August 23, 2005

Employee Benefits in Mergers & Acquisitions

Parties to a merger or acquisition transaction typically concern themselves with employee
benefits for 2 reasons: (1) to avoid unexpected or unwanted liabilities for either the buyer or
the seller, and (2) to ensure that the acquisition creates a smooth transition for affected
employees.

Due diligence is the term used to describe the investigative activities taken by a buyer to
determine whether it should purchase the target. In a benefits context, the due diligence
involves a review of the seller's benefit programs to identify whether there are latent
liabilities associated with the programs. These liabilities could arise from—

§ A failure to follow the tax-qualification rules of the Internal Revenue Code

(Code),

§ A breach of fiduciary responsibilities under the Employee Retirement Income

Security Act of 1974 (ERISA),

§ A failure to pay appropriate benefits due under the plan terms,

§ A failure to fulfill the reporting and disclosure requirements of both the Code and
ERISA, or

§ A failure to properly fund the plans.

When representing a buyer, Holland & Hart LLP begins the employee benefits due diligence
with a request for information from the seller, typically following a confidentiality agreement
or a letter of intent. For benefits purposes, the information request should start with a listing
by the seller of all of its employee benefit plans, including informal or unwritten
arrangements that some employers may maintain for vacation or bonus arrangements.

This initial information request should cover—

§ All retirement plans, including pension plans, profit sharing plans, 401(k) plans,
money purchase pension plans, employee stock ownership plans (“ESOPs”), and
multiemployer (union) pension plans;

CIRCULAR 230 DISCLAIMER: Due to recent changes in the rules applicable to tax
practitioners, the Treasury Department and the IRS ant you to know: This communication
was not intended or written to be used, and cannot be used, for the purpose of (i)
avoiding tax penalties or (2) promoting, marketing or recommending to another party any
transaction or matter addressed herein.
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 § All welfare benefit plans, including group health plans, accidental death and
dismemberment plans, dental plans, vision plans, cafeteria plans (premium only and
“flexible spending account” plans), long-term disability plans, short term disability
plans, life insurance plans, severance pay plans, retiree medical plans, and multi-
employer (union) welfare plans; and

§ Any deferred compensation and incentive compensation arrangements, including

stock option plans (nonqualified and incentive stock option plans), phantom stock
plans, stock appreciation rights, deferred compensation agreements, supplemental
employee retirement plans, excess benefit plans, fringe benefit plans (for example,
an educational assistance plan or transportation expense reimbursement plan), and
annual bonus plans.

The review of these plans may uncover—

§ Undisclosed seller liabilities (such as unpaid accrued vacation or COBRA

continuation coverage);

§ Misclassification of workers with respect to taxes and benefit eligibility;

§ Any regulatory audits or inquiries;

§ Contested benefit claims;

§ Employees classified as disabled but not carried on seller's employee census;

§ Whether group health insurance contracts are assignable;

§ Whether in the case of self-insured medical plans the stop loss insurance covers all
benefits provided under the plan;

§ In the case of plan terminations, whether termination will result in market value
adjustments, ERISA liabilities or issues in benefit distributions;

§ Costs and potential ERISA liabilities or taxes with respect to severance plans;

§ Whether the seller is better served by requiring a termination of seller’s retirement

plan(s) or merging the plan(s) into the buyer’s plans;

§ Whether there are any implications or costs related to collective bargaining

agreements for union employees.

Because benefit plans and the rules that govern them are so complex, due diligence of
plans commonly turns up compliance issues. Many issues can be resolved through
correction programs, but others may have a direct impact on the negotiation of the merger
or acquisition. There are likely to be only 4 types of situations in which employee benefits
problems can have that type of power:
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 § When the cost of correction is so large that the seller is not willing to fix the problem
and the buyer is not willing to assume it;

§ When the benefits problems signal that there might be poor management of the
target company in other areas, calling the true value of the target into question;

§ In situations related to employer stock held in retirement plans, when the deal itself
raises fiduciary or tax issues that make the acquisition untenable; and

§ When the liability identified in the due diligence process cannot be reasonably
contained or limited, or even fully identified, so the parties are effectively prevented
from coming to terms.

The purpose of due diligence is to identify areas of liability, and to communicate those to the
buyer so that they can be factored into the decision of whether to buy the company and for
what price.

Holland & Hart understands that how to resolve the discovered problem or what arguments
can be made to defend the actions of the target are important factors in the buyer's analysis
of the viability of the purchase. We provide the buyer with the information and practical
analysis needed for the buyer to make the business decision of whether these potential
liabilities are small or large, whether likely to turn into significant costs or never to mature
into anything of consequence, whether they are nonissues or deal breakers. We present
this analysis with an eye towards the buyer’s assimilation of employees acquired from the
target and the buyer’s success in the new venture.

This Holland & Hart news alert has been provided to you for informational purposes only
and should not be interpreted as legal advice.

Irene F. Gallagher
Partner
Denver and Boise Offices
Phone: 303-295-8270
208-383-3957
Fax: 866-607-8680
igallagher@hollandhart.com
www.hollandhart.com/employeebenefits

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