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Mergers and Acquisitions in Canada

No Successor Plan Option

This option is not available if a registered pension plan is required pursuant to a collective agreement. Even if no collective agreement exists, this option may pose severance cost risks for the seller if the purchaser’s offers of employment do not provide substantially the same terms and conditions of employment in the aggregate as those provided by the seller immediately before closing. This is especially true in Quebec, where most corporate transactions will result in the transfer of employment agreements.

As pointed out above, the seller is at risk of being ordered by the pension regulator to partially or fully wind-up its pension plan if no successor pension plan is provided by the purchaser (e.g. if the purchaser chooses to provide a group RRSP instead). Once partial wind-ups are removed from Ontario legislation, severance costs will include the same grow-in benefits that an Ontario member would be entitled to if there had been a partial wind-up.

Successor Plan Option - No Transfer

In this case, on retirement, a transferred employee would receive his or her pension payments from two sources: the purchaser’s plan and the seller’s plan (or an insurance company if an annuity was purchased by the purchaser or seller). The seller continues to have control and obligations in respect of the pre-closing assets and liabilities relating to the transferred employees, and the responsibility for administering and investing those assets.

For purposes of benefit accrual in a DB plan, the purchaser’s plan can either recognize service and salary from the closing date only (“post-closing service approach”), or recognize the employee’s combined service and salary with both the seller and the purchaser, but require an offset for the benefit payable from the seller’s plan (the “wrap-around approach”). The deemed continuous employment and plan membership requirements under pension legislation does not apply to benefit accrual and a wrap-around approach is not required. The impact on the employee’s overall pension benefit under these two approaches will vary depending on the type of DB plans provided by the purchaser and seller. However, in a final average earnings plan, the transferred employee would definitely be disadvantaged under the post-closing service approach as the pre-closing service benefits would be calculated using the earnings of the employees as of the closing date, without taking into account salary increases provided by the purchaser.

Under the “wrap-around” approach, higher initial funding obligations would be created for the purchaser (actuarial input should be obtained). The purchaser may want to take this added funding cost into account when negotiating the overall purchase price of the deal, if the “wrap-around” approach is being considered by the parties. Also, it is important to distinguish between what is payable in accordance with the seller’s plan and what is paid, in case the seller becomes bankrupt. The purchaser would not want to be obliged to make up for any shortfall or non-payment from the seller’s plan.

As noted earlier, if there is no transfer of assets and liabilities to the purchaser’s plan, there is a risk that a wind-up might be ordered by the pension regulator.

Successor Plan Option - With Transfer

Under this option, upon retirement employees would receive one cheque from the purchaser’s plan (or an insurance company). Also, it allows the purchaser to have control over the pre-closing and post-closing pension assets of the transferred employees, rather than leaving the control of the pre-closing assets with the seller.

In the case of DB plans, there are generally two ways to determine the value of assets to be transferred from the seller’s plan to the purchaser’s plan. Under the first approach, the parties could agree that assets in an amount equal to the liabilities relating to the accrued benefits of the transferred employees be transferred. The second approach is to transfer the proportion of assets in the seller’s plan that is equal to the same proportion by which the transferred employees’ liabilities compare to the overall liabilities of the seller’s plan. In this second scenario, a proportionate amount of any surplus or of any deficit would also be transferred to the purchaser’s plan. In Quebec, this second approach is required by pension legislation. There are also currently cases before various provincial courts that may require a transfer of existing surplus if there is a transfer of assets.

Adjustments to the purchase price could be negotiated to account for any deficits or surplus. In this regard, it should be kept in mind that just because surplus might be transferred over to the purchaser’s plan, the purchaser may not necessarily have the legal right to use it for contribution holidays or to withdraw it. Thus, there is a risk that the surplus transferred (which may have translated into a higher overall purchase price for the purchaser) may not end up having any practical value to the purchaser. In many jurisdictions, surplus withdrawals by employers are permitted only if authorized under the plan documents and/or a certain number of plan members consent to the proposed surplus withdrawal. In all cases, regulatory approval of the proposed surplus withdrawal is also required. In short, the withdrawal of surplus from a registered pension plan by an employer can be difficult (and in some cases, impossible) to effect. It is usually a costly and lengthy process.

