Archive for November, 2012

Buyer Beware: COBRA Obligations in an Asset Purchase

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.


Keith R. McMurdy “Employee Benefits Legal Blog.” Fox Rothschild, LLP. 6 May 2008.

COBRA and Dependent Children

COBRA regulations for dependent children can be confusing and we receive many calls from both brokers and employers about what must be offered to dependent children, newborns, and adopted children in regards to COBRA coverage. Hopefully the following will provide a better understanding on how to administrate COBRA for children as beneficiaries.

It is important to remember that the term “dependent child” is not defined by COBRA, but rather by the terms of the group health plan. Therefore the COBRA term “dependent Child” is not to be confused with the terms “dependent” or “tax dependent” which are used for federal tax purposes. For example, it is possible that an individual living in the household might be a tax dependent and yet not a COBRA qualified beneficiary because he or she is not a dependent child of the covered employee. Furthermore, dependent children who are qualified beneficiaries have COBRA rights separate from and independent of the covered employees and spouses who are their parents.

There is one circumstance that allows a child to be a qualified beneficiary regardless of whether that he or she is a dependent of the covered employee. For example, a child is receiving benefits according to a qualified medical child support order (QMCSO). A QMCSO creates the right of a child of a plan participant to receive benefits under the participant’s group health plan. It may be required that the health plan of a noncustodial parent provide coverage for that child even though he or she is not considered to be a “dependent” per the health plan’s definition. When a child is enrolled in a group health plan under a QMCSO he or she is treated as a beneficiary for all purposes of ERISA regardless of his or her status as a dependent of the covered employee.

In terms of adult children, if the group health plan provides coverage for the children of their participants, then the coverage generally must be available until the child turns age 26 regardless of their student status. Furthermore, a child enrolling under this mandate must be treated as a HIPAA special enrollee and be offered all of the benefits available to similar individuals who did not lose coverage due to loss of dependent status.

Newborn and newly adopted children that are born to or placed for adoption with the covered employee during COBRA continuation coverage are also considered to be a qualified beneficiary. However, there is a limitation added per the IRS COBRA regulation: If a covered employee who is a qualified beneficiary has not elected COBRA coverage then any newborn or adopted child of the employee born or adopted after the qualifying event is not a qualified beneficiary. It must be pointed out, however that the meaning of this statue is somewhat unclear and may be difficult to interpret in various scenarios. One thing is clear – the newborn or newly adopted baby must be born to or adopted by the covered employee in order to be a qualified beneficiary. For example, if a dependent child Mary ceases to be a dependent and elects COBRA, then gives birth to a baby, that baby would not be considered a qualified beneficiary.

As for a newborn or newly adopted child added at Open Enrollment, the qualifying event giving rise to the period of coverage during which the child is born or adopted determines the amount of remaining coverage. However, if there is a second qualifying event, such as the death of the covered employee, then the child’s COBRA coverage will be extended 36 months from the employee’s termination date. A newborn child has the parent’s maximum coverage period and a child is entitled to the same coverage as children of active employees. For example, if the active employee is allowed to change coverage or add dependents at subsequent open enrollments, then the newborn or adopted child must be allowed to do so as well. Additionally, there are stipulations in the case of an adopted qualified beneficiary with a dependent. For example, if 18 year old Julie is adopted by an active employee during his COBRA coverage, but her daughter Natalie is not adopted, then only Julie can elect coverage at that time. However, at the next open enrollment Natalie can become covered, although Natalie will not be considered a qualified beneficiary.

