Court Rules that Company Discretionary Offer of Voluntary Separation Agreements Does Not Create an ERISA-Covered Severance Plan

It always has been difficult to give a consistent answer as to whether informal severance arrangements have created an ERISA-covered severance plan. In Mance v. Quest Diagnostics Inc., 2017 WL 684711 (DC NJ 2017), the U.S. District Court held that Quest’s decision to provide some departing employees with severance benefits under a voluntary separation agreement (“VSA”) process was provided on such a discretionary basis that it did not establish a plan under ERISA.

By way of background, the U.S. Department of Labor and the courts uniformly have held since the 1980’s that severance pay benefits are covered by ERISA if the severance benefits are provided pursuant to a “plan, fund or program.” Under the test most commonly applied by the courts including the District Court here, a “plan, fund or program” will be established for purposes of ERISA if, from the surrounding circumstances, a reasonable person can ascertain (1) the intended benefits, (2) a class of beneficiaries, (3) the source of financing, and (4) procedures for receiving benefits.  The courts have applied these factors to find that the existence of an ERISA plan can be established from written guidelines set forth in internal policy statements or corporate manuals or by descriptions in employee handbooks or from an employer’s consistent past practice of awarding severance benefits to involuntarily terminated employees.

But to make the determination more confusing, the Supreme Court has added the requirement that a plan, fund or program subject to ERISA will not exist unless it is necessary to establish an “administrative scheme” to provide the benefits. Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987).  The court decisions understandably have not established a hard and fast rule regarding how much administration is too much.

Interestingly, the District Court found that Quest had established a separate administrative scheme to determine both eligibility for and the type of VSA benefits that might be offered to an employee. However, the District Court found that having an administrative scheme by itself did not establish an informal ERISA-covered severance plan.  Applying the factors described above for determining whether a “plan, fund or program” existed, the Court found that a reasonable person could not determine the class of intended beneficiaries, the intended benefits or the process to request VSA benefits.  Accordingly, Quest did not create an informal ERISA plan.  (Note that the VSA benefits at issue were separate from the benefits provided by Quest under its ERISA-covered severance pay plan).

COMMENT: It is important to note that the application of ERISA to severance pay benefits is more favorable to employers than state law:

  • An employer may design a severance plan under ERISA that specifically provides the employer with the discretion to make determinations that affect an employee’s eligibility for benefits. Further, a deviation from a plan’s written terms for particular individuals does not prohibit the employer from again applying the written terms to other individuals.
  • A participant who sues for benefits is entitled only to the actual benefits – unlike state law, ERISA does not permit consequential or punitive damages or provide for tort remedies. (In egregious cases, a court may award attorney’s fees.)
  • ERISA does not provide for jury trials and claims for benefits may be removed to federal court.
  • If a severance plan is properly drafted, company decisions will be reviewed by a court only to determine whether the decision is “arbitrary and capricious” (or an “abuse of discretion”).

New Bill Could Add Safe Harbor to Definition of Employee

In the employee benefits world, a lot can hang on an individual’s classification as an employee. Whether someone is a leased employee, an independent contractor, or a member of the rank and file can have a dramatic impact on a retirement or welfare plan. While employers typically attempt to create relationships that comply with the law, the IRS might not always agree. And it’s a bit more complex than one might expect at first. ERISA attorneys joke about the unhelpful and circular nature of ERISA §3(6) (“[t]he term ‘employee’ means an individual employed by an employer”). At the same time, tax practitioners will readily rattle off a list of twenty (yes, 20!) factors that can go into the determination.

A bill newly introduced in the U.S. Senate aims to change the complex analysis. Senate Finance Committee member John Thune, R-S.D., has introduced the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2017. By adding a safe harbor, the bill would “would ensure that the service provider (worker) would be treated as an independent contractor, not an employee, and the service recipient (customer) would not be treated as the employer,” according to the press release. The bill focuses on three elements: 1) the relationship between the parties, 2) the location of the services or means by which services are provided, and 3) a written contract.

Of course, we can’t throw out our twenty factors test just yet. The bill would merely provide a safe harbor. For relationships that don’t meet the criteria, the common law tests would still apply. While passage of the bill is yet to be determined, and its application to ERISA is also a bit murky (this is a tax provision aimed at collecting income and employment taxes), the legislation will be welcome news to many employers who have a difficult time discerning where the line is between independent contractor and employee.

