Recently, there has been an uptick in the number of business transactions in the marketplace. From a legal perspective, employee benefits issues are often a key element of any business transaction. Everything from employee pay, retention, and bonus payments to 401(k), pensions, and fringe benefits is “on the table” as the parties negotiate terms. Of course, health benefits are also a frequent item of negotiation, and this is where continuation coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA) fits in.
Applying COBRA coverage rules in the merger and acquisition (M&A) context has always been challenging. Various COBRA rules spelled out are in regulations from the Internal Revenue Service (IRS) and other guidance and case law. But then there is the “real world”; how can these rules be applied in the context of an ever-changing and evolving M&A environment?
To start, let’s consider the basic COBRA M&A rules.
Many technical rules have to be evaluated in any transaction. These rules are described in detail in ¶1126 of Mandated Health Benefits—The COBRA Guide. For purposes of this column, a short overview will suffice.
The IRS regulations establish certain baseline rules for how to treat business transactions depending on whether they are classified as “stock sales” or “asset sales.”
A sale of a corporation’s stock is typically not a qualifying event for employees who continue in employment with the buyer. Of course, if someone incurs another qualifying event (for example, a true termination of employment, divorce, death, etc.), that event will trigger COBRA’s requirements. However, the sale itself is not a qualifying event regarding the covered employee, spouse, or dependent children, even if the buyer terminates all group health coverage after the sale for the affected individuals.
Asset sales are much more complicated from a COBRA perspective depending on the facts.
An asset sale generally is a qualifying event regarding:
- A covered employee whose employment immediately before the sale was associated with the purchased assets; or
- That covered employee’s spouse or dependent children who are covered under a group health plan of the selling group immediately before the sale.
However, the regulations further provide that a qualifying event will not occur in an asset sale in two situations:
- If the buying group is a successor employer (as explained below) and the covered employee is employed by the buying group immediately after the sale.
- The covered employee (or the spouse or any dependent child) does not lose coverage under a group health plan of the selling group after the sale.
Thus, if the asset seller continues to maintain a group health plan after the sale and the sale causes the sold employees to lose coverage from the seller’s group health plan, the asset sale will be a qualifying event. Therefore, COBRA notices must be given, regardless of whether the covered employee is employed by the buying group right after the sale.
Accordingly, the covered employee—and any spouse and dependent children who lose coverage under a selling group’s plan due to the sale—is referred to as an “M&A-qualified beneficiary” in connection with the sale and must be provided with COBRA notices and COBRA options.
One often overlooked point is that this result is the same even if, after the sale, the M&A-qualified beneficiary associated with the sale continues to be covered under the same (or substantially the same) coverage by a group health plan of the buyer.
As mentioned above, special rules might apply if a buyer is a “successor employer.” Under the IRS rules, a buying group is a successor employer to the selling group in connection with that asset sale if:
- The asset seller ceases to maintain any plans in connection with the sale.
- The buying group continues without interruption or substantial change in the business operations associated with the assets purchased from the selling group.
In that case, no qualifying event will have occurred if the employees are treated as continuously employed by the business involved.
Other Key Rules
Regardless of the form of the transaction, though, some rules are still common to all transactions. One key rule is that if the selling group maintains a group health plan after the transaction, then the selling group continues to have the legal obligation to make COBRA coverage available to:
- Affected existing qualified beneficiaries; and
- Qualified beneficiaries whose qualifying event occurred in connection with the transaction (called “M&A-qualified beneficiaries,” as explained below).
On the other hand, if the selling group (including affiliated businesses) ceases to maintain a group health plan in connection with the sale, then the regulations allocate liability between the selling group and the buying group—and the rules are different for stock sales and asset sales.
Parties are Free to Allocate COBRA Responsibility
Another important general rule is that the regulations specifically provide that the parties to any transaction are free to allocate the responsibility for providing COBRA coverage in the contractual agreements governing the transaction. This is the case even if the agreement imposes responsibility on a different party than do the regulations.
However, if the party to whom the responsibility is contractually delegated fails to comply with COBRA, then the party assigned responsibility under the IRS regulations must pick up that liability. That is, even if the IRS regulations would impose COBRA responsibility on a buyer in a particular transaction, the parties could allocate that liability to the seller. But if the seller failed to comply with its responsibilities, the buyer has residual liability for COBRA coverage for the affected qualified beneficiaries.
