New COBRA rules affect business sales and acquisitions
NOTE: The following article is from the collection of articles in our Automobile Dealership Buy/Sell Newsletters. The newsletter deals with the complex area of buying and selling automobile dealerships. Some of the material may not be up to date because of changes in the law from the date shown at the end of the article. This article is not to be taken as legal, accounting, tax, or other advice. You should consult your own professionals for such advice and for any updating of the information provided.
On February 2, 1999, the Internal Revenue Service (“IRS”) issued long-awaited COBRA regulations providing updated and detailed guidance on many different areas. The 1999 regulations essentially update the IRS rules contained in the proposed regulations of 1987 and consist of two parts – final and proposed regulations. Although the new regulations do not change the basic COBRA mandates, they do clarify several gray areas of the law, especially with respect to proper administration of COBRA rights.
One very important area covered in the 1999 proposed regulations concerns the area generally referred to as “business reorganizations,” and these regulations provide detailed guidance on business sales and acquisitions. This was in response to numerous comments from attorneys and their clients who wanted to know how to deal with COBRA in the context of business sales and acquisitions. Although contained in the set of proposed regulations rather than in the set of final regulations, until finalized, the IRS will look to compliance with these proposed regulations as a reasonable interpretation of COBRA requirements under federal law. Because these new business reorganization rules are themselves complex, they raise their own set of questions and uncertainties and dealers involved in buy-sell transactions whether as a buyer or seller should seek legal counsel in determining their obligations to the employees of the selling dealership under federal COBRA law.
Although too complex to summarize in detail, the new COBRA rules on business reorganizations do shed light on the following matters:
.For purposes of the COBRA proposed regulations, a business reorganization refers to both a sale of a company’s stock and a sale of all or substantially all of the assets of a trade or business.
.The new COBRA rules use the term “M&A qualified beneficiary” to identify those individuals who will become qualified beneficiaries entitled to COBRA continuation coverage as a result of the sale transaction. For example, in a dealership buy-sell transaction in which the dealer is selling all or substantially all of the dealership assets to a buyer, the M&A qualified beneficiaries could include both the preexisting qualified beneficiaries (individuals who used to work for the selling dealer and elected COBRA coverage due to a qualifying event that occurred before the buy-sell transaction) as well as individuals who become qualified beneficiaries due to the sale transaction.
.Selling the stock of a corporation under the proposed regulations is not a qualified event which will trigger COBRA rights for employees who continue in employment with the buyer, even if the buyer terminates all group health plan coverage after the sale for the affected individuals. This is not the case in an asset sale. If an asset seller continues to maintain a group health plan after the sale and the sale causes the sold employees to lose coverage under seller’s plan, the asset sale will be a qualifying event for which COBRA notices must be given to the covered employees and their dependents, even if the covered employee is employed by the buying group after the asset sale and will be covered under the buyer’s health plan.
.In the case of any business reorganization (whether a stock or asset sale) so long as the seller maintains a group health plan after the sale, seller’s group health plan has the obligation to make coverage available to M&A qualified beneficiaries with respect to the sale.
.If seller ceases to maintain a group health plan in connection with the sale and the buyer maintains the business operations associated with the purchased assets (i.e., continues to operate a new car dealership), then the new regulations impose liability on the buyer to provide coverage for the M&A qualified beneficiaries after the sale. Thus, if a selling dealer terminates all health coverage under its plan as a result of the buy-sell transaction, the buying dealer will be obligated to make COBRA coverage available to the M&A qualified beneficiaries on the later of the date seller stopped provided group health coverage altogether or the date of the asset sale. This liability continues for the ordinary duration of COBRA coverage rules until the buyer ceases to maintain any group health plan.
.In determining whether a selling dealer has in fact terminated all health coverage, the parties to a sale transaction need to take into account whether the selling dealer may be considered to be part of a controlled group of dealerships which under COBRA rules may be treated as a single employer. For example, if a selling dealer sells the assets of one store (“Dealership No. 1″), but maintains an 80% interest in another operating dealership (“Dealership No. 2″), and Dealership No. 2 continues to maintain a group health plan for its employees after the sale of Dealership No. 1, the selling dealer may be deemed under COBRA rules to still be maintaining a group health plan because of the group health plan coverage maintained for Dealership No. 2.
.The COBRA rules allow and in fact recommend that the parties to the sale transaction address these COBRA issues and contractually allocate their responsibilities in the buy-sell agreement. However, these new regulations also make clear that if the party assigned the COBRA responsibility in the agreement fails to comply with its obligations, then the COBRA rules require that the party who has the regulatory liability pick up the COBRA coverage for the affected qualified beneficiaries. For example, if a buyer agrees to assume the COBRA responsibility for certain M&A qualified beneficiaries and fails to do so, the seller is required to provide the COBRA coverage instead if the proposed regulations would have otherwise required the selling group to do so (of course, the party that has to pick up this “residual” liability may have contractual claims against the defaulting party pursuant to the terms of the buy-sell agreement).
As can be seen from the above discussion, COBRA issues and responsibilities can be complicated in a dealership buy-sell transaction. In light of this, it is best to deal with these issues early on in the negotiations and incorporate the COBRA responsibilities of the buyer and seller in the buy-sell agreement.
This article was written in 1999.