THE FULL FIFTH CIRCUIT WILL RE-VISIT THE STANDARD OF REVIEW IN DENIAL OF BENEFITS CASES

On July 10, the Fifth Circuit Court of Appeals announced that the full Court would re-hear a recent case concerning the applicable standard of review in an ERISA denial of benefits case – which is often outcome-determinative in favor of insurers and benefit plans.

As we previously reported, in Ariana M. v. Humana Health Plan of Tex., Inc., 2017 U.S. App. Lexis 7072 (April 21, 2017), a three-judge panel of the Fifth Circuit reviewed a summary judgment in favor of a Plan Administrator who denied benefits to a claimant with eating disorders.  Even though the plan in question did not call for deference, the Court, bound by its prior decision in Pierre v. Conn. Gen. Life Ins. Co. of N. Am., 932 F.2d 1552 (5th Cir. 1991), applied an abuse of discretion standard.  Not surprisingly, the panel affirmed the District Court’s grant of summary judgment.  However, a separate concurring opinion (joined by all three judges), called Pierre into question and set the stage for a reversal.

The concurring opinion noted that the Fifth Circuit is the only circuit that applies a deferential standard to factual determinations made by an Administrator when the plan does not vest the Administrator with that discretion, and pointed to the growing number of state laws prohibiting discretionary clauses in insurance contracts.  Based on these factors, the panel opined that Pierre has not withstood the test of time:  “This question concerning the standard of review for ERISA cases is not headline-grabbing.  But it is one that potentially affects the millions of Fifth Circuit residents who rely on ERISA plans for their medical care and retirement security.”  The panel concluded that, given the “lopsided split” in the circuits and the potential for conflicting standards across different jurisdictions, further review of Pierre is warranted.

So, just as the outcome in Ariana M. v. Humana Health Plan was no surprise, it is not the least bit surprising that the Fifth Circuit has decided to re-examine the standard of review it applies in ERISA denial of benefits cases.  And it is probably not too difficult to guess that the Court, en banc, will reverse Pierre, and align with other circuits holding that a de novo review is called for when reviewing decisions made by retirement and health plans during some of life’s most difficult times.

 

 

An Update on the DOL’s Fiduciary Rule

The DOL’s much anticipated (or maligned depending on the audience) Fiduciary Rule expands the definition of what constitutes investment advice under ERISA and thereby increases the number and types of retirement plan service providers that are considered ERISA fiduciaries (see our prior coverage of the Fiduciary Rule here, here and here).  It also imposes stringent compliance and disclosure requirements in order for those service providers to avoid breaching their ERISA fiduciary duties.

Reaction to the Fiduciary Rule has been mixed, and many hoped that the new DOL leadership would repeal the Rule.   That did not occur, and the Rule went into effect on June 9, 2017.  However, there is a phased implementation period for compliance with new prohibited transaction exemptions (e.g., Best Interest Contract Exemption; Principal Transactions Exemption).  During that phase-in period (which expires on January 1, 2018), service providers must only comply with more limited impartial conduct standards in order to take advantage of the exemptions. This means that from June 9 until January 1, service providers that wish to take advantage of the exemptions will generally need to provide advice that meets the best interests of the investor (without regard to the adviser’s financial or other interests), charge only reasonable compensation (as described in the rules under ERISA 408(b)(2)), and avoid making materially misleading statements. The prohibited transaction exemptions allow service providers to receive compensation for certain investment advice that they would otherwise be prohibited from receiving under ERISA’s prohibited transaction rules.

The DOL previously noted that it would continue to review the Fiduciary Rule and seek public comments on potential changes (see here for further information).  Consequently, on July 6, 2017, the DOL published a Request for Information seeking public input on several aspects of the Fiduciary Rule, including the following:

  • Whether the applicability date (currently January 1, 2018) for certain prohibited transaction exemptions, such as the Best Interest Contract Exemption, should be delayed.
  • Whether the Principal Transactions Exemption can be revised to better serve investors and provide greater market flexibility.
  • Whether certain requirements related to service provider contracts should be eliminated or changed.
  • Whether service provider disclosure requirements can be simplified.
  • Whether recommendations to make or contribute to a retirement plan should be expressly excluded from the Rule’s definition of investment advice.
  • Whether there should be an amendment to the Rule (or streamlined exemption) for certain investment transactions involving bank deposit products and Health Savings Accounts.
  • Whether the exclusion from the Rule for certain arms-length transactions with independent plan fiduciaries that have financial expertise should be expanded or changed (including whether additional relief should be provided through a prohibited transaction exemption).
  • Whether a streamlined exemption or other change to the Rule could be developed for investment advisers that comply with or are subject to updated standards of conduct that may be adopted by the SEC or other regulators.

