Section 1



From PLI’s Course Handbook

Pension Plan Investments 2008: Current Perspectives

#14928

18

ReVISITING vEBAs

Edmond T. FitzGerald

Davis Polk & Wardwell

Disclaimers and Suggested References: The outline that follows provides a general overview of retiree medical benefit VEBAs, with specific focus on the VEBAs recently proposed by the Big Three U.S. automakers. The author is by no means an expert on medical benefit plans or VEBAs. Nor can the author claim special insight into any aspect of the Big Three VEBAs. The information in this outline is gleaned entirely from public sources. For two very practical references on retiree medical and VEBAs see: (1) the ABA-JCEB teleconference “Shifting Retiree Health Benefits from Employers to VEBAs” (December 6, 2007 – available in archived teleconf format or CD), in which Nell Hennessey, Douglas Greenfield, Karen Handorf and Vicki Hood do a terrific job describing the background on union retiree medical and the Big Three VEBAs and (2) Jones Day Commentary – Who Killed Yard-Man (Apr. 2007), a Jones Day client newsletter available on-line which provides an excellent summary of the state of the case law up to April 2007 concerning an employer’s ability to amend retiree medical arrangements in a union context.

REVISITING VEBAs

Edmond FitzGerald

Davis Polk & Wardwell

Disclaimers and Suggested References: The outline that follows provides a general overview of retiree medical benefit VEBAs, with specific focus on the VEBAs recently proposed by the Big Three U.S. automakers. The author is by no means an expert on medical benefit plans or VEBAs. Nor can the author claim special insight into any aspect of the Big Three VEBAs. The information in this outline is gleaned entirely from public sources. For two very practical references on retiree medical and VEBAs see: (1) the ABA-JCEB teleconference “Shifting Retiree Health Benefits from Employers to VEBAs” (December 6, 2007 – available in archived teleconf format or CD), in which Nell Hennessey, Douglas Greenfield, Karen Handorf and Vicki Hood do a terrific job describing the background on union retiree medical and the Big Three VEBAs and (2) Jones Day Commentary – Who Killed Yard-Man (Apr. 2007), a Jones Day client newsletter available on-line which provides an excellent summary of the state of the case law up to April 2007 concerning an employer’s ability to amend retiree medical arrangements in a union context.

REVISITING VEBAs

I. Introduction

In 2007, General Motors, Ford and Chrysler (the “Big Three”) each entered into new agreements with the UAW which provided for the transfer of all hourly employee retiree medical benefit liabilities of the automakers to independent voluntary employee benefit associations (VEBAs). If all goes according to plan, starting in 2010 these VEBAs will assume all responsibility for the retiree medical benefits payable to the current and future hourly retirees of the automakers. While retiree medical VEBAs are not new, the VEBA deal struck by the Big Three is unprecedented in its scale. Collectively the VEBAs will be funded with more than $50 billion in cash and securities and will assume retiree medical liabilities for more than 700,000 employees valued at over $80 billion. If the VEBA deal is completed, it will enable the Big Three to significantly reduce their balance sheet liability for retiree medical benefits.

This outline summarizes the basic legal and practical aspects of retiree medical VEBAs and the public information provided to date on the proposed Big Three VEBAs.

II. VEBA Basics

A. Codes § 501(c)(9). A VEBA is an invention of Section 501(c)(9) Internal Revenue Code (the “Code”), which bestows tax-exempt treatment on:

“Voluntary employees’ beneficiary associations providing for the payment of life, sick, accident, or other benefits to the members of such association or their dependents or designated beneficiaries, if no part of the net earnings of such association inures (other than through such payments) to the benefit of any private shareholder or individual.”

B. VEBA Form. A VEBA can be established as a trust, corporation or association, but because ERISA § 403 generally requires plan assets to be held in trust, a trust is the natural form of choice for most VEBAs.

C. VEBA Beneficiaries. A VEBA can be established to fund benefits for union or non-union employees. A VEBA can be established by a union, an employee association or an employer. It can either provide benefits directly to the VEBA members or act as a funding source for benefits provided under a separate plan or insurance policy of the union or the employer. The membership of a VEBA (i.e., the covered participants) must consist of employees who are related by a common labor union or by a common employer, affiliated employers or a consortium of employers in a particular line of business in the same geographical locale. VEBAs are subject to nondiscrimination rules which require VEBAs to cover an employee group defined by reference to objective standards that constitute an employment-related common bond. Eligibility and benefits must be determined based on permissible objective criteria and cannot be skewed to officers, shareholders or highly compensated employees. A VEBA might also be subject to the nondiscrimination requirements of § 505 or § 79 of the Code, depending on the benefits provided, but a VEBA maintained pursuant to a collective bargaining agreement (CBA) is exempt from these requirements.

