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Buyer Beware: COBRA Obligations in an Asset Purchase

Posted in Plan Administration

When one company purchases another, there can be significant implications to the obligation to provide health benefits. Former employees of the seller company are typically entitled to continue health benefits under COBRA if they lose coverage as a result of the transaction. The traditional view is that the seller company has the obligation to provide COBRA coverage. But what happens when the seller company ceases operation and terminates its health plan? How do these displaced employees get continuation coverage.

It is not uncommon, in an asset purchase transaction, for the buyer to assume a substantial portion of the operations of the selling company. In many instances, the buyer also agrees to take on and hire former employees of the seller. These types of arrangements give rise to special considerations for employee benefit plans, the continuation of health coverage being one of them.

The COBRA regulations contain a number of regulations explaining what happens to qualified beneficiaries in the event of an asset purchase transaction. 26 CFR 54.4980B-9 includes provisions that deal specifically with continuation rights and obligations in an asset purchase transaction. Included in these regulations is an explanation of instances where the buyer is obligated to provide the continuation coverage under its own plan, even though it may not have ever employed the individual employees.

In the context of a business reorganization, the regulations recognize the existence of a “M&A qualified beneficiary.” In an asset sale, this is someone who has a COBRA qualifying event prior to or in connection with the sale and whose last employment prior to the qualifying event was associated with the assets being sold. Under this definition, an employee working for the seller company who loses coverage as a result of the asset sale (typically through termination of employment) would be an “M&A qualified beneficiary.”

The regulations go on to provide that if the seller ceases to provide health coverage as a result of the transaction, and if the buyer continues the business operations associated with the assets purchased “without interruption or substantial change,” the buyer becomes a “successor employer.” If the buyer is a “successor employer,” a group health plan maintained by the buyer has the obligation to make COBRA coverage available to M&A qualified beneficiaries with respect to that asset sale. So if the seller is ceasing to offer health benefits as a result of the transaction, the buyer could, by operation of law, take on the COBRA obligation of the seller regardless of whether it agreed to do so in the asset purchase agreement.

An example: Seller provides group health coverage to its employees. Seller sells all of its assets to Buyer, which also sponsors a health plan. Buyer agrees to take on all but 2 of Seller’s former employees and continues the operations of Seller without significant interruption. Seller terminates its health plan. Under these facts, Buyer would be considered to be a “successor employer” and would have the obligation to provide continuation coverage to all M&A qualified beneficiaries when the Seller plan terminated. This coverage would be for the employees assumed AND the two employees not assumed (as well as their qualified dependents). In some instances, it may also include those former employees already receiving COBRA from the Seller’s plan (if their loss of coverage is deemed to be attributable to the asset purchase).

The regulations acknowledge that the determination of the obligation to provide COBRA coverage under asset purchase arrangements is based on “relevant facts and circumstances,” so there are not clear cut guidelines. There is also a provision that the Buyer and Seller may specifically contract or allocate the responsibility to make COBRA coverage available. However, if the party contractually obligated to make COBRA coverage available fails to meet obligations, the party liable under the statute will not be relieved of their burden to provide coverage.

The complexity of this analysis demonstrates just one of the reasons it is important to consult with counsel about the employee benefit implications of any transaction involving the acquisition of another employing entity, including asset purchases. There can also be issues with retirement plan obligation, severance obligations and bonus plans. Every buyer and seller should fully explore what benefit obligations they may have before completing the sale.