Comments on delaying the applicability date for prohibited transaction exemptions are due on July 21, 2017, and all other comments are due on August 7, 2017.

Separation Agreement Drafting Error Corrected by Michigan Appeals Court

A Michigan appellate court denied an attempt by an employee to receive a severance jackpot based on a drafting mistake made by his former employer. Notwithstanding the employee’s entitlement, based on the terms of his separation agreement, to receive approximately $81 thousand dollars per week for 34 weeks, the State of Michigan Court of Appeals upheld the lower court’s decision to reform the contract, resulting in the employee receiving a total of $81 thousand over 34 weeks. The case highlights, among other things, the importance of proofreading.

The employee was employed for 28 years. In 2014, following the sale of the company, he was permanently laid off in a reduction in force. He was given a separation agreement providing separation pay for 34 weeks, among other benefits, which were consideration for a general release and a covenant not to compete. The employee eventually signed the separation agreement and returned it to the Company.

His execution of the agreement was not surprising. The agreement provided that the employee, who was then earning approximately $125 thousand per year, was to receive $80,805.97 per week for 34 weeks! This amount, which totals approximately $2.7 million dollars, represented more money than the employee had earned over his entire 28-year career with the company.

When the company discovered the error and declined to honor its “promise”, the employee sued to enforce the agreement. The trial court found that a unilateral mistake had clearly occurred, supported by both the testimony of the company’s director of human resources (who stated that she mistakenly inserted the total amount to be received over the 34-week payment period, or $80,805.97, as the weekly payment amount) and the reference to certain separation pay guidelines in the agreement (which provided for a continuation of the employees’ “gross monthly salary” for the specified period.) Accordingly, the trial court reformed the contract to correct the error.

The appellate court affirmed, based in principal part on the employee’s conduct in ignoring the seemingly obvious mistake. Not surprisingly, the Court did not ascribe much credence to the employee’s affidavit, in which he stated his belief that severance pay in excess of $80 thousand per week was “fair based on my 28 years of service.”

The case highlights the importance of proofreading legal documents for easily avoidable drafting errors. The company’s failure to do so here resulted in the expense and aggravation of trial and appellate litigation, and nearly cost the company $2.7 million dollars! It presents a cautionary tale and states a good case for multiple levels of internal review, not to mention the involvement of counsel.

Tenth Circuit Follows Majority of the Circuit Courts and Holds Plaintiff Bears the Burden of Proving Causation in ERISA Breach of Fiduciary Duty Cases

On June 5, 2017, in Pioneer Centres Holding Co. Employee Stock Ownership Plan & Trust v. Alerus Fin., N.A., Case No. 15-1227, the U.S. Court of Appeals for the Tenth Circuit held that the plaintiff bears the burden on each element of its breach of fiduciary duty claim under ERISA.

Plaintiff brought suit for breach of fiduciary duty against the independent transactional trustee in connection with a failed employee-stock purchase transaction which would have allowed the ESOP to become the 100% owner of the car dealerships. The ESOP purchase transaction failed because one of the car manufacturers, whose contract required that it approve any change in ownership of the dealership, had stated that it would not approve the transaction if it gave the ESOP 100% ownership. Plaintiff asserted that Defendant failed to sign the transaction documents and send them to the car manufacturer. As a result, the car dealership sold its assets to a third party for a significantly higher price.

The Tenth Circuit recognized that the Fourth, Fifth, and Eighth Circuit Courts of Appeals have adopted a “burden-shifting” framework which requires that once an ERISA plaintiff has proven a breach and prima facie case of loss, the burden shifts to the trustee to prove that the breach of duty did not cause the loss. However, the Court rejected this analysis and found that the statute’s plain language did not support “burden-shifting.” In addition to holding that Plaintiff had failed to demonstrate that Defendant’s alleged breach caused the Plaintiff to suffer damages, the Court concluded that the statute’s plain language limited liability to losses “resulting from” a breach of fiduciary duty. The Court determined that because causation is an element of the claim, the burden remains with the plaintiff at all times. This holding follows decisions from the Second, Sixth, Ninth, and Eleventh Circuit Courts of Appeals.

The Fiduciary Rule Applicability Date is Finally Here! What now?

