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COBRA Continuation Coverage in Mergers and Acquisitions

HEALTH & WELFARE

JOURNAL OF PENSION BENEFITS

ISSUES IN ADMINISTRATION, DESIGN, FUNDING, AND COMPLIANCE

Volume 30 • Number 3 • Spring 2023


This column describes the COBRA rules as they apply to Mergers and Acquisitions, as well as the risks of non-compliance. It assumes a basic familiarity with the basic requirements of COBRA.


By Sherrie Boutwell

Sherrie Boutwell is a founding partner of Boutwell Fay LLP and has focused for 30 plus years in the areas of employee benefits law and ERISA. She is a highly sought-after advisor, speaker and writer on employee benefits topics and takes pride in bringing a practical and down-to-earth approach to resolving complex benefits issues involving qualified, nonqualified, and health and welfare plans.


The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA)

[Pub. L. No. 99-272, 100 Stat. 82 (Apr. 7, 1986)] generally requires that an employer permit an employee and any eligible dependents of the employee, known as “qualified beneficiaries,” to continue to participate in its group health plan for 18 months following termination of employment. Group health plans include medical, dental, vision, and any other plan that provides group medical benefits, for example, employee assistance plans, health flexible spending accounts, physician hotlines, and even some wellness programs. COBRA imposes surprisingly specific rules for how to handle this requirement in the context of an M&A transaction.


COBRA in M&A Transactions

The Treasury regulations create an additional type of qualified beneficiary, called an “M&A qualified beneficiary.” An M&A qualified beneficiary is someone who (1) was a qualified beneficiary of the acquired entity because of an event that occurred before the acquisition, or (2) anyone whose qualifying event occurred in connection with the transaction and whose last employment was with the acquired organization (in the case of a stock acquisition) or was associated with the assets being sold (in an asset deal). [Treas. Reg. § 54.4980B-9, Q&A-4]


This distinction is important because the special COBRA rules that apply in an M&A transaction apply only to M&A qualified beneficiaries can result in liability on buyers and sellers, as well as members of their respective controlled group (or group under common control—referred to in the alternative here as controlled group) for noncompliance.


A failure to offer COBRA coverage can result in significant costs, including:

  • Excise taxes ($100 per day/$200 per day if more than one qualified beneficiary is involved). [§ 4980B(b)(2)]

  • Statutory penalties for notice failures or failures to provide requested documents of up to $110 per day. [§ 502(c)(1); DOL Reg. § 2575.502c-1]

  • Potential liability for unpaid medical costs not covered by insurer. Individuals who elect COBRA often do so because they have health issues and need the coverage. Failure to offer COBRA could result in large amounts having to be self-insured. Quick action to correct a failure can mitigate these risks, for example where the failure is discovered prior to the end of the 60-day period following the loss of coverage (which would have been the election period had COBRA been offered timely), it might be possible to work with the qualified beneficiaries to elect COBRA prior to the end of that period so there is no gap in insurance coverage. [See, for example, Buford v. Gen. Motors, 4:16-CV-14465-TGB-MKM, (E.D. Mich. Jan. 26, 2022)]


COBRA Requirements in a Stock Sale

When the Buyer purchases the stock of another company, the entity being acquired (the Target) continues to exist after the transaction as its own entity (unless additional action is taken to dissolve or merge the Target). In that situation, the employees do not experience a termination of employment (which is normally the trigger for COBRA coverage).


If the Target maintains its own health plan, that plan may continue to provide coverage to the Target’s employees after the transaction is consummated. As a result, unless an employee’s employment is actually terminated as a result of the transaction, there is no qualifying event and no interruption of coverage, and thus COBRA coverage of continuing employees is not required. The selling group is required to provide COBRA continuation coverage for the qualified beneficiaries who existed at the time of the acquisition and the new M&A qualified beneficiaries.


And, because this is an obligation of the seller’s entire controlled group, even if the Target’s plan is terminated and the Target’s new employees become covered by the Buyer’s health plan, the selling group will still be obligated to both cover the Target’s qualified beneficiaries and the new M&A qualified beneficiaries who were terminated in connection with the transaction.