It must be noted that COBRA election rules (including the 60-day deadline) do not apply to the children born or adopted during the COBRA continuation period. They must be enrolled during either the plans’ special 30-day enrollment period or some other period such as open enrollment. In summary although a newborn or newly adopted child is automatically considered a qualified beneficiary, the child is not covered until enrollment occurs. Because the IRS COBRA regulations do not provide for a specific period in which a newborn or newly adopted qualified beneficiary must enroll for COBRA coverage, special caution and legal counsel should be taken before rejecting late enrollments. Furthermore, because the plan administrator is not required to provide a separate COBRA election notice for the newborn or adopted child, the rights of these children should be clearly explained in the election notice that is provided to the qualified beneficiary. The IRS regulation’s definition of adoption or placement for adoption means, “The assumption and retention by the covered employee of a legal obligation for total or partial support of a child in the anticipation of the adoption of the child.” ERISA offers more guidance on what “placed for adoption” means however plan administrators should note that a child may be placed for adoption prior to the adoptive parents having physical custody of the child. Typically when COBRA is elected coverage begins on the date of the qualifying event. Because this rule cannot be applied to a newborn or adopted child who becomes a qualified beneficiary during a COBRA continuation period caused by another qualifying event, the plan administrator will need to determine when the child’s coverage is effective.

Is Your Company Subject to COBRA Requirements?

It is quite common for insurance companies that offer fully insured benefits to automatically pair the coverage with COBRA coverage as a part of the “product” offering. Often times insurers aren’t aware of whether the employer that is purchasing the coverage is subject to COBRA or not. Even a small business of less than 20 employees could be part of a larger controlled group. In that instance, the small business would actually be subject to COBRA rules so it’s important to remember that the insurer cannot judge whether a company must follow COBRA rules simply by counting the number of employees in its workforce. Furthermore, the brokers that are selling these policies to insured plans may need to do further investigating when determining whether an employer is indeed subject to COBRA coverage rules. It is critical that that insurers and brokers be aware of the basic rules in order to instruct their clients, and ultimately let the employer make the determination. Under COBRA’s small employer exception, companies with less than 20 employers are not required to be subject to COBRA coverage after what would otherwise be regarded as a “qualifying event.” This criterion is based upon how many workers were employed, on average, during the preceding calendar year.

To add to this confusion, many states have “mini-COBRA” laws that apply to small employers with insured group health plans. Often this state-law continuation coverage is mistakenly referred to as “COBRA coverage” by both brokers and insurers because it does offer a similar level of coverage than that of federally mandated COBRA coverage; however, the two should not be confused. This mini COBRA coverage may not be required to last as long as federal COBRA coverage and other terms & conditions may vary as well. It is imperative that employers be well advised of the applicable rules; otherwise they could be vulnerable to claims based on estoppel principles from former employees who mistakenly believed they had broader rights. In most cases, the courts do not side with an employer’s ignorance of the law as a defense to an estoppel claim. In fact, this ignorance can be proven to be evidence of gross negligence. A recent decision raised questions in this scenario regarding the responsibilities of the employer and the insurer. In the case, Hanysh v. Buckeye Extrusion Dies Inc., 2012 WL 3852569 (N.D. Ohio, Sept.5, 2012) the beneficiary’s claim for equitable estoppel survived a motion to dismiss after the court found the employer was grossly negligent when it did not realize it was not subject to federal COBRA rules because it employed less than 20 employees. After mistakenly offering Michael Hanysh COBRA coverage and accepting payments for several months, Buckeye later realized the error and promptly cancelled Haynsh’s coverage retroactively and refunded the premiums. Needless to say, the Hanyshes sued Buckeye for equitable estoppel, claiming that because of its material misrepresentations regarding their COBRA coverage, they were left with unreimbursed medical bills of over $16,000. The court concluded that Buckeye demonstrated gross negligence amounting “constructive fraud.” The 6th U.S. Circuit Court of Appeals has made the following definition of constructive fraud:

“A breach of legal or equitable duty which, in spite of the fact that there is no moral guilt resulting from the beach of duty, the law declares fraudulent because of its tendency to deceive others, to violate public or private confidence or to injure public interests. Constructive fraud may be found merely from the relation of the parties to a transaction or from the relation of the parties to a transaction or from circumstances and surroundings under which it takes place. It is said that constructive fraud is a term that means, essentially, nothing more than the receipts and retention of unmerited benefits.” U.S. v Lichota, 351 F.2d 81, 90 (6th Cir. 1965)


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