Workers’ comp complication

How a buyer could inherit seller’s unfavorable ‘mod’ rate

An unfavorable workers’ compensation modification — or “mod” — rate can strangle a company and drive it to insolvency. Even just a few workers’ comp claims can lead to staggering premiums, which take years to overcome.

If your client buys the assets of a company (and of course, if it buys the stock) your client must absorb the seller’s mod rate. This little-known fact is often overlooked by buyers and their counsel and can be a nasty surprise to the buyer after closing — a surprise that can lead to a heated phone call to buyer’s counsel.

By way of background, the mod rate is a mandatory program designed to measure and rate the risk of individual companies. Your mod rate reflects your actual claims experience compared to the expected or average experience of all similar business types within a state.

In general, your mod rate refers to a record of premiums and losses under a policy or policies. This provides a basis to predict future rates or costs for insurance carriers. Mod rates are normally recalculated for an employer annually by organizations known as rating bureaus and rely on information reported by insurance companies. The rating bureau used by most states is the National Council on Compensation Insurance, which sets mod rates in New Hampshire.

NCCI has consistently taken the position that a company’s mod rate follows its assets, or at the very least is combined with the mod rate of the acquirer, even when the company is closed and sells its assets as part of a liquidation. So even in the context of a straight asset sale, when none of the seller’s management, or even its employees, are involved with the purchaser, the purchaser is going to be saddled with or have to absorb the mod rate of the seller, which in many cases can result in a tremendous jump in workers’ compensation premiums for the buyer.

There is a way to completely avoid a high mod rate — an acquisition through a Chapter 11 proceeding and a sale under Section 363 of the bankruptcy code.

The U.S. Bankruptcy Court in New Hampshire recently ruled that a mod rate is a “claim,” and a sale free and clear of all liens, claims and encumbrances under section 363 essentially scrubs assets of their seller’s mod rate, allowing the buyer to sail off into the sunset with just the assets, not the baggage of the seller.

In the case of ARSN Liquidating Corp., the court ruled that NCCI could not impose the seller’s mod rate on the purchaser of substantially all of the seller’s assets because the mod rate was an “interest” of which the seller’s assets were sold free and clear in the 363 sale.

Prior to that ruling, NCCI had taken the position that the buyer of the debtor’s assets was essentially a change in ownership and that “[t]he experience for any entity undergoing a change in ownership will be retained or transferred to the experience ratings of the acquiring, surviving or new entity…”

So it follows that any lawyer advising a client on an acquisition of assets must include an analysis of how a transferred mod rate will affect the buyer.

Compared with a straight asset sale, a 363 sale is more costly, may take longer, introduces some measure of competition in the sale (which may be good for the seller) and has some risks associated with it, as with every court proceeding. On the upside, in addition to getting rid of an unfavorable mod rate, a 363 sale eliminates any claims for successor liability and ensures a finality of the sale process.

How much more costly? Figure at least $25,000 for transactional costs and perhaps several times that, depending on the complexity of the seller and how cooperative its creditors and equity are inclined to be.

The process can be relatively simple or it can be exceedingly complex (think GM or Lehman Brothers, both of which were 363 sales). When one considers the potential of several hundred thousand dollars in premiums continuing for years, the costs may be well worth the results.

Peter N. Tamposi, principal of the Tamposi Law Group, can be reached at 603-204-5513 or peter@tlgnh.com. This article originally appeared in NH Bar News, the official publication of the NH Bar Association.