Introduction and background
This article provides a roadmap for plan fiduciaries who wish to contribute qualifying employer real property (QERP) to their defined benefit pension plan, and who would like to ensure that the fiduciary decisions to accept the contribution of such real property — and on what terms to accept such a contribution — are made by an experienced, knowledgeable and un-conflicted independent fiduciary, who will solely serve the plan and its participants.
Volatile and uncertain financial conditions can put extra pressure on pension plan sponsors meeting their funding obligations. The same economic conditions that depress the investment return on plan assets can also negatively impact the plan sponsor's underlying business, reducing the cash available for contribution to its pension plan. If a pension plan is closed to new participants and new accruals are eliminated, corporate managers may view the contribution of cash to the legacy liability of a plan as particularly burdensome, since it provides no new benefits to current employees.
One solution to combat these volatile conditions is using corporate-owned real property to replace cash as a source of funding by a plan sponsor for their defined benefit pension plan. The Employee Retirement Income Security Act of 1974 (ERISA), as amended, provides a statutory exemption that permits a plan sponsor to contribute corporate-owned real property to its defined benefit plan and to lease it back for corporate use.
The applicable statutory exemption is ERISA Section 408(e), which provides that the prohibited transaction provisions of ERISA Section 406 don't apply "to the acquisition, sale or lease by a plan of qualifying employer real property" (as defined is ERISA Section 407(d)(4)) if three conditions are met:
- The acquisition, sale or lease must be for "adequate consideration."
- The plan may not be charged with a commission.
- The acquisition or lease must comply with the requirements of ERISA Section 407(a), which places a limit on the plan's ownership of employer real property and employer securities to 10 % of the fair market value of the assets of the plan, valued immediately after the acquisition of such assets.
ERISA Section 407(d)(2) defines "employer real property" as real property that is "leased to an employer of employees covered by the plan, or to an affiliate of such employer." This leasing requirement means that every contribution of real property to a plan must be accompanied by a leaseback to the employer or an affiliate to be eligible for the statutory exemption. ERISA Section 407(d)(4) defines "qualifying employer real property" as parcels — emphasis on the plural — that are dispersed geographically, adaptable without excessive cost and leased to the employer or an affiliate of the employer.
The following two sections outline the common steps for contributing QERP to a defined benefit pension plan and managing that property once it's contributed.
The plan's fiduciary committee or hired independent fiduciary does the following when contributing QERP to a defined benefit pension plan:
- Determine whether and on what terms to enter into the transaction (i.e., the acceptance of the real property) on behalf of the plan, including deciding which of the properties to accept as part of the transaction, keeping in mind the requirements of ERISA Section 407(d) noted above.
- Negotiate the transfer agreement, leases and other instruments to memorialize the transaction and execute those instruments on behalf of the plan, with the assistance of legal counsel.
- Determine the fair market value of the assets that the plan will acquire as of the effective date of the consummation of the transaction (if the transaction occurs), on behalf of the plan and based on an appraisal performed by an independent, qualified Member of the Appraisal Institute (MAI) appraiser.
- Establish or direct the plan sponsor to establish single purpose entities such as limited liability companies, the entire equity interests of which shall be held by the plan (the "Titleholders"), to accept and hold title to the properties, and serve as non-member manager or in a similar capacity with respect to the Titleholders.
- Assuming the plan fiduciary or independent fiduciary determines it's in the interest of the plan to consummate the transaction, execute on behalf of the plan or the Titleholders, as the case may be, or direct other fiduciaries of the plan as necessary, the agreements and other instruments necessary to consummate the transaction.
- Acquire for the benefit of the plan such title, property and other insurance (including, without limitation, Directors and Officers insurance for the Titleholders) as the plan fiduciary or independent fiduciary may determine is in the plan's interest.
- Engage the following professionals on behalf of the plan to the extent the plan fiduciary or independent fiduciary determines it's in the interest of the plan to do so:
- Legal counsel in real estate law and the law applicable to the investment of the plan's assets, including one local legal counsel admitted to practice in the jurisdiction in which a property is located
- An MAI appraiser to provide a report of the current fair market value and fair rental value of each property
- An engineering firm to provide a property condition assessment for each property
- An environmental consultant to prepare a Phase I environmental report on each property
- A zoning consultant to confirm that the current use of each property is in compliance with local land use regulations
- Such other professionals as necessary to complete a commercial real estate transaction.
Managing the assets
Once the properties have been contributed, the plan's fiduciary committee or hired independent fiduciary does the following to manage the assets:
- Serve as manager for each Titleholder, and monitor and enforce the plan's and the Titleholders' rights and interests with respect to the properties pursuant to the transaction documents.
- Maintain the Titleholders in good standing, including taking such steps as are necessary to establish and maintain the tax-exempt status of each Titleholder.
- Propose, negotiate and decide whether to enter into any agreements to amend the transaction documents or other agreements regarding the properties.
- Evaluate and decide whether to grant requests for waivers of terms of the transaction instruments and other agreements.
- Arrange for such appraisals, property condition assessments and other reports of the properties as may be necessary to satisfy the plan's responsibilities under ERISA to establish and report the properties' value and to enforce the Titleholders' and plan's rights under the transaction documents.
- Report annually concerning the physical and financial condition of the properties.
- Determine whether continued ownership of one or more of the properties is in the interests of the plan's participants and beneficiaries, and determine whether, when and on what terms to seek prudently to sell one or more of the properties subject to such limitations, if any, as may be provided for in the transaction documents and other agreements.
- Possibly engage a qualified, licensed real estate broker on behalf of the plan or the Titleholders to market some or all of the properties for sale or lease.
- If the plan fiduciary or independent fiduciary determine to sell or otherwise dispose of one or more of the properties, negotiate the terms and conditions of the sale or disposition of such properties on behalf of the plan, and consummate the sale or disposition.
- On behalf of the plan or Titleholders, engage professionals who the plan fiduciary or independent fiduciary reasonably determines are necessary to help perform the above duties.
What can an independent fiduciary do?
Independent fiduciaries, such as Gallagher, can be engaged at the onset to perform all of these steps on behalf of the plan fiduciaries. Independent fiduciaries serve as special-purpose fiduciaries, engaged by the plan fiduciaries to serve as their surrogate when a conflict of interest arises requiring an experienced and knowledgeable third-party decision-maker to step in and make a decision on behalf of the plan, when the law requires the use of an independent fiduciary decision-maker or to mitigate risk.
If you would like more information on our independent fiduciary decision-making services with respect to non-employer stock funds, or any other of our services, please contact Darin Hoffner at (212) 918-9662.