After what Judge Posner described as 19 "interminable" years of litigation, the latest round of Matz v. Household International Tax Reduction Investment Planmay be the last. In late December 2014, the 7th Circuit of Appeals rejected a class action claim that a qualified profit-sharing retirement plan experienced a partial termination by virtue of a unrelated series of corporate transactions that spanned a three year period, which, if sufficiently related, would have entitled the affected participants to immediate vesting of benefits.
Code Section 411 (d)(3) generally provides that in the case of a partial termination of a qualified retirement plan, affected participants must be fully vested in their benefit under the plan. While Code Section 411(d)(3) does not provide additional guidance as to when a partial termination occurs, case law and guidance from the Internal Revenue Service ("IRS") explain how partial terminations can occur in the context of corporate transactions.
When a significant portion of participants in a plan cease to participate in the plan in connection with a transaction (because they are terminated from employment, an amendment reduces their benefits under the plan, or they are otherwise excluded from participating in the plan), a partial termination may have occurred.
A prior ruling in the Matz case adopted a 20% test for determining whether a partial termination had occurred, and this test was adopted by the IRS in Revenue Ruling 2007-43. This test generally provides that if an employer's actions eliminate 20% or more of a plan's participants during an applicable period (generally a plan year), the actions are presumed to constitute a partial termination. Generally, most employer-initiated actions that include a termination of employment are required to be included in this calculation.1Also, in determining the percentage, if separate transactions are sufficiently related, the 20% test may be calculated based on the combined series of transactions and over the course of a time period longer than a year.
Matz v. Household International Tax Reduction Investment Plan
The Matz plaintiffs, participants in a profit-sharing plan, originally filed their complaint in 1996. From 1994 to 1996, their employer sold off various subsidiaries, which resulted in the plaintiffs and other participants losing their jobs. Because the employer contributions to the plan were subject to a 5-year vesting schedule, participants forfeited non-vested portions of their accounts. The plaintiffs argued that the transactions should be aggregated because they were sufficiently related to one another and, combined together, resulted in a partial termination.
After decades of procedural delays and fact-finding, in April 2014, a district court found that a partial termination did not occur because:
- There was no overarching reorganization plan for selling the subsidiaries;
- The decisions to sell were made sequentially rather than all at once;
- Each business was evaluated on its own terms and there was no major corporate event that drove the employee reductions over multiple years; and
- The time period chosen by the plaintiffs to determine a partial termination (1994-1996) was arbitrary (i.e. not tied to a specific event) and the plaintiffs simply carved out a time period in which a significant number of participants were terminated.
On appeal, the 7th Circuit noted that no single transaction resulted in a turnover rate greater than 5%, and even aggregated together, the turnover rate for all the transactions was about 17%. Accordingly, the 7th Circuit affirmed the district court's ruling that there was no partial termination.
The 7th Circuit reiterated that the period over which plan turnover may be aggregated to determine whether a partial termination occurs can expand beyond a plan year (recognizing the realities of corporate transactions); however, the facts here did not support a finding of a "related series of events."
Takeaways for Employers
Employers that have experienced, or expect to enter into, a significant corporate transaction should consider the risk of a partial termination of their qualified retirement plans. While the risk of a partial termination is not new, the Matz ruling serves as a reminder that a series of corporate transactions over several years may be aggregated together in determining whether a partial termination occurred. If those transactions are sufficiently related and participant count is significantly lowered as a result of those transactions, the IRS or a court could find that participants should be entirely vested in their accounts.
The partial termination issue may also arise in the course of due diligence in connection with mergers and acquisition transactions. If a potential target in an acquisition has a noticeable turnover rate within its qualified plan during a plan year or over the course of several years, further inquiry regarding the facts surrounding that turnover should be made.