M&A lawyers likely consider matters of human resources and benefits of little importance in a merger or acquisition. Time spent on such niceties can occur well after the transaction date, some say, and the details that keep an HR professional up at night are often relegated to the proverbial back burner. However, identifying potential liabilities prior to a business sale could significantly affect the details of the transaction and even the price itself. One of the most obvious but easily forgotten aspects is how to determine who will handle COBRA obligations.
Mergers and acquisition transactions raise two basic COBRA liability issues. First, at the time of a merger or acquisition, the seller's group health plan is likely to have a group of qualified beneficiaries already receiving COBRA coverage. Will the COBRA liability for these existing qualified beneficiaries be affected by the merger or acquisition? Second, mergers and acquisitions can affect the employment status of large numbers of employees of the seller. When will a merger or acquisition itself cause qualifying events for those employees, spouses and dependents who are covered under a plan of the seller? If COBRA must be offered to a new group of qualified beneficiaries who loses coverage because of the merger or acquisition, which group health plan will be liable for providing their COBRA coverage?
Now, let’s get nuts. Recall that President Biden recently signed the American Rescue Plan Act (ARPA) into law? The Act includes a 100% COBRA subsidy available to certain COBRA-qualified beneficiaries who lose group health plan coverage as the result of an involuntary termination or reduction in hours. Employers will be able to claim a credit against payroll taxes to reimburse the cost of the subsidy. Oh, but which employer will be responsible if an involuntary termination results as a consequence of the sale? Who will be charged with determining who among all qualified COBRA beneficiaries will be eligible for the subsidy? If a transaction agreement provides for the seller to cover the employees on their health insurance for a period of time before the eligibility requirements of the buyer’s health plan is met, which party bears the COBRA subsidy notice obligation and tracking of qualified beneficiaries?
IRS regulations specifically deal with the COBRA consequences of business transactions involving either the sale of stock in a corporation or the sale of assets owned by a corporation. Generally, the regulations provide for the default allocation of COBRA liability in the absence of a contractual agreement to the contrary. The problem lies in the general lack of awareness or foresight to realize the purchase agreement may be written to accommodate both parties. What follows is an overview of the IRS default regulations.
In a nutshell, the responsibility for making COBRA coverage available to M&A qualified beneficiaries is determined according to the following rules:
Seems like common sense, but the devil is hidden in the details. Notice how the IRS focuses on a subtle distinction that must exist if the type of transaction is an asset sale as opposed to a stock sale. The regulations also introduce the new term, “M&A qualified beneficiary.” It’s important to understand these nuances that identify who ends up being a qualified beneficiary affected by the transaction – which, in turn, ultimately determines the assignment and scope of COBRA liability.
When businesses consider how to structure business reorganizations, they are often influenced by the cost structure and legal consequences that attach to a stock sale versus an asset sale. The COBRA implications will also depend on how the transaction is structured. Under the regulations, a “stock sale” is “a transfer of stock in a corporation that causes the corporation to become a different employer or a member of a different employer.” By comparison, an “asset sale” is “a transfer of substantial assets, such as a plant or division or substantially all the assets of a trade or business.” The definition is broad, intended to be flexible, and is derived from various formulations of successor employer rules that have been fashioned by the courts for various labor law purposes.
After understanding the nature of the sale transaction, businesses need to spend time identifying the M&A qualified beneficiaries, as the IRS calls them, affected by the transaction. The regulations define “M&A qualified beneficiaries” to mean those qualified beneficiaries already receiving COBRA coverage before the sale under a plan of the seller; and those qualified beneficiaries who experience their qualifying event in connection with the sale. For those qualified beneficiaries already receiving COBRA coverage prior to the sale, each member would have already experienced a qualifying event securing their COBRA rights. Conversely, an employee/dependent of the seller could experience a qualifying event in connection with the sale due to termination; but the COBRA liability determination falls on whether the transaction was a stock or asset sale.
Continuing employment following stock sale
Employees already on COBRA at the time of the transaction will move over to the buyer’s health plan as COBRA participants assuming the seller likely will not still offer a health plan. The IRS regulations recognize that an employee who continues to be employed by the acquired corporation after the sale of its stock does not, as a legal matter, experience a termination of employment in connection with the sale. Rather, these employees remain employed by the same employer as before the sale. In other words, no qualifying event equals no COBRA.
Those workers who may lose their jobs and subsequent health coverage because of the transaction will be considered M&A qualified beneficiaries. The obligation to offer COBRA depends on whether the seller maintains a health plan following the transaction. If so, then the seller is the defaulting responsible party; if not, then the buyer assumes responsibility and must offer COBRA continuation coverage.
Continuing employment following asset sale
In an asset sale, the employees of the seller are technically terminated and then hired by the buyer. However, the regulations clarify that a covered employee (and any covered spouse or dependent child) must actually lose coverage under a group health plan of the selling group to be deemed to have a qualifying event and thus be an M&A qualified beneficiary. To further complicate things, if the buyer continues business operations without interruption or substantial change, the IRS rules state that the buyer is a “successor employer."
So, here’s how the asset rules play out for individuals already on COBRA and for those individuals who are terminated at the time of the transaction and not rehired by the buyer:
Whether the acquisition involves a stock sale or an asset sale, if the seller ceases to maintain any group health plan in connection with the sale, then the buyer must arrange to provide COBRA coverage as of the date of the transaction for any M&A qualified beneficiaries who will lose their seller-provided coverage.
As we’ve seen, the COBRA implications of a merger or acquisition are largely based on whether and for whom a qualifying event has occurred. In a small business reorganization to which the successor employer rules apply, for example, assumption of COBRA liability by the buying group could have a substantial negative impact on its health insurance premiums. Similarly, with respect to self-funded plans, the assumption by a buying group of the COBRA responsibility for M&A qualified beneficiaries can impact the economics of the plan if some of those beneficiaries have very high claims expenses. This potential impact needs to be determined early in the due diligence process and should either be factored into the purchase price or handled in another way by agreement.
The true cost of COBRA is often not recognized by corporate transaction attorneys or business professionals who may believe that COBRA is not a financial issue because the qualified beneficiary pays the “whole cost” of the coverage. Early involvement of experienced benefits consultants can facilitate compliance with the COBRA mergers and acquisitions regulations and lead to an appreciation of the true economics of COBRA during the negotiation process.
Download our latest Compliance Update addressing recent Department of Labor (DOL) guidance on the ARPA COBRA subsidy or register for our upcoming webinar, Employee benefits in mergers and acquisitions to learn more.
Bret works with HR professionals to ensure they have a clear understanding of the rules governing all aspects of human resources. He works with employers to maintain compliance of health and wellness benefit packages under state and federal guidelines, including taxation and healthcare reform.
Bret works with HR professionals to ensure they have a clear understanding of the rules governing all aspects of human resources. He works with employers to maintain compliance of health and wellness benefit packages under state and federal guidelines, including rules of taxation and healthcare reform. Bret holds a bachelor of science in economics from the University of Kentucky and a law degree from the University of Pittsburgh, School of Law.
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