owners of Corporation A. Provided that the acquiring company would be adequately indemnified in the event it incurred any liability in the future because of the 401(k) plan or its termination, it seems to me that this would be attractive to the acquiring company as well, because it keeps them from having the administrative responsibility associated with terminating the plan. I would appreciate your or anyone else's thoughts about this evaluation of the situation.

[pjkoehler]

Davis, as practical matter, if the seller maintains a form of prototype or volume submitter plan, the restrictions on plan language may not permit this substitution by an unrelated company, since it would in theory result in a multiple employer plan. This will probably require an amendment and restatement to an individually-designed plan and a determination letter as part of the plan termination determination letter process. Another consideration is the impact on the plan's filing status for purposes of Form 5500. Presumably, the plan will convert from a single employer to a multiple employer filing entity. The identity of the plan sponsor will change also, not merely the name and the TIN of the plan sponsor, and perhaps the plan administrator will also change, which is an anomlous event for filing purposes. Even if you could resolve these form and administrative issues by amending and restating the plan as an individually designed multiple employer plan, it seems that Corp. A will have to undergo a some sort of withdrawal procedure in order to leave Newco as the sole plan sponsor. All of this sounds fairly time consuming, i.e. expensive.

I'm guessing that Newco will have no employees itself. QUESTION: Since Newco had no employer relationship to any participants and never made any contributions, could the plan be attacked as a plan not maintained by an "employer" for purposes of Code Section 401(a)? I don't know the answer; but it may be worth some research.