D. Control of the VEBA. A VEBA must be controlled by its membership, an independent trustee or trustees (e.g., a bank), or a trustee or trustees, at least some of whom are designated by or on behalf of the membership.

E. Application of ERISA. The administration and investment of assets held under a VEBA are governed by the fiduciary and prohibited transaction rules of Title I, Part 4 of the Employment Retirement Income Security Act of 1974 (“ERISA”) in much the same way as a pension plan trust. Typically, a VEBA’s board of trustees will be regarded as the “sponsor” as well as the primary “named fiduciary” of the VEBA. It appears that ERISA preempts state laws (e.g., insurance laws) as to most issues relating to the operation of a VEBA, although this conclusion is not beyond doubt and a more probing analysis of preemption is beyond the scope of this outline.

F. Funding and Deductibility of Contributions to a VEBA. VEBAs can use a variety of methods for recording and applying amounts contributed and held under the VEBA. For example, a VEBA can have a defined contribution feature whereby an employer and a union agree that an increment of each employee’s compensation will be contributed to a VEBA on a pre-tax basis. These contributions can be credited to a separate benefit account in the name of the employee and the account can be applied to reduce the employee’s cost for benefits. Employees may not be given a choice to receive a compensation directly in lieu of having the compensation contributed to a VEBA. So typically, contributions to be credited to an employee under a VEBA come from a per employee increment that is automatically paid by the employer to the VEBA. At the same time, the same VEBA (or a parallel VEBA) can allow other additional contributions by the employer to be held under a general account in the VEBA and used to fund benefits costs applicable across the entire VEBA population (e.g., to pay benefit claims, off-set basic premium costs or fund a stop loss policy).

Contributions are subject to the deduction limits imposed by § 419 and § 419A of the Code on the prefunding welfare benefits. Under these limits the annual deduction that an employer can take is typically limited to the amount of the benefit costs and expenses expected to be incurred within the tax year of the contribution. But there are a few important exceptions:

• Pursuant to Code § 419A(f)(5), a full deduction can be taken for all amounts contributed to a VEBA pursuant to a CBA; and

• Pursuant to Code § 419A(c)(2), even without a CBA, a full deduction can be taken for contributions to fund a reserve over the working lives of the covered employees where such contributions are actuarially determined on a level basis as necessary for post-retirement medical or life insurance benefits to be provided to the employees.

G. Tax-Exempt Status of a VEBA. Earnings on amounts and investments held under a VEBA are tax-exempt. A VEBA is required to obtain a determination of tax-exempt status from the IRS by filing an IRS Form 1024 within 15 months after the VEBA’s establishment (subject to a possible 12-month extension).

H. Taxation of Benefits Provided. Benefits funded or provided by a VEBA are taxable to the beneficiaries at the time they are provided, unless the benefits are tax-exempt under other applicable tax rules, such as the general exemption for premiums and claims payments under a non-discriminatory employee and retiree medical plan.

I. Anti-Inurement Requirement. Amounts contributed to a VEBA by an employer may not inure or revert to the employer. If all liabilities under a VEBA have been satisfied, any remaining assets can be applied to purchase additional insurance or benefits that would have been permissible benefits under a VEBA or to provide a direct cash distribution to employees if so provided under a controlling CBA. However, most other diversions of a VEBA’s assets will result in a 100% reversion tax.

III. Typical Process for Implementation of Defeasement VEBAs

A. Bankruptcy Retiree Medical VEBAs. At the risk of oversimplifying, in the bankruptcy context, the typical implementation of a VEBA is as follows:

• For active employees, a debtor-employer is often permitted to unilaterally modify or terminate retiree medical benefits under Bankruptcy Code § 1113, which provides that an employer may make changes to benefits of active employees (even benefits agreed under a CBA) if the changes are necessary to facilitate the reorganization of the debtors.

• For former employees in retiree status it is critical to determine whether the debtor-employer has reserved the right to change the retiree medical benefits. If so, the § 1113 standard above might apply (i.e., employer may unilaterally change benefits if necessary to facilitate the reorganization). If not, Bankruptcy Code § 1114 applies, which requires the retirees to be represented by a committee for purposes of participating in a process to determine what will be done about the retirees’ benefits.

