Form and Substance: Why the Form of a Transaction is so Critical to Employee Benefits and Executive Compensation Strategy
April 21, 2021
The form of a corporate transaction sets the stage for the employee benefits and executive compensation (EBEC) strategy – in the scope of due diligence and purchase agreement negotiations and post-closing activity. The charts below provide a high-level analysis of some of the most critical EBEC issues that companies and their advisors should consider in corporate transactions.
For purposes of this chart, we discuss three different forms of a corporate transaction:
- A (complete) stock purchase transaction: For this purpose, we assume that the buyer purchases all of the stock of a holding or stand-alone company, such that no entities with employees or benefit arrangements remain behind with the seller.
- An asset purchase transaction: For this purpose, we assume that the buyer has the ability to “pick and choose” which assets and liabilities (including benefit plans and compensation arrangements) to purchase and which to leave behind.
- A “carve out” transaction: For this purpose, we assume that the buyer purchases all of the stock of an operating subsidiary, but that the benefit plans remain behind with the seller.
Will the benefit plans and compensation arrangements come with the transaction?
[More details on certain benefits below.]
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| Yes, unless the buyer directs the seller to terminate the plans and arrangements in connection with closing. Practice Note: Assuming there are no material liability issues or other business integration considerations, taking the plans at closing is the easiest approach, as very few changes are needed. Plans (both buyer and seller plans) should still be reviewed to confirm whether amendments are needed (e.g., to exclude any “new” controlled group members from participation). More planning may be required down the road – does the buyer want to maintain more than one set of benefit plans indefinitely? |
It depends. If the buyer would like the plans or other compensation arrangements, then those items should be listed as included assets and liabilities. The parties will need to determine whether certain assets will be transferred to buyer to cover assumed liabilities or if certain purchase price adjustments are needed. If the buyer does not want the plans to come over (e.g., because the buyer has an existing benefits platform or significant liability issues have been identified in diligence), then those items should be listed as excluded assets and liabilities. |
Generally, no. Although there are exceptions – e.g., if the buyer would like to take a spinoff of certain existing plans. We assume for this chart that the plans do not come with the transaction. Practice Note: As with an asset transaction that excludes the plans, this structure will necessitate significantly more work for a buyer in connection with closing, as new plans will have to be adopted or employees added to existing plans. |
Will employees and employment agreements come with the transaction?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| Yes, unless the buyer directs the seller to terminate certain employees pre-closing (which is unusual). Employees will not experience a termination of employment or separation from service in connection with the transaction. |
It depends. The buyer will need to determine which employees will receive offers of employment from the buyer and whether or not buyer will assume any current employment agreements. In-scope employees will experience a termination of employment and separation from service in connection with the transaction. Therefore, the buyer will be required to provide an offer of “new” employment with the new/surviving entity in order to keep the workforce stable. It is also possible that employment agreements can be assigned (depending on their terms and buyer’s preference). Practice Insight: When certain employees are critical to the ongoing success of the business, some purchase agreements will condition closing on certain key employees accepting offers with the buyer and/or a certain percentage of employees being offered and/or accepting employment. |
It depends which entity (the target subsidiary or the seller/parent company) is the legal employer of the employees pre-closing. The employees who are employed by the target entity will generally come with the transaction, like a stock purchase. If certain employees at the seller/parent company provide significant services to the target entity, then the transaction will act like an asset purchase with respect to this group of employees. Practice Insight: Because of the potential in a carve-out transaction for “hybrid” treatment in this and other EBEC areas, carve-out transactions often require the most pre-closing planning and it is important that the buyer clearly defines the group of employees the buyer wishes to retain or take in the transaction. |
What happens to the 401(k) plan?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| If the buyer does nothing, then the seller’s 401(k) plan will come with the transaction and the seller employees will continue to participate in that 401(k) plan uninterrupted. Employees are not eligible to take distributions from their account in connection with the transaction. Plan loans will continue to exist as they did pre-closing. If the buyer does not want to take the plan, then the purchase agreement should require termination of the plan prior to closing. In this case, the 401k plan impact works more like an asset transaction. Legal Insight: If the plan is not terminated prior to closing and the buyer maintains a 401(k) plan in its controlled group, then employees will not be permitted to take a distribution if the plan is terminated post-closing. |
