Managing Pension Risks In Corporate Transactions - Part 1

Article by Mitch Frazer, Torys LLP, and Jana

Steele, Goodmans LLP


  1. 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

  2. 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

  3. 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

  4. Strategies for the Successful Conversion of Pension Plans

  5. Issues Related to Multi-Employer Pension Plans in Corporate


    MEPP Issues Specific to Share-Purchase Transactions

    MEPP Issues Specific to Asset-Purchase Transactions

  6. 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


    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


  7. 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


    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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