• In the end, it is not uncommon for a debtor-employer to entirely cancel the retiree medical benefit rights of some or all of its active employees and establish a compromise arrangement for the retirees and perhaps some class of the active employees (e.g., employees over age 55 with 20 years of service).

• The compromise plan may include a VEBA established to fund a portion of the cost of benefits for the qualifying employees and the retirees (e.g., the employees and retirees might be required to pay most of the cost for their benefits, but a VEBA might be established to subsidize some portion of the cost for as long as the VEBA’s assets are sufficient to do so.

• The VEBA might be funded with a minimal amount of cash and a larger contribution of employer stock.

B. Non-bankruptcy Retiree Medical VEBAs. In the non-bankruptcy context, VEBAs with significant prefunding have historically been less typical. (See limits on pre-funding deductions summarized in paragraph II.F. above.) But there have been at least a few high profile pre-funded retiree medical VEBAs established in the non-bankruptcy context: Navistar (1993), Goodyear VEBA (2006) and AK Steel VEBA (approved/pending 2007). And now we have the proposed Big Three VEBAs (subject to court approval). A pre-funded retiree medical VEBA in the non-bankruptcy context is a Hobson’s choice for both the employer and the employees.

1. Employer Motives. From the employer’s perspective:

• The employer seeks to reduce its retiree medical costs and liabilities both from a recurring cash flow perspective and an accounting perspective.

• Reducing or eliminating benefits, or increasing employee cost-sharing, can entail legal risks and social costs. A review of the case law regarding an employer’s ability to change or terminate benefits is beyond the scope of this outline, but in many cases there is significant legal and social risk.

• Transferring the retiree benefit obligation to a VEBA is a difficult process that often requires court approval (see below) and entails a significant funding commitment over several years. The funding commitment depletes the employer’s cash position, which can crimp short-term capital raising, stall capital expenditures and increase solvency risks if the company faces a downturn in the near term. But a VEBA might be the most viable alternative for unburdening the employer’s balance sheet and eliminating the long-term drag on earnings.

2. Employee Motives. From the perspective of employees and retirees:

• As long as retiree benefits remain an unfunded liability payable from the employer’s earnings, the employees and retirees are at risk of employer curtailments to the benefits or employer insolvency.

• The more demonstrably onerous the benefits become for the employer, the more likely a court will see clear to permitting employer curtailments.

• However, accepting a funded VEBA in lieu of an employer promise shifts the funding risk to the VEBA, which raises issues of the sufficiency of the employer contributions, investment performance of the VEBA, healthcare cost inflation, etc.

3. Process for Implementing a VEBA. Under the National Labor Relations Act (“NLRA”), retiree medical benefits being provided to former (i.e., retired) employees at any given time are a permissive topic of bargaining for union negotiations but not a mandatory topic of bargaining. Therefore, while the employer and the union may agree to negotiate over retirees’ benefits, neither the employer nor the union can force this negotiation, the union cannot strike over the issue and the employer cannot announce a lock-out over the issue. Moreover, even if an employer and a union negotiate a deal concerning the benefits of retirees, the union cannot bind the retirees. So the process for transferring to a VEBA the retiree medical benefits of both active and retired employees will typically be as follows:

– The employer will get the union to agree to include retiree benefits as part of the negotiation relating to the new labor contracts.

– The employer might give the union access to company books in order to validate the dire financial straits that the retiree benefits create for the employer.

– The employer and the union will reach an agreement providing for the funding of a VEBA and a transfer to the VEBA of all liabilities for the retiree medical benefits of active and retired employees.

– Once the union contract is ratified, active employees are bound by the contract. Separately, legal counsel is appointed to represent the retirees and class representatives are appointed and a class action suit is brought in the name of the retirees.

– The employer seeks to consolidate the entire class of potential plaintiffs and have the class representatives agree to the proposed plan for the implementation of the VEBA and the transfer of the retiree medical liabilities to the VEBA, which will then become binding on all retirees under a court-approved settlement agreement.