A Practical Approach
As this discussion shows, the IRS regulatory approach is very technical and not always easy to follow. Therefore, another way for an employer to evaluate its COBRA responsibilities in connection with a business transaction is to consider the various employee groups that could be affected by the sale. That way, an employer will be sure to catch all of the possible issues involved from a practical perspective. This approach can be used as a structure within which the employer can apply the applicable regulations.
Four groups of employees (and related qualified beneficiaries) must be considered in any transaction:
- Active employees affected by the transaction,
- Existing qualified beneficiaries,
- Potential qualified beneficiaries (those whose election period is in existence at the time of the business sale), and
- The qualified beneficiaries attributable to any of the seller’s past COBRA violations.
Active employees affected by the transaction
As explained earlier, a stock sale generally will not result in a qualifying event for employees who continue in employment with the buying group after the sale. By contrast, an asset sale of a substantial business operation generally will result in a qualifying event for active employees who remain employed by the buying group after the sale. Therefore, employers that are selling a portion of their businesses must consider the structure of the sale and whether COBRA notices are needed.
Existing qualified beneficiaries
Qualified beneficiaries who are already on COBRA coverage with the seller have the right to retain COBRA coverage under that plan or another group health plan maintained by the seller. If the seller ceases to maintain any group health plans and the buyer continues the business operations being sold, the buyer generally must include the affected M&A-qualified beneficiaries in its plan for the remainder of the maximum COBRA coverage period. This can be very tricky in cases in which a seller maintains multiple group health plans and there is some question about which plan is to provide the applicable coverage.
In some cases, no successor plan may be maintained after an assets sale (that is, the employees transferred to the buyer might not be covered under any of its other group health plans). However, to avoid COBRA responsibility, the buyer must show that it is not a successor employer.
Note that in IRS Information Letter 2016-0045, the IRS answered a question regarding the rights that an existing qualified beneficiary had regarding COBRA coverage under the group health plan that was acquired by a seller in a business transaction. As a general rule, qualified beneficiaries must be provided the same rights as similarly situated active employees. This means that if an employer provides an open enrollment period to active employees, qualified beneficiaries also can participate in the open enrollment. Information Letter 2016-0045 provided that this rule remains applicable even after the seller’s plan is acquired by the buyer.
Thus, a qualified beneficiary on COBRA coverage at the time of the transaction can participate in the buyer’s open enrollment if employees who previously participated in the seller’s plan and then became the buyer’s active employees were also able to participate in the open enrollment.
In light of the risk and uncertainty in this area, the parties should specify in the purchase agreement which one will be responsible for existing qualified beneficiaries.
Qualified beneficiaries who have not elected COBRA coverage but have COBRA rights
A third category of individuals affected are those whose qualifying events occurred close to the acquisition. If an acquisition occurs during an individual’s COBRA election period, from whom will that individual receive notice and be entitled to elect coverage? Again, generally, the seller has responsibility for sending COBRA notices to these individuals, as they are considered part of the M&A-qualified beneficiary group. Nevertheless, to be sure about the liability, the parties to the acquisition should allocate that responsibility in the purchase agreement and notify the affected qualified beneficiaries of their rights.
Persons not given COBRA rights by the seller
Finally, in any business acquisition, the parties must determine whether the seller has committed any COBRA violations. If so, the parties will probably want to allocate responsibility for individuals who are deprived of their COBRA rights. Thus, in investigating the acquisition, the buyer should:
- Obtain the names of all potential qualified beneficiaries, the dates of any qualifying events known to the seller, copies of COBRA procedures used by the seller, and proof that the COBRA procedures were followed by the seller.
- Obtain appropriate representations; warranties; and, if relevant, indemnities regarding past COBRA violations. Because this may be the most important aspect of the buyer’s potential successor (or residual) liability, individuals who were deprived of their COBRA rights by the seller should not be ignored in the acquisition.
These practical recommendations should help employers focus on the various qualified beneficiaries affected by a sale. However, these recommendations are not required by the IRS regulations; indeed, they are not even discussed there, per se. Instead, employers should always consult with their benefits counsel on how to apply the IRS regulations in their particular situation.
Paul M. Hamburger is co-chair of the Employee Benefits, Executive Compensation, and ERISA Litigation Practice Center and head of the Washington, D.C., office of law firm Proskauer Rose LLP. He is also a leader of the Practice Center’s health and welfare subgroup and a member of Proskauer’s Health Care Reform Task Force. Hamburger has more than 35 years of experience in advising employers and administrators and is the author of numerous articles and publications on COBRA and other employee benefits issues affecting pension and welfare plans. Hamburger is contributing editor of Mandated Health Benefits—The COBRA Guide. You can reach him at email@example.com.