The applicability date for the long-awaited, much-debated Fiduciary Rule (see prior Jackson Lewis coverage here) is now upon us. So what does it mean?

The Secretary of the Department of Labor Alexander Acosta recently said in a Wall Street Journal piece that the Fiduciary Rule “may not align” with the President’s goals and that the Department will “seek additional public input on the entire Fiduciary Rule.” At the same time, Secretary Acosta wrote that the Department has “no legal basis to change the June 9 [applicability] date.” It is important to keep in mind, however, that June 9 is the start of a “transition period” which ends January 1, 2018.

The Department of Labor also recently provided a Temporary Enforcement Policy on the Fiduciary Duty Rule, and a set of FAQs entitled “Conflict of Interest FAQs (Transition Period)”.

The Temporary Enforcement Policy—really a non-enforcement policy—reflects the Department’s “general approach to implementation” consisting of “assisting…plans, plan fiduciaries, [and] financial institutions” rather than “citing violations and imposing penalties on” them. Therefore, the Department has said it will “not pursue claims against fiduciaries who are working diligently and in good faith to comply with the fiduciary rule and exemptions, or treat those fiduciaries as being in violation of the fiduciary duty rule and exemptions” during the transition period. This approach should offer some reassurance to those not quite ready to implement the Rule’s full requirements but are making sincere efforts towards those ends.

The FAQs remind us that as of June 9 investment advice providers to retirement savers become fiduciaries and “the impartial conduct standards” become requirements of the different available exemptions (for example the Best Interest Contract Exemption (prior JL coverage here), or PTE 84-24).

The impartial conduct standards require advisers and financial institutions to:

• Give advice that is in the “best interest” of the retirement investor. This best interest standard has two chief components: prudence and loyalty:
o Under the prudence standard, the advice must meet a professional standard of care as specified in the text of the exemption;
o Under the loyalty standard, the advice must be based on the interests of the customer, rather than the competing financial interest of the adviser or firm;
• Charge no more than reasonable compensation; and
• Make no misleading statements about investment transactions, compensation, and conflicts of interest.”

So, as the applicability date comes and goes, it’s worth noting that while Department of Labor enforcement may be scarce during the transition period, the rules still apply and the impartial conduct standards must be met. Some believe that the Department will extend the transition period beyond January or that perhaps Congress will step in to overrule the regulation. But absent further action, the transition period will end this coming January, and full compliance with all of the rule exemption conditions will be required for firms and advisers.

UNANIMOUS SUPREME COURT DECISION IN FAVOR OF “CHURCH PLAN” DEFENDANTS

Today, the Supreme Court handed a long-awaited victory to religiously affiliated organizations operating pension plans under ERISA’s “church plan” exemption. In a surprising 8-0 ruling, the Court agreed with the Defendants that the exemption applies to pension plans maintained by church affiliated organizations such as healthcare facilities, even if the plans were not established by a church. Justice Kagan authored the opinion, with a concurrence by Justice Sotomayor.  Justice Gorsuch, who was appointed after oral argument, did not participate in the decision.  The opinion reverses decisions in favor of Plaintiffs from three Appellate Circuits – the Third, Seventh, and Ninth.

For those of you not familiar with the issue, ERISA originally defined a “church plan” as “a plan established and maintained . . . for its employees . . . by a church.”   Then, in 1980, Congress amended the exemption by adding the provision at the heart of the three consolidated cases.  The new section provides: “[a] plan established and maintained . . . by a church . . . includes a plan maintained by [a principal-purpose] organization.”  The parties agreed that under those provisions, a “church plan” need not be maintained by a church, but they differed as to whether a plan must still have been established by a church to qualify for the church-plan exemption.

The Defendants, Advocate Health Care Network, St. Peter’s Healthcare System, and Dignity Health, asserted that their pension plans are “church plans” exempt from ERISA’s strict reporting, disclosure, and funding obligations.  Although each of the plans at issue was established by the hospitals and not a church, each one of the hospitals had received confirmation from the IRS over the years that their plans were, in fact, exempt from ERISA, under the church plan exemption because of the entities’ religious affiliation.

The Plaintiffs, participants in the pension plans, argued that the church plan exemption was not intended to exempt pension plans of large healthcare systems where the plans were not established by a church.

Justice Kagan’s analysis began by acknowledging that the term “church plan” initially meant only “a plan established and maintained . . . by a church.” But the 1980 amendment, she found, expanded the original definition to “include” another type of plan—“a plan maintained by [a principal-purpose] organization.’”  She concluded that the use of the word “include” was not literal, “but tells readers that a different type of plan should receive the same treatment (i.e., an exemption) as the type described in the old definition.”