4. Core Accounting Issue. Assuming that an employer’s liability for reiree medical benefits is transferred to a VEBA in a binding transfer, there are apparently two possible accounting treatments for the employer: settlement treatment or negative plan amendment treatment. Settlement treatment involves a removal from the employer’s balance sheet of the entire liability for the benefit obligations that have been transferred and would apply, for example, in the case of a one-time contribution to a VEBA and an immediate and binding assumption of all future benefit obligations by the VEBA. Negative plan amendment treatment applies when benefit obligations are transferred but the arrangement entails an agreed long-term schedule for employer contributions to the VEBA. In this case, the employer’s balance sheet continues to reflect an OPEB liability equal to the present value of the future contribution obligations. The liability is limited to the present value of the future contribution obligations and is not affected by healthcare cost trends. The liability is defrayed as the contributions are satisfied.

This is essentially the process followed in the recently proposed Big Three VEBAs.

IV. Big Three VEBAs

A. Background on GM and Ford. Before discussing the newly proposed Big Three VEBAs, some background on an earlier UAW deal at GM and Ford might be helpful.

• In 2005, GM and Ford each reached an agreements with the UAW for the institution of retiree cost-sharing on retiree medical benefits (i.e., premium cost contributions, deductibles, co-payments, prescription and dental coverage changes).

• In exchange, GM and Ford agreed to establish a VEBA to help defray retiree costs.

• For example, the UAW and GM agreed that GM would fund its VEBA with: (1) a $1B contribution in each of 2006, 2007 and 2011, (2) specified stock appreciation and profit sharing payments and (3) diversion of certain wage/COLA increases into the VEBA.

• The 2005 arrangement followed the process outlined in paragraph III.B.3. above. After the UAW and the automakers reached a negotiated deal, a class action was initiated on behalf of retirees and the arrangement was ultimately blessed by a court-approved settlement and an outside challenge against the class certification and the process was recently overruled by the Sixth Circuit Court of Appeals.

B. The Newly Proposed VEBAs. In the 2007 negotiation of their new contracts with the UAW, the Big Three decided to propose a full transfer of retiree medical obligations to the UAW. The parties followed the process outlined in paragraph III.B.3. above and reached agreements that were ratified by the active employees. Under the agreements, future hires will not be eligible for retiree medical benefits and the UAW has agreed not to request bargaining over retiree benefits again at any future date. All obligations for retiree medical benefits for the existing active and retired employees will be shifted to new VEBAs effective January 1, 2010.

The details and analysis that follow in the remainder of this outline were pieced together from public sources and are bound to be flawed in some respects. Because Chrysler is a privately held company, information on Chrysler is more limited and more prone to inaccuracy.

|The Proposed Big Three Auto VEBAs |

|Company |Estimated Hourly Retiree |Estimated VEBA Funding |

| |Liabilities | |

|General Motors |$46.7 B |- $16 B cash and funding obligations transferred from 2005 VEBA |

| | |- $9.1 B add’l cash contribution |

| | |- up to 20 payments of $165 M cash |

| | |- $4.3725 B convertible note |

|Ford |$23.7 B |- $3.8 B cash transfer from existing VEBA |

| | |- $2.7 B add’l cash contributions |

| | |- up to 20 payments of $52 M cash |

| | |- $3.3 B convertible note |

| | |- $3.0 B second lien note |

|Chrysler |$20 B |- $7.1 B cash contribution |

| | |- up to 20 payments of $50 M cash |

| | |- $1.2 B debenture |

| | |- Common stock warrant (potential $605 M) |

As described below the convertible notes to be issued to the GM and Ford VEBAs come along with registration rights. The Chrysler securities presumably do not entail registration rights, given that Chrysler is privately held.

The In addition to the VEBA contributions above, the Big Three have also agreed to specified monthly pension increases for retirees which are intended to offset the retirees’ contributions to cost of their medical benefits. The automakers have also agreed to make contributions to a union-sponsored study of retiree medical costs and funding.

Although assets and liabilities will not be shifted to the VEBAs until 2010, the agreements require each of the automakers to establish a temporary asset account (“TAA”) and to begin funding the agreed VEBA amounts immediately. For example, GM is required to contribute to its TAA an initial cash amount and the $4.4B convertible note. The note will begin to accrue interest immediately, but will be held by GM’s TAA until it is transferred to the GM VEBA in 2010. For more on the potential ERISA treatment of the TAAs ERISA see paragraph V.C. below.

