Mergers and acquisitions among private companies always present a range of HR challenges, especially in light of Covid-19. Many of those issues revolve around benefits. Here are the most common that organizations typically need to address.
1. COVID-19-Specific Representations in Transaction Documents
It is important to understand how Covid-19 has impacted the business and workforce being acquired in a transaction. While not yet industry standard, practitioners are seeing transaction documents that more frequently include Covid-specific representations pertaining to:
- Compliance with the Families First Coronavirus Response Act
- Compliance with Covid-19 rules for workplace safety, sick leave, and the Family and Medical Leave Act
- An intention not to terminate or furlough employees or to defer or reduce compensation as a result of the pandemic
- No actual or anticipated changes to benefit plans as a result of Covid-19.
Furthermore, if a company has received a loan under the Paycheck Protection Program, an acquirer may request representations that the seller is not aware of any facts that would jeopardize the ability of the loan to be forgiven.
2. General Representation and Warrant Deal Concerns and Traps for the Unwary
Companies are more routinely seeking representation and warranty insurance in transactions, which often requires a more detailed and fulsome review of a seller’s operations through the due diligence process.
In light of Covid-19, representation and warranty insurers have started inquiring about specific employment and benefit diligence related to the pandemic, including whether there have been furloughs or layoffs due to Covid-19 and details on employee and workplace-related safety precautions.
During the pandemic, companies undergoing a corporate transaction should be prepared to provide detailed information regarding the effects that Covid-19 has had on its workforce and any precautionary measures that it has taken to protect its workforce.
3. Addressing the Federal Workers’ Adjustment and Retraining Notification (WARN) Act in Transaction Documents
The WARN Act, to the extent it is triggered, requires advance notice in the event of certain terminations of employment. However, there are exceptions to the notice required under WARN. One such exception that could apply, depending on the specific facts involved, is the unforeseen business circumstances exception as a result of Covid-19.
Since companies may have laid off employees as a result of the pandemic, it is important to include provisions in a purchase or merger agreement that would highlight to a buyer any WARN issues or contemplated layoffs. Depending on the deal structure, consider whether to include a covenant addressing allocation of liability for any layoffs contemplated as a result of the transaction. (Note also that some states have their own WARN or mini-WARN requirements that should be examined carefully.)
4. Furloughed Employees
When a buyer is acquiring a business, the seller’s workforce and whether to continue employment of existing employees play a role in determining the future of the business. Therefore, a buyer will be interested to know whether a seller has employees on furlough (which has become more common these days), what the company has communicated to such employees, and the benefits for which they are eligible.
5. Dealing With Employees on COBRA
Employees who incur a “qualifying” termination in connection with a transaction (or have incurred a termination within the 18 months prior to the transaction, due to Covid-19 or otherwise) may be eligible for health, dental, and vision insurance coverage (at the employee’s expense) for up to 18 months (subject to extensions). That is, to the extent they had such coverage prior to termination under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA).
Often this responsibility will fall on the acquirer when a seller ceases to provide any group health insurance plan following closing. Moreover, the responsibility of providing such benefits after closing should be clearly allocated within the transaction documents, especially with a growing number of employees who have been terminated due to the recent economic downturn and may be electing COBRA coverage.
Smaller companies that may not be within the purview of COBRA should also be mindful of state “mini-COBRA” laws that create similar responsibilities under state law.
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6. Continuation of Benefit Plans and Onboarding of Employees
Common questions that arise in transactions are whether to assume or terminate benefit plans and how to transition employees into a buyer’s business. If an acquirer has existing benefit plans in place, it may be administratively easier to transition acquired employees to existing plans than to maintain multiple benefit plans for different groups of employees. Cost, administrative burdens, and benefits offered are some key considerations in determining how to address these items, in particular for companies that may be cash-strapped due to COVID-19.
7. Comparable Compensation and Benefits
A question often arises in transactions as to whether to agree to provide substantially similar or comparable compensation and benefits to continuing employees for a certain period of time after closing. While this is a business point, as a result of the uncertain economic climate, buyers may be less likely than in the past to agree to comparable compensation and benefits. Rather, they might desire to set new terms of employment. Of course, a buyer can always agree to provide comparable compensation and benefits and bear the cost of terminating such employees.
8. Treatment of Seller 401(k) and Other Retirement Plans
Buyers frequently require, through a covenant in the transaction document, that a seller take formal action to terminate its 401(k) plan and take steps to terminate other retirement plans prior to closing. If they have an existing 401(k) plan, buyers often make this request to avoid inheriting historical liability, creating additional administrative work or operational complications, such as passing nondiscrimination testing.
Such termination often requires coordination between all parties involved and the plans’ service providers. This includes possible amendments to a buyer’s plan to allow for rollover of 401(k) loans or to allow immediate eligibility for a buyer’s plan. Therefore, it should be considered early in a transaction to avoid unnecessary closing delays.
9. Section 280G and Reduced Compensation Due to Covid-19
In response to the pandemic, executives may be asked by an employer to reduce their cash compensation (e.g., base salary or bonuses). For those who may be subject to the “golden parachute” rules of Section 280G of the Internal Revenue Code of 1986, a compensation reduction could increase excise tax exposure in the event of a change in control of an entity taxed as a corporation in the next few years.
The Section 280G excise tax applies to amounts in excess of a “base amount” (which, in general, is the executive’s annual taxable compensation with the company over the five-year period preceding a change in control). Companies that could undergo a change in control in 2021 or later should be mindful that such a reduction would likely reduce base amounts and potentially subject certain executives to the golden parachute excise tax. For a change in control of a private company, the shareholder vote exception should be explored to avoid subjecting the executives to the excise tax.
10. Treatment of Outstanding Equity Awards
If a business is anticipating a sale in the near future, it is important to confirm that any existing equity plan provides adequate flexibility for the treatment of outstanding equity to align with the business deal. To the extent a seller’s equity plan does not provide its plan administrator broad discretion, sellers should consider amending their equity plan so that the plan administrator can take one or more of the following actions upon a change in control:
- Cancel out-of-the-money (“underwater”) or unvested stock options without payment of consideration therefor;
- Cancel any equity awards (vested or unvested) in the event such equity is not exercised prior to closing; and/or
- Cancel any equity award in exchange for the deal consideration equity holders would be entitled to had they exercised it prior to closing. Consider permitting the plan administrator to take any such action without the consent of equity holders, which can often be administratively burdensome to obtain. A seller may also want to consider whether this can be an opportunity to obtain a release of claims from option holders. This flexibility would be particularly helpful to companies whose stock options may currently be underwater due to Covid-19.
These issues involve complex analyses of complicated rules and regulations. Therefore, it’s always best to consult a benefits attorney attorney to assist with these items if your company is engaging in a transaction.