Thus, according to Justice Kagan, because Congress included within the category of plans “established and maintained by a church” plans “maintained by” principal-purpose organizations, those plans—and all those plans—are exempt from ERISA’s requirements. Although the DOL, PBGC, and IRS had all filed a brief supporting the Defendants’ position, Justice Kagan mentioned only briefly the agencies long-standing interpretation of the exemption, and did not engage in any “Chevron-Deference” analysis.  Some observers may find this surprising, because comments during oral argument suggested that some of the Justices harbored concerns regarding the hundreds of similar plans that had relied on administrative interpretations for thirty years.

In analyzing the legislative history, Justice Kagan aptly observed, that “[t]he legislative materials in these cases consist almost wholly of excerpts from committee hearings and scattered floor statements by individual lawmakers—the sort of stuff we have called `among the least illuminating forms of legislative history.’” Nonetheless, after reviewing the history, and as she forecasted by her questioning at oral argument (see our March 29, 2017 Blog, Supreme Court Hears “Church Plan” Erisa Class Action Cases), Justice Kagan rejected Plaintiffs’ argument that the legislative history demonstrated an intent to keep the “establishment” requirement.  To do so “would have prevented some plans run by pension boards—the very entities the employees say Congress most wanted to benefit—from qualifying as `church plans’…. No argument the employees have offered here supports that goal-defying (much less that text-defying) statutory construction.”

In sum, Justice Kagan held that “[u]nder the best reading of the statute, a plan maintained by a principal-purpose organization therefore qualifies as a `church plan,’ regardless of who established it.”

Justice Sotomayor filed a concurrence joining the Court’s opinion because she was “persuaded that it correctly interprets the relevant statutory text.” Although she agreed with the Court’s reading of the exemption, she was “troubled by the outcome of these cases.”  Her concern was based on the notion that “Church-affiliated organizations operate for-profit subsidiaries, employee thousands of people, earn billions of dollars in revenue, and compete with companies that have to comply with ERISA.”  This concern appears to be based on the view that some church-affiliated organizations effectively operate as secular, for-profit businesses.

Takeaways:

  • Although this decision is positive news for church plans, it may not be the end of the church plan litigation.  Numerous, large settlements have occurred before and since the Supreme Court took up the consolidated cases, and we expect some will still settle, albeit likely for lower numbers.
  • In addition, Plaintiffs could still push forward with the cases on the grounds that the entities maintaining the church plans are not “principal-purpose organizations” controlled by “a church.”

If you maintain a church plan, reach out to us with any concerns about the impact of, and your ability to rely on, this decision.

 

Are You Computing Your Maximum Participant Loan Amount Correctly (or in the Best Interest of Your Plan Participants)?

In late April 2017, the IRS issued a Memorandum for Employee Plans (EP) Examinations Employees providing two alternatives for computing the maximum participant loan amount when the participant has prior loans. Prior to this Memorandum, the law was not clear concerning how to compute the maximum loan amount where a participant had taken a previous loan during the year.

The maximum participant loan amount is the lesser of:

• 50% of the participant’s vested account balance; or
• $50,000 less the highest outstanding balance within one year of the loan request.

The reason for adjusting the maximum by the repayment amount is to prevent an employee from effectively maintaining a permanent outstanding $50,000 loan balance. The question is how to compute the amount of the highest outstanding balance within one year of the request for a new loan.

The issue is best described by an example. Assume the following facts:

• The participant has a vested balance of $150,000.
• The participant borrows $30,000 in February and fully repays that amount in April.
• The participant borrows $20,000 in May and fully repays that amount in July.
• The participant applies for a third loan in December.

What is the highest outstanding loan balance within one year — $50,000 ($20,000 plus $30,000) or $30,000 (the largest loan during the one year period)? What is the highest loan amount this participant can take: $0 ($50,000 less $50,000) or $20,000 ($50,000 less $30,000)?

Until the recent IRS Memorandum, the answer was not clear. The IRS Memorandum answers the question by providing that either amount can be used as the maximum loan amount. Notably, from the participant’s perspective, the $20,000 is a better resolution since the employee can get another loan. Of course, many employers discourage loans and would not want to provide such flexibility.

In any event, whichever approach the plan decides to use, it must be used consistently. In addition, the best practice would be to have the methodology set forth in the plan’s loans procedures.

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