Managing Pension Risks In Corporate Transactions - Part 1
Article by Mitch Frazer, Torys LLP, and Jana
Steele, Goodmans LLP
Contents
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Introduction to Pension Plans
Types of Pension Plans
Defined Benefit Plan
Defined Contribution Plan
Multi-Employer Pension Plan
Funding of Pension Plan
Surpluses and Deficits in Pension Plans
Pension Plan Valuation
Nature of the Transaction
Share-Purchase Transactions
Mergers and Amalgamations
Asset-Purchase Transactions
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Managing Pension Risks in Corporate Transactions
Due Diligence
Step 1: Signing a Confidentiality Agreement
Step 2: "Valuing" the Pension Plan
Step 3: The Seller's Obligations
Step 4: The Buyer's Obligations
Step 5: Signing a Letter of Intent
Step 6: Retaining Pension Counsel at an Early Stage
Negotiation of Representations and Warranties
Other Provisions in an Agreement of Purchase and Sale
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Evaluating Options and Obligations in Complex Corporate
Transactions or Restructurings
Pension Issues Specific to Share-Purchase Transactions
Pension Issues Specific to Mergers
Pension Issues Specific to Asset-Purchase Transactions
(i) Buyer does not offer pension plan
(ii) Seller retains past-service liability and buyer offers plan
for future services only
(iii) Wraparound arrangement
(iv) Carve-out arrangement
(v) Transfer of pension plan
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Strategies for the Successful Conversion of Pension Plans
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Issues Related to Multi-Employer Pension Plans in Corporate
Transactions
MEPP Issues Specific to Share-Purchase Transactions
MEPP Issues Specific to Asset-Purchase Transactions
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Conclusion
Mergers and acquisitions can bring a host of pension and
benefits issues to the surface. To minimize the risks associated
with acquiring or divesting pension liabilities, each party to a
corporate transaction must be aware of its options as well as the
consequences that flow from each. Specifically, both buyer and
seller must consider how the transaction will affect the rights and
interests of the beneficiaries of the pension plans. The
transacting parties should also know the types of pension plans
available to the affected employees, the manner in which those
pension plans are funded and administered, and where the plans are
registered. Additionally, the nature of the transaction itself must
be considered: specifically, whether it involves a sale of assets,
a sale of shares or a merger or amalgamation of companies and
potentially of pension plans. Ideally, these issues should be
considered before or in the early stages of any business
transaction.
In this paper, we identify and analyze pension issues,
obligations and risks that arise in corporate transactions. We
examine registered pension plans from an Ontario perspective. Such
plans must be registered with the Canada Revenue Agency (CRA) under
the Income Tax Act (Canada) (ITA)1 and with the
Financial Services Commission of Ontario (FSCO) under the
Pension Benefits Act (Ontario) (PBA).2
Federal pension benefits standards legislation applies to
federally regulated industries (such as airlines and
telecommunications), and every province in Canada (except Prince
Edward Island) has its own pension benefits standards legislation.
These statutes set out minimum standards for registered pension
plans. When a company has employees in more than one province, its
pension plan is generally registered in the province where the
greatest number of members reside. However, members residing in
other provinces are subject to the minimum standards of the
applicable legislation of their province of residence to the extent
that such minimum standards provide a greater right or benefit. It
is important to ascertain the jurisdiction of registration of any
pension plan in a transaction and to determine whether employees in
other provinces are covered under the plan.
Note that there are many other types of plans that should be
considered in corporate transactions, including benefit plans,
profit sharing plans, group RRSPs, supplementary executive
retirement plans and retirement compensation arrangements. A
discussion of these plans is, however, beyond the scope of this
paper.
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Introduction to Pension Plans
Generally speaking, there are three principal types of
registered pension plans: defined contribution plans, defined
benefit plans and multi-employer pension plans. The employer must
contribute to all types of plans. Employees may also be required to
make contributions, in which case the plans are known as
"contributory." In "non-contributory" plans,
the employees are not required to contribute.
