A key issue of M&A transactions is the pension obligations of the enterprise to be sold. Sellers and acquirers are well aware of the legal liability risk, the severity of which often cannot be appraised with any degree of certainty due to unknown factors such as increased life expectancy and uncertain interest developments. In the past this uncertainty has been reflected in a tough wrangle over an appropriate reduction of the purchase price; most recently, greater attention has been given to the possibilities of risk minimisation and relocation.
Adjustment prior to the transaction practically unrealisable
It is practically impossible to revise the company pension scheme prior to the transaction. The financial capabilities to compensate past mistakes are frequently quite simply not available. Additionally, works councils regularly have to be involved, which also triggers a protracted procedure. Thus, the only option available to the seller in the forefront of a transaction is to identify the substantial risks and establish a line of argumentation as a negotiation basis and/or present the acquirer with structuring proposals.
In view of the impending risks, the acquirer should make a point of addressing the issue of the company pension systems at the outset of the transaction. Often one may find hidden pension regulations, for example on grounds of company practice, errors in the pension regulations, pension promises for which no coverage exists or a lack of adjustments for pensions. The acquirer's aim is to exclude or contain legal and financial risks, to harmonise company pension systems and to clean-up the balance sheet.
The realisation of the different aims of the seller and acquirer should lead to a transaction structure which, from the legal, tax and balance sheet perspectives, represents the most sensible of the possible variants. A further point of consideration is the attractiveness of the enterprise for employees. The seller should not, for example, close the pension scheme to new employees as per the Closing if the company pension is a substantial factor for attracting new skilled employees in a particular market segment.
Solution also depends on the transaction structure
It is the transaction structure itself that sets the course. In case of a share deal, the acquirer assumes the legal unit as it is and hence including all pension obligations. This type of acquisition is actually the least problematic method as far as the company pension is concerned. However, in case of an acquisition from a group structure it can become a stumbling block if external pension providers are involved or a contractual trust arrangement (CTA) is used for the outplacement. With a CTA, the company sets up its own trustee company which manages the pensions. Should the acquirer continue to use the CTA in future, it becomes a multi-company CTA, which then no longer falls under the group privilege of the German Banking Act (Kreditwesengesetz, "KWG"), with the result that a licence to operate as a financial service provider must be obtained. In this case, another solution will also have to be found in case of a share deal.
Should the parties to the purchase agreement decide to execute the transaction by way of an asset deal so that the company pensioners and pension obligations of past employees are essentially left with the seller, then this raises virulent legal questions for the acquirer on grounds of the transfer of all employee rights frequently triggered by this, which could restrict the structuring possibilities for the active employees. Should a due diligence of the pension obligations not be possible or productive in an individual case, then detailed regulation is required through representations and warranties as wee as indemnities in the sale and purchase agreement. Here, the acquirer will soon notice to what extent the seller is willing to share this burden or, in the event of the seller's refusal, will draw its conclusions herefrom.
Effective containment of the risks
One way of effectively containing the risks is to outsource pension liabilities to a so-called "pensioner company" (Rentnergesellschaft). This option is of particular interest if the seller only wishes to realise a share deal, yet the acquirer wishes to run the company without the load arising from the pension obligations. In this case, in a staggered procedure the acquirer initially executes a share deal and subsequently spins off the pension obligations to a pensioner company. The German Courts have since confirmed that spinning off pension obligations is permissible. However, an obstacle has been laid in the path of the clear, fixed ten-year term of continued liability stipulated in German mergers and transformations law. The German Federal Labour Court (Bundesarbeitsgericht, "BAG") has established a liability system pursuant to which the pensioner company must adhere to specific capital funding requirements, as employee damage claims could otherwise arise, and that is beyond the 10-year statutory liability period. The outsourcing of pension obligations within the scope of a transaction can therefore only lead to an actual release from liability if the capital funding requirements – for which the BAG by all means grants structuring possibilities – are observed. The acquirer might otherwise bear the full liability despite the outplacement.
In practice, the primary purpose of a CTA is not to protect against insolvency, but rather to clear up the balance sheet. Since a netting is now also possible pursuant to the German GAAP, CTAs are increasingly gaining in importance. If the parties to the purchase agreement should upon request by any side have committed to establish a CTA, then the choice of a group CTA can generally be recommended. A CTA established at the seller is of no benefit to the acquirer, since it cannot automatically be used by it.
Reinsurances offer solutions and pitfalls
Should the acquirer be critical of direct pension promises because it shies away from the uncertain financial risks, the mode of operation of the company pension could be changed by transferring pension obligations to an external pension provider. However, the seller will not implement such a change itself as this involves considerable time and costs; the pension providers frequently demand one and a half times the pension reserves as a single premium.
Should the acquirer change the mode of implementation to an external pension provider, a congruent reinsured benevolent fund or pension fund come into consideration. This can trigger a considerable tax burden for the employees. In order to avoid this, the expenditure for the outsourcing – to the extent at all deductible for the respective mode of implementation – needs to be spread over several years. This in turn means that the premium payment to the insurance company falls due immediately but can only be amortised for tax purposes over a course of years. Under certain circumstances the acquirer can have the seller participate in the outsourcing costs. Both variants usually also entail a change in the pension plan, where it cannot be ruled out that the separate consent of the beneficiaries might be required.
In a further alternative transaction structure the acquirer can acquire a company by way of a share deal, then in a second step transfer individual purchased items by asset deal to a special purpose vehicle and subsequently dissolve the remainder of the company. In this way, the existing company pension scheme can be transferred to an external pension provider without requiring the consent of the persons concerned. Pension promises of active employees generally continue to exist on grounds of the transfer of business through the executed asset deal. This structure can therefore be recommended if pension promises previously existed at the target or if, in relation to the workforce, a large number of pensioners are entitled to draw pensions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