It depends. If the 401(k) plan is an included asset, then it will come with the transaction. Although this approach will feel more like a stock transaction to employees, there is more work to do in advance of closing since the plan sponsor has to change and service agreements must be assigned. Accordingly, more contract diligence is required pre-closing. If the 401(k) plan is excluded from the transaction, then it will stay behind. Employees who are terminated in connection with the closing will be permitted to take rollover-eligible distributions. Buyer should consider how to handle plan loans. Buyer should also ensure that someone remains responsible for the plan post-closing so that it does not become an orphan plan. |
Nothing. As noted above, we are assuming the plan stays at the seller level. Buyer may take a plan-to-plan transfer (like a group rollover, but with successor-type liability to the buyer). If a plan-to-plan transfer does not occur, then employees will be eligible to elect a distribution of their accounts when they are transferred to the buyer and it will work more like an asset transaction. Practice Insight: Buyers with an existing 401(k) plan should consult the plan’s recordkeeper to see if they have a preference on how to address the 401(k) plan. Assuming there are no material compliance issues with the seller’s 401(k) plan, a plan-to-plan transfer will make the transition feel smoother for employees, especially those with plan loans. |
|
Notes on Acquired 401(k) Plans:
|
||
What happens to nonqualified retirement plans?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| Similar to 401(k) plans – either they come with the transaction or should be terminated in connection with closing. A separation from service will not occur for the target employees. Code Section 409A includes special termination (and cash-out) rules that apply in the context of a transaction. |
Similar to 401(k) plans – if certain requirements are met, then the 409A regulations permit parties to an asset transaction to decide whether employees who continue in the same position with the buyer will be treated as experiencing a separation from service (the “same desk rule”). If this is not addressed, then an asset transaction generally results in a separation from service, which may result in a distribution event for the employee under the nonqualified retirement plan. |
It’s complicated! The employees of the target subsidiary do not experience a separation from service. Employees of seller/parent company who come with the transaction do experience a separation from service. This raises a number of issues and complex planning opportunities regarding how to handle these benefits. |
What happens to equity awards?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| It depends. The terms of the equity plan and award agreements (including the definition of “change in control”) will generally guide the approach for the parties. Awards may be cashed out or cancelled in connection with the transaction. Or, the buyer may agree to assume some or all of the outstanding equity awards. Specific tax rules may be implicated and additional documentation needed for any approach when there is outstanding equity awards. |
It depends. The terms of the equity plan and award agreements (including the definition of “change in control”) will generally guide the approach. Awards may become vested at the closing of the transaction or even cashed out, otherwise when the employees terminate with the seller generally they will forfeit any unvested equity awards. | It depends. The terms of the equity plan and award agreements (including the definition of “change in control”) will generally guide the approach. If the carve-out transaction will meet the plan’s definition for a “change in control,” then employees may become vested in their outstanding equity awards. The actual structure of the transaction will be critical to analyze these definitions. The seller may also agree to vest outstanding equity awards or allow the target employees to continue to hold awards after closing. |
Does the structure impact how/whether Code Section 280G (“golden parachute rules”) applies?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| A complete stock sale of a company to a third-party buyer will implicate the Code Section 280G rules and the parties will need to conduct a thorough analysis to determine whether or not there are “excess parachute payments”. Legal Insight: Code Section 280G generally only applies to c-corporations (or LLCs that are taxed as corporations). If the seller entity is a partnership, LLC (taxed as partnership) or an S-corporation (or an entity that would satisfy all of the rules for an S-corporation), then Code Section 280G will generally not apply. |
A sale of assets can trigger the Code Section 280G rules for the transaction. Generally, the sale must be for a “substantial portion of the assets” of the selling entity. A sale of assets with a gross fair market value (without regard to liabilities) of 1/3 or more of the total fair market value of all the assets of the company will trigger the 280G rules. | It’s complicated! In a “carve-out” transaction, the parties need to determine whether or not the stock of the target subsidiary (and any other transferred assets) are considered a “substantial portion of the assets” of the selling/parent company immediately before the transaction. If so, then the transaction will trigger Code Section 280G for both the target subsidiary and the selling/parent entity. |