The result is the same when the Target is part of a controlled group with the Seller and the Seller sponsors the health plan covering the Target’s employees. When the Target is acquired, it ceases to be part of the selling group; therefore, the Target’s employees are no longer covered by the Seller’s plan. Under the regulations, the Seller will continue to be responsible for the provision of COBRA continuation coverage for all M&A qualified beneficiaries. However, if the Seller and its entire controlled group ceases to provide any health benefits to all employees in connection with the sale, the Buyer is then required to provide COBRA continuation coverage for all M&A qualified beneficiaries. [Treas. Reg. § 54.4980B–9, Q&A-8] Note: The Buyer is not obligated to provide COBRA continuation coverage for the employees of the other members of Target’s controlled group, only for the employees of the company that was purchased. [Treas. Reg. § 54.4980B–9, Q&A-8]


COBRA Requirements in an Asset Sale

In most asset sales, the employees who continue to work for the Buyer generally do actually terminate employment with the Seller. This creates a COBRA qualifying event in an asset transaction for all employees who cease to work for the Seller. [Treas. Reg. § 54.4980B–9, Q&A-8] In that situation, the Seller is responsible for COBRA obligations for all M&A qualified beneficiaries if it continues to maintain a group health plan for any employee. If, however, there is no loss of coverage under the health plan as a result of the transaction, there is no qualifying event. Suppose, for example, that the Seller sells all its assets to the Buyer. As part of the transaction, the Buyer assumes the Seller’s health insurance program, so that there is no interruption in the acquired employees’ coverage. In that case, there is no qualifying event and no COBRA continuation coverage obligation.


If the Seller ceases to provide health benefits to all employees in connection with the sale within 18 months of the sale, but the Buyer continues the business operations associated with the purchased assets, the Buyer is considered a “successor employer” for COBRA purposes. In that case, the Buyer is required to provide COBRA continuation coverage for all M&A qualified beneficiaries for the remainder of their COBRA period, even those who terminated employment before the transaction and who were never employed by the Buyer. [Treas. Reg. § 54.4980B–9, Q&A-8] If, however, the Buyer is not a successor employer for this purpose, the employees who are hired by the Buyer in connection with the transaction are not considered to experience a qualifying event and are not M&A qualified beneficiaries.


Contractual Modifications to the Normal COBRA M&A Rules

The Treasury regulations permit the parties to contract to reallocate COBRA obligations. [Treas. Reg. § 54.4980B-9, Q&A-7] The purchase agreement may allocate all COBRA continuation coverage responsibilities for employees who continue to work for the Buyer to the Buyer. In that case, the Buyer would have a contractual obligation to provide COBRA continuation coverage to certain M&A qualifying beneficiaries, but the Seller would continue to be legally liable for COBRA obligations if the Buyer failed to meet its contractual obligations. In that situation, the Seller would have recourse against the Buyer for breach of contract.


In addition to the basic issues described above, parties to an M&A transaction also will need to take into consideration the following:

  • State Law. Some states require that the employer provide continuation benefits that exceed those mandated by COBRA. It is important for the Buyer and the Seller to review applicable state law to ensure that sufficient continuation coverage is provided to the affected employees.

  • Due Diligence. There have been a number of class action lawsuits involving COBRA violations and even a single COBRA violation can result in significant liability if an employee loses coverage and has large, unreimbursed medical expenses. For this reason, it is important to review COBRA compliance issues in any M&A transaction.

  • Multi-employer Plans. Special rules apply to multi-employer group health plans and those should be reviewed if multi-employer plans are involved in a transaction.

Conclusion

Because COBRA violations can be costly (even for small employers), and the statute and regulations can result in liability for both buyers and sellers (and their controlled group members), it is important to carefully consider and handle COBRA obligations in any M&A transaction.



Copyright © 2023 CCH Incorporated. All Rights Reserved.

Reprinted from Journal of Pension Benefits, Spring 2023, Volume 30, Number 3,

pages 52–54, with permission from Wolters Kluwer, New York, NY,

1-800-638-8437, www.WoltersKluwerLR.com


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