C. The Notes Issued to the GM and Ford VEBAs. Taking the convertible note to be transferred by GM to its VEBA, for example, this note entails the following terms:

• senior unsecured and unsubordinated debt

• 6.75% interest paid semi-annually

• 5-year maturity from issuance on 1/1/08

• callable by GM any time after year three

• convertible for approximately 109 million GM shares based on $40 per share conversion price (approx. 20% of current outstanding)

• may only be converted (i) during any earlier calendar quarter if the average price of GM stock for any 20 trading days in the last 30 trading days of the prior quarter exceeds $48 per share or (ii) if the issuer calls the note or (iii) during the last three months before maturity regardless of the stock price or call

• demand registration rights applicable to note and shares (described below)

• prohibition on sale to any one buyer of notes representing more than 2% of the outstanding shares on an as converted basis

• sale limited to approximately 50% of note/shares per year

Shares issued on any conversion of the note must be voted by the VEBA in proportion to the voting of outstanding shares generally and the shares will be subject to standard registration rights/restrictions, as follows:

• demand registration of up to 50% of shares (54 million shares) per year, less number of shares sold in private sales during year

• permitted private sales of up to 13.5 million shares per quarter (54 million per year)

• piggy-back registration rights

• VEBA may be subject to standard 180 blackout on sales in event of any registered offering by GM (whether or not VEBA participates in the offering)

• no sales of more than 2% of outstanding shares to any one buyer and no sales to any 5% holder seeking influence

• trustee may not tender into any hostile tender offer

• GM right of first offer if VEBA seeks to sell any shares

D. Conditions to the VEBA. The automakers intend to seek comfort from the SEC that transfer of the retiree medical obligations to the VEBAs will permit the automakers to apply settlement treatment or treat the arrangement as a substantive negative plan amendment for accounting purposes. If the automakers are unable to get SEC comfort, the agreement with the UAW provides that the parties will negotiate in good faith to reach an acceptable alternate arrangement and if no such arrangement is agreed, the existing tentative arrangement will be void. Whether settlement treatment or negative plan amendment treatment is applied, the effect will not be reflected in the automakers’ financial statements until 2010 when the VEBAs assume the benefit obligations. Given the structure, substantive negative plan amendment treatment is more likely. Under negative plan amendment treatment the liability shown on the automakers’ balance sheet beginning in 2010 will be based on the present value of (i) the notes issued to the VEBAs and (ii) the future VEBA funding payments. The liability will decline when the note is paid and when funding payments are made. GM estimates, for example, that its OPEB liability will be $6B-$13B in 2010 and will decline to $2B-$9B by the time its convertible note has matured.

The VEBA deal is also conditioned on reaching a court-approved settlement with the retirees. If court approval of the arrangement is not obtained by January 1, 2010, the VEBA transfer will be delayed until a settlement is approved.

E. The VEBAs: Each of the Big Three automakers negotiated separate CBAs with the UAW. Each will have its own separate VEBA, but the papers suggest that one consolidated VEBA could be formed if the UAW prefers. If so, the assets and liabilities of each automaker will still be segregated.

In connection with benefit plans negotiated and administered by a union but funded by an employer, the Taft-Hartley provisions of the NLRA typically require that the board of trustees of the plan comprise an equal number of employer and union representatives. NLRA § 302(c) states that “[i]t shall be unlawful for any employer… to pay… or agree to pay… any money or other thing of value… to any labor organization… which represents… employees of such employer.” NLRA § 302(c)(5) offers an exception for the contribution of cash or other assets to a trust fund established for the sole and exclusive benefit of the employees of an employer, and their dependents, provided, that certain conditions are met, including a condition requiring that the employer and employees are equally represented in the administration of the fund. However, apparently, an exception has been recognized that permits a union-sponsored benefit plan to satisfy this requirement without necessarily having employer representatives serve on the board, provided that the board has a sufficient complement of independent members. It appears that the Big Three VEBAs will use this approach. The UAW has expressed a desire that the automakers nominate company representatives to serve on the VEBA committees, but it seems that the accountants for the automakers are concerned that this might jeopardize the automakers’ ability to achieve the preferred accounting treatment. Therefore, it is contemplated that the automakers will only place representatives on the board of trustees if the accountants and the SEC conclude that this will not affect the accounting treatment. If the accountants or the SEC conclude that it would affect the accounting treatment, then the board of trustees will consist of a majority of independent members (e.g., the board would be 3 union officers and 4 independents appointed pursuant to rules established under the VEBA).

