Make early provision for retirement funds upon sale of a business

When employees are transferred between retirement funds following the sale of a business by their former employer to their new employer, they could end up losing out on investment returns and incurring a nasty tax liability.

On the other hand, the seller’s fund may be exposed unnecessarily to risk claims from transferring employees who are no longer its members. Companies and fund trustees should take great care to avoid those consequences.

In terms of the Labour Relations Act (LRA), when a business, or part of it, is transferred as a going concern, the employees engaged in that business automatically become the employees of the buyer of that business.

The LRA also enables the buyer (the new employer) to transfer its new employees into a new retirement fund, though that transfer, unlike the employment transfer, is not automatic.

The change from being a member of the old employer’s retirement fund to becoming a member of the new employer’s retirement fund can only take place by means of a procedure, known as a “section 14 transfer”, contained in the Pension Funds Act.

The rules of a retirement fund usually provide that membership of the fund by an employee will terminate when that employee’s employment terminates. If the employee is engaged in a business which is sold as a going concern, then that employee’s employment with the old employer terminates automatically in terms of the LRA’s provisions as soon as the business is transferred.

This was confirmed by the Supreme Court of Appeal in the case of Telkom v Blom. The employees claimed that their service with Telkom, their previous employer, had terminated in terms of the Telkom pension fund rules. They should therefore have been entitled to withdrawal benefits even though they were automatically absorbed into the business of a new employer and were to become members of that new employer’s pension fund.

The court agreed with Mr Blom and his colleagues, who became entitled to cash out their withdrawal benefits.

While most employees may welcome access to that kind of cash windfall, the problem is that the benefit accrues to them for tax purposes and therefore results in an immediate tax liability.

While the section 14 transfer is awaiting approval from the Registrar of Pension Funds, the seller’s pension fund remains liable to the transferring employees for so long as withdrawal benefits have not been paid, even if the employment relationship with the seller has terminated in law.

The Registrar has recognised the problems that could arise from such an arrangement and has therefore recommended that transferor funds should amend their rules to ensure that transferring members are treated as “paid up” members, who have no entitlement to death and disability benefits arising after the transfer date.

Such a rule amendment would obviously require a fair deal of forward planning, as it would itself need to be approved by the Registrar before it could take effect.

As employee benefits lawyers know all too well, the seller and buyer in the sale of business transaction often only begin to consider the arrangements for a section 14 transfer towards the end of, or even after the completion of, the deal.

In many cases, because of the time involved in obtaining approval for a section 14 transfer, transfer of membership between the retirement funds can only take place some time after the employees have already transferred (automatically) from the old employer (the seller) to the new employer (the buyer).

The obvious way of avoiding these consequences is to start making the necessary arrangements at an early stage in the sale of business process so that the receiving fund is in a position to take transfer of the members at the effective date of the business transfer.

Another approach is to ensure that the rules of the seller’s fund do not provide for automatic termination of membership when employment ceases but, rather, contain appropriate provisions to cater for a transfer of members in the context of a sale of business – for example, by granting the trustees the discretion to extend membership for the period necessary to give effect to the section 14 transfer.

In reality, sellers’ retirement funds seldom pay out withdrawal benefits in the circumstances discussed above, because the transferring employees are usually unaware of their entitlement to a withdrawal benefit and hence fail to claim it.

When they do, as was done by Mr Blom and his colleagues, the fund must pay.

David Geral (pictured above right) is a Director, Employee Benefits Group, at commercial law firm Bowman Gilfillan