What happens to group health plans?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| Similar to 401(k) plans – either they come with the transaction or should be terminated in connection with closing. In the stock purchase context, employees who do not experience a termination of employment in connection with the transaction will not be eligible for COBRA (even if coverage is lost). Former employees (and beneficiaries) who had previously elected COBRA (or are in their election period) continue to be eligible for COBRA. |
Similar to 401(k) plans – they can be included (more like a stock transaction) or excluded (more like a carve-out transaction). Contracts should be reviewed when the plans are transferred/assumed. In an asset transaction, the default IRS rules (as described below) will generally make the seller responsible for providing COBRA coverage to “M&A qualified beneficiaries.” However, if the seller (and its controlled group) stops proving a group health plan in connection with the transaction, the obligation for offering COBRA coverage can shift to the buyer (including for former employees of the seller’s business who are currently receiving COBRA coverage). These COBRA rules are complex and should be carefully considered on a case-by-case basis in the context of an asset transaction. |
Welfare plans will stay behind. Even though target employees will not technically experience a termination of employment, the best practice would be to run the employees through buyer’s on-boarding process, like a new employee, for purposes of enrolling in their new plans. Practice Insight: If closing occurs mid-year, many purchase agreements will require the buyer plan to provide “credit” for deductibles and other cost-sharing requirements. This is also true for asset transactions. COBRA generally tracks the stock plan rules, but there may be unique issues that should be considered on a case-by-case basis. |
| Under the default IRS rules, if COBRA obligations arise, the seller will generally be responsible for providing COBRA coverage to “M&A qualified beneficiaries” (generally individuals who are already receiving COBRA coverage from seller (or who are in their election period) or employees of seller (or their eligible beneficiaries) who experience a qualifying event in connection with the sale). Noting, however, (i) if the seller no longer maintains a group health plan within its controlled group post-closing, then the buyer becomes responsible for offering COBRA coverage to “M&A qualified beneficiaries,” and (ii) the parties can agree to contract around these default rules. | ||
What about flexible spending accounts (FSAs)?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| The FSAs will generally continue in effect and uninterrupted after the closing of the transaction unless the buyer terminates these benefits going forward. |
When the employees terminate employment with the seller, the FSA will cease (and the employee can get reimbursed for any pre-termination claims based on the terms of the plan). An alternative approach is for the seller to agree to transfer the FSA account balances to the buyer’s FSA plan and the employee’s FSA elections and contributions continue under buyer’s plans uninterrupted. The parties need to address this under the purchase agreement and determine how the assets and liabilities will be transferred appropriately so neither buyer nor seller takes on a disproportionate liability. |
Similar to an asset transaction, when the employees leave the seller’s controlled group (and benefit plans) their participation in seller’s FSA plans will stop. The parties could agree to transfer FSA account balances as described under the asset transaction. |
What about accrued vacation or bonus liabilities?
| STOCK PURCHASE | ASSET PURCHASE | CARVE OUT |
| The accrued vacation and bonus liabilities will remain in place as a liability of the target entity. The parties may need to address the “cost” associated with these liabilities under the purchase agreement. |
Typically, the selling entity will retain these obligations (and may need to pay out any accrued obligations when the target employees are terminated). The parties can agree in the purchase agreement for the buyer to assume some or all of these liabilities (subject to any applicable employment laws requiring payment upon termination of employment). | The parties will need to determine how to address/account for these accrued liabilities as they may not be currently accounted for under or allocated to the target subsidiary from a financial perspective. |
관련 인사이트
December 10, 2025
Foley Viewpoints
NAIC Fall Meeting Update: Cybersecurity (H) Working Group Receives Comments on Cyber Event Notification Portal
On December 10, 2025, the Cybersecurity (H) Working Group met to discuss, and receive comments regarding, its proposed Cybersecurity…
December 10, 2025
Foley Viewpoints
NAIC Fall Meeting Update: Producer Licensing (D) Task Force Receives Report on NIPR Expansion and Changes
In an efficient meeting on December 10, 2025, the Producer Licensing (D) Task Force received a report from the National Insurance…
December 10, 2025
Foley Viewpoints
No Score on “Gol”: SDNY Rejects Non-Consensual Third-Party Releases and Finds That Opt-Outs Do Not Constitute Consent
The Gol Linhas Holding The recent December 1, 2025, opinion from Judge Denise Cote of the SDNY reversing confirmation of the Gol Linhas…