F. Securities Law Issues. Neither the notes to be issued to the VEBAs nor the shares that would be issuable on a conversion of the notes will be issued to the VEBAs as part of a registered offering under the Securities Act of 1933 (“’33 Act”). Accordingly, the notes and shares will be restricted securities for ’33 Act purposes. The VEBA trustees will have to consider the resale limits imposed under the terms of the notes (described above) and the appropriate use of the registration right provided. But, generally speaking, the GM and Ford VEBAs will have three possible methods available for selling the notes/shares, while the Chrysler VEBA will only have the second and third alternatives below, at least until there Chrysler goes public again:

1. In the case of GM and Ford, registered offerings pursuant to the registration rights. As noted, GM and Ford have each promised their VEBAs demand registration rights to register and sell approximately one half of the note/shares in a single registered offering in any year. The GM and Ford VEBAs also have piggy-back rights to sell into any registered offering by the automakers.

2. One or more private sales pursuant to the so-called § 4(11/2) exemption under the ’33 Act (i.e., a private sale to one or more sophisticated private investors).

3. One or more unregistered resales into the market pursuant to the Rule 144 safe harbor under the ’33 Act. The constraints imposed on market resales pursuant to Rule 144 depend on whether the VEBAs are considered underwriters, i.e., affiliates, of the issuers for purposes of the ’33 Act and Rule 144. It is always risky to analyze these issues from 500 paces, but taking the GM convertible note, for example, at least until the note becomes freely convertible it would seem that the GM VEBA should not be regarded as an affiliate of GM, based on the fact that the VEBA will exist solely for the benefit of its members and will neither control nor be controlled by GM (although the public documents do suggest that GM representatives might serve on the VEBA board of trustees at the UAW’s request if this will not negatively impact the accounting result). For as long as the GM VEBA is respected as a non-affiliate of GM, Rule 144 would permit the VEBA to resell the notes/shares in regular market transactions, without any volume limit, any time after the notes have been held by the VEBA for at least six months. The GM note is convertible into approximately 109 million GM shares (based on $40 per share conversion price), which represents approximately 20% of the currently outstanding shares of GM. Thus, unless the VEBA sells down the note, it is possible, if not likely, that it will be regarded as an affiliate of GM if and when the note becomes convertible. In this case, sales by the VEBA in reliance on Rule 144 will be subject to the volume limits under Rule 144 (i.e., sales in any 3-month period are limited to the greater of 1% of outstanding class or the weekly trading volume, subject potentially more liberal limits for the notes/debt (as opposed to shares)).

V. ERISA

A. Contribution of Employer Securities. Both ERISA and the Code prohibit the sale or exchange of property, including securities, between a plan or VEBA and an employer whose employees participate in the plan or VEBA, unless the conditions of ERISA § 408(e) are satisfied.

It is settled law that an employer’s contribution of property to a pension plan in satisfaction of the employer’s funding obligation with respect to the plan is a “sale or exchange” for these purposes. By the same token, a transfer of property by an employer to a union VEBA in exchange for the VEBAs assumption of employer liabilities would presumably be treated as a sale by the employer to the VEBA.

In addition, whether or not the transfer of securities to a VEBA involves a prohibited transaction, ERISA places a more general prohibition on any acquisition or holding by a plan of securities issued by an employer whose employees are covered the plan (or by an affiliate of the employer), unless the conditions of ERISA § 408(e) are satisfied.

ERISA § 408(e) exempts the acquisition and holding of employer securities by a plan if:

• the employer securities are “qualifying employer securities,”

• the plan pays no fee or commission in acquiring the securities,

• the plan pays no more than adequate consideration for the securities, and

• as of the moment immediately following plans the acquisition of any employer securities not more than 10% of the plan’s assets are invested in employer securities and employer real property collectively (subject to a limited exception for individual account plans (e.g., 401(k) plans and ESOPs).

Qualifying employer securities include:

• stock, provided that immediately following each acquisition of shares of the stock by the plan not more than 25% of the stock class outstanding is held by the plan and at least 50% is held by persons independent of the issuer, and

• obligations (i.e., debt) provided that immediately of any such debt interests following the acquisition by the plan not more than 25% of the debt issue is held by the plan, at least 50% is held by persons independent of the issuer and not more than 25% of the assets of the plan are invested in obligations of the employer or an affiliate of the employer.