Another important issue in the determination of the transfer amount is the basis on which the liabilities are calculated. The parties should, in the sale agreement, agree on whether the transfer amount will be determined using liabilities calculated on a going concern basis, on a solvency basis or the higher of the two. The going concern financial position of a pension plan is determined based on the assumption that the plan will continue indefinitely into the future (e.g. it assumes increases in earnings). The solvency financial position is determined by comparing the market value of assets to the liabilities, for benefits earned prior to the valuation date, calculated as though the pension plan had been terminated on the valuation date (e.g. earnings are frozen and all plan members are fully vested). The liabilities and funded status of the seller’s plan could be drastically different, depending on whether the calculations were made on a going concern or a solvency basis.

For DB plans, an actuarial report would have to be prepared outlining the assumptions used to calculate the amount of assets and liabilities being transferred. The transfer amount can be contentious if, for example, the purchaser’s actuary does not agree with the assumptions and the calculations used by the seller’s actuary. It is typical to see lengthy provisions in the purchase and sale agreement to address what would happen if there is a disagreement amongst the actuaries, who the arbitrator will be, and also what would occur if the agreed-upon transfer amount is not approved by the regulator.

Transfers of assets and liabilities between two DC plans are much simpler to deal with. Essentially, the transferred employees’ account balances as of the closing date, adjusted for net earnings thereon (and any expenses charged to such accounts) from the closing date to the actual transfer date, would be transferred to the purchaser’s DC plan. The surplus or deficits (provided that contributions under the seller’s plan are up to date as of the closing) are usually not at issue with transfers involving DC plans (although an exception could arise if the DC plan had been converted from a DB plan with surplus). Forfeited contribution amounts, if any, should be addressed. It is uncommon to see agreements between purchasers and sellers involving a transfer of assets and liabilities from a DB plan to a DC plan or vice versa.

In an asset transfer situation (DB or DC), the sale agreement should indicate how the transferred assets are to be administered and invested while waiting for regulatory approval, and who will bear the administration expenses during the waiting period. The agreement may also dictate whether the assets ultimately transferred will be in cash and/or in-kind.

A transfer of assets and liabilities from a seller’s pension plan to a purchaser’s pension plan requires written approval from the pension regulator. Each jurisdiction has its own policies in respect of proposed asset transfers. For example, in Alberta, if there is a surplus in the seller’s DB plan and the surplus is not transferred as part of the asset transfer, the transferred members retain any rights they may have had to the surplus in the seller’s plan, even though they are no longer employed by the seller and their assets and liabilities have been transferred out of the seller’s plan.

Plan Assignment Option

If sponsorship of the seller’s plan is assigned to the purchaser, the assets and liabilities of the entire plan (i.e. relating to active members, retirees, terminated members with deferred vested benefits, beneficiaries) are assumed by the purchaser. Thus, the purchaser could end up administering the benefits of individuals with whom they have no prior relationship. The purchaser should include language in the agreement of purchase and sale to the effect that the purchaser will not be responsible for liabilities in respect of the administration or operation of the plan prior to closing. Strong indemnities regarding pre-closing administrative errors should be included to protect a purchaser from these liabilities. From the perspective of the regulator and the plan members, the purchaser would likely be seen as the entity responsible for both pre- and post-closing obligations and liabilities regarding the assigned plan, regardless of any language favouring a purchaser’s interest incorporated into the agreement of purchase and sale.

The assignment of sponsorship and administration of the seller’s plan does not require regulatory approval, although the appropriate amendments to the plan (and related documents, such as excerpts of the sale agreement, the pension assignment, or the assumption agreement, if any) will have to be filed with the pension regulator and CRA for registration.

This assignment option is not feasible if the seller is retaining some of the employees who are members of that plan (unless those retained employees are removed from the plan prior to closing). In addition, if the seller’s plan participates in a pooled investment arrangement with other plans of the seller or its affiliates (e.g. master trust arrangement), such participation should be terminated prior to the effective date of the assignment of the plan from the seller to the purchaser.

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