Types of Pension Plans
Defined Benefit Plan
A defined benefit (DB) plan stipulates the pension benefit that
will ultimately be received by the participant without detailing
the contributions required to provide the benefit promised.
Typically, a DB plan identifies a formula, based on factors such as
earnings and years of service or plan membership, that determines
what benefit a plan member is entitled to receive upon retirement.
For example, the plan may provide a benefit of 2% of the
employee's average salary over a specific period multiplied by
the number of years of pensionable service.
Defined Contribution Plan
In contrast to a DB plan, a defined contribution (DC) plan
specifies the contributions that the employer (and the employee if
the plan is contributory) is required to make but does not specify
the benefits ultimately payable to plan members. The contributions
made on behalf of a member are contributed to his or her account,
which is invested.3 Upon retirement, the member's
pension depends on the balance in his or her account. For example,
the employer may contribute 2% of the employee's salary for
each year of employment and the pension benefit ultimately payable
will be based on the aggregate contribution made in respect of that
employee and the investment return on the contribution.
Multi-Employer Pension Plan
A multi-employer pension plan (MEPP) is defined in subsections
1(3) and 1(4) of the PBA as a "pension plan established and
maintained for employees of two or more employers who contribute,
or on whose behalf contributions are made, to a pension fund by
reason of agreement, statute or municipal by-law to provide a
pension benefit that is determined by service with one or more of
the employers," but it does not include a pension plan in
which all employers are affiliates within the meaning of the
Business Corporations Act (Ontario).4 MEPPs are
often established by unions in industries with significant mobility
in their workforces. Contributions to MEPPs are generally the
subject of labour negotiations and are entrenched in the applicable
collective agreement. The advantage of an MEPP is that even if an
employee works for a number of employers who contribute to the
MEPP, he or she will always remain a member of the plan and earn
credits as if employed continuously by the same employer.
Issues related to MEPPs arise in the context of corporate
transactions. As with any other pension plan, it is important to
review all relevant documents related to the MEPP, which may
include the plan text, a participation agreement, a funding
agreement and an applicable collective agreement and/or
participation agreement. In addition, the PBA contains certain
special rules applicable to MEPPs that must be considered. In the
final section of this paper, we elaborate on pension issues
specific to MEPPs.
Funding of Pension Plans
Registered pension plans must be funded in accordance with the
CRA's requirements, as set out in the ITA, and the applicable
pension legislation and regulations. The two most common mechanisms
for funding pension plans are trust agreements and insurance
contracts.5 When a trust is used, the plan sponsor
generally prepares a plan document and enters into a trust
agreement to make a trust company the trustee of the pension fund.
The trustee holds the pension fund assets in trust under the terms
set out in the relevant documents. When the pension plan is funded
by a trust, classic trust principles generally apply.6
If the plan sponsor has opted for an insurance policy, the pension
plan is established by an insurance contract between the plan
sponsor and an insurance company, which will usually hold and
invest the assets and administer the plan. Under both arrangements,
a wide array of investment options are generally available,
including guaranteed investment certificates, segregated funds and
specialty pooled funds that may be invested in bonds, equities,
venture capital, money market instruments, mortgages or real
estate.7
Surpluses and Deficits in Pension Plans
In the context of a corporate transaction, the buyer must
determine whether the seller's pension plan has excess funding
(a surplus) or unfunded liabilities (a deficit). A plan is in a
surplus position if the assets of the pension fund exceed the
present value of the pension benefits promised under the plan. On
the other hand, a pension plan has a funding deficiency when the
assets are not sufficient to cover the present value of the accrued
pension benefits.
Whether a pension plan has a surplus or an unfunded liability is
an important consideration for all parties in a business
transaction or reorganization. As discussed later, a plan's
funded status may have an impact on the negotiation of the purchase
price and the terms of the transaction. So it is important that
there be an accurate assessment of the plan, and that both the
buyer and the seller fully understand and approve the assumptions
that were made in completing the assessment.8
Pension Plan Valuation
Two funding tests for pension plans are required under the PBA
and are performed by an actuary: solvency and going-concern. The
solvency position of a pension plan is determined on the assumption
that the plan is...
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