In the case of the proposed Big Three VEBAs, the notes contributed by automakers will exceed the basic 10% limit on employer securities (i.e., 10% of the VEBAs total assets). In addition, the notes might not be qualifying employer securities (i.e., the notes might not be held by other investors independent of the issuer and might exceed 25% of VEBAs assets). Accordingly, the automakers will have to obtain an individual exemption from the U.S. Department of Labor (“DOL”) to permit the VEBAs to acquire and hold the debt securities that will be contributed by the automakers. Similar exemptions have been issued in the past by the DOL, but these exemptions have involved employer stock, rather than debt securities. In addition, as noted, the notes to be issued to the Big Three VEBAs include features such as call rights, rights of first offer and voting restrictions. Accordingly, it is doubtful that the automakers will be able to use the expedited exemption procedure under Prohibited Transaction Class Exemption 96-62, but they have time to go through the regular process, since the notes will not be transferred to the VEBAs until 2010.

Prior DOL exemptions have imposed a number of conditions on the terms and administration of the employer securities contributed to the relevant plan. A typical condition is that the plan be represented by an independent fiduciary in matters relating to the employer securities. The proposed design of the Big Three VEBAs calls for each to have a board of trustees composed of a minority of union representatives and a majority of independent representatives. This satisfied the DOL in the case of the Navistar exemption (1993). Although the UAW has requested that the Big Three automakers appoint company representatives to serve on the VEBA boards, even if this would not adversely affect the accounting result, the DOL might not permit this or might require that an outside fiduciary be given authority over the employer securities.

B. More General ERISA Issues. Stepping back from the per se prohibited transactions that might be implicated by the contribution and holding of the employer securities by the Big Three VEBAs, there is the more general question of whether any of the fiduciary rules of ERISA are implicated by the elements of the agreements struck by the automakers and UAW (e.g., the automakers’ transfer of the benefit obligations, the consideration promised to the VEBAs, the conditions and limitations on the voting, resale and tender of the contributed securities). Separately, there is the ongoing administration of the VEBAs and fiduciary issues and standards that will apply there (e.g., the investment decisions, decisions regarding the benefits to be provided and the arrangements to provide those benefits (insurance, etc.)). The VEBA trustees will have to engage advisors to help them make a variety of decisions, from long-term benefit design decisions to day-to-day investment decisions. In both the initial agreement and the ongoing administration of the VEBAs it might be difficult to discern a clear line between fiduciary decisions that are subject to ERISA’s fiduciary rules and settlor decisions that are not subject to the fiduciary rules. But, in any case, it would seem that the process has and will continue to be one infused with adequate independence and prudence on the employee side so as to avoid any ERISA fiduciary implications.

C. The Temporary Asset Accounts. The notes and a portion of the cash to be contribution to the VEBAs will be funded immediately and held in the automakers’ Temporary Asset Accounts (“TAAs”) until these assets are transferred to the VEBAs on January 1, 2010. The automakers will seek to ensure that the assets will not be considered plan assets subject to ERISA while held in the TAAs prior to transfer to the VEBAs. ERISA does not identify when assets become “plan assets” subject to ERISA. In seeking to identify the scope of ERISA’s bonding requirements, the DOL temporary regulations under Section 2580.412-5(b) state that “contributions made to a plan . . . would normally become [plan assets] if and when they are taken out of the general assets of the employer . . . and placed in a special bank account or investment account; or identified on a separate set of books and records; or . . . otherwise segregated.” However, those regulations are not particularly germane to the VEBA scenario at hand. DOL Advisory Opinions 92-02A, 92-24 and 94-31A would appear to be more relevant. DOL Advisory Opinion 94-31A, for example, states that assets set aside to fund an employer’s future obligation under a welfare benefit plan will not constitute plan assets unless the arrangement gives the plan a beneficial interest in the assets. The opinion acknowledges that under ordinary notions of property rights, such assets would become plan assets if, under common-law principles, the property is held in trust for the benefit of the plan or its participants and beneficiaries or the plan otherwise has an interest in such property on the basis of ordinary notions of property rights. The DOL notes that the identification of plan assets therefore requires consideration of any contract or other legal instrument involving the plan, as well as the actions and representations of the parties involved. The Big Three VEBAs will not have any control over the assets of the TAAs until the assets are transferred to the VEBAs. In the case of the GM TAA, for example, the agreement with the UAW specifically states that the assets of the TAA are not intended to be regarded as plan assets under the DOL opinions, and if GM concludes that the assets would be deemed to be plan assets, it may apply to the DOL for any necessary exemptions from ERISA’s prohibited transaction rules.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download