Avoiding Litigation with ERISA Compliant Severance Plans
Is your severance plan subject to ERISA? Typically, we recommend, if you are going to design a severance program and it's not just a one-off type of payment, that it is designed in accordance with ERISA. There are many advantages to designing your severance to be ERISA compliant, and a few disadvantages.
In a recent #SmartTalkHR webinar, “Avoiding Litigation After a Reduction in Force,” Ben Briggs and I discuss the legal aspects of severance plans and best practices for employers hoping to reduce legal liability. As part of that webinar, I addressed the specifics of designing a severance plan to conform to ERISA guidelines as a way to protect employers from legal action. To get more information and hear about IRS 409A tax liability and designing severance and benefits plans in the context of workforce restructuring, view the webinar here.
What is ERISA?
ERISA is a law is designed to protect employees who have been promised retirement income from their employers, insuring that the money is actually paid upon retirement, as agreed. One of the most contended aspects of ERISA is the broad preemptive portion that preempts state laws that regulate employee benefit plans or the administration of employee benefit plans. Lawsuits involving ERISA benefits are handled in federal court rather than state court.
The broad requirements of ERISA include:
- A written document
- Named fiduciaries
- Reporting requirements
- Filing with the Department of Labor
- Disclosure requirement
- Participants must be informed about the plan and the eligibility requirements
- Funding requirement for pension plans
- Rules for protecting accrued benefits and vesting requirements
ERISA tends to apply to almost all severance arrangements that impact more than one employee. ERISA regulates employee benefit plans, like welfare benefit plans and pension benefit plans, unless there's an exemption.
Employer Benefits of ERISA severance plans
Establishing an ERISA severance plan avoids state law claims for damages. Under ERISA, individuals are generally limited to recovering the benefits under the plan if a lawsuit is filed and not for other reasons outside of the benefits under the plan.
Another reason for ERISA severance plan is administrative consistency and flexibility. Your ERISA plan includes details about who's eligible, what the payments are, when the payments are going to be made, and other key aspects of the benefits. This lends itself to administering the plan consistently among the employees versus having different parameters for different people. Under an ERISA severance plan, employers are permitted to have different payment amounts for various levels of the employee.
The ERISA severance benefit plan would define the amount of the severance benefit, how the benefit will be paid, when the benefit will be paid, and to whom it will be paid. Defining these terms helps employers avoid being forced to pay severance to a person who isn’t specifically in the group of employees eligible for the severance plan.
Minimized legal costs
Under ERISA, the plan may provide that the employee who has been denied severance benefits will need to go through a defined claim and appeal process before a lawsuit can be filed in court. The court can actually dismiss the case and tell that employee, or former employee, that he or she needs to go back through the plan's claims and appeals process before the lawsuit can be filed with the court. This type of an ERISA plan requirement allows the plan administrator to resolve the issue before the individual files a lawsuit in court.
The ERISA plan’s claims and appeal procedure also provides an employer with an efficient way to evaluate the claim for severance pay benefits. In case there has been an error, the employee has recourse through this claims process, and the plan has the opportunity to correct any errors that may have been made with the payment of the benefit without going to court.
ERISA pre-empts state laws and limits plaintiff’s remedies
ERISA preempts most state laws that regulate employee benefit plans. ERISA also limits the remedies available to an employee seeking damages due to the denial or partial denial of benefits provided by the ERISA severance plan. If it's an ERISA plan, the employee can sue for the plan benefit, the payment of the severance benefits, but there would not be other types of state law claims like misrepresentation, fraud, or breach of contract. ERISA precludes extra-contractual and punitive damages which could be available to the plaintiff under state law.
Standard of Review and Federal Courts
As long as the plan administrator for the ERISA severance plan follows the ERISA claims and appeals procedures and the terms of the plan document, then the court would review the plan administrator’s decision to determine if the decision was arbitrary and capricious. The plaintiffs would have to prove that the plan administrator failed to follow the terms of the plan and the individual was entitled to benefits under the severance plan.
The case would appear in federal courts instead of state courts. Employers tend to prefer federal courts over state courts for a number of reasons, but it usually tends to be a more balanced forum in the federal courts.
Employer Disadvantages of ERISA severance plans
Maintaining plan documents
In addition to a formal benefit plan document, ERISA requires a summary plan description to be distributed to participants. For an ERISA severance plan, it is possible to combine the plan document and summary plan description into one document. The summary plan description and plan documents have specific contents requirements under ERISA. For example, the summary plan description needs to describe the benefits available, who is eligible for the benefits, the events that would cause the participant to lose the benefits, and additional specifics about the plan or administration of the plan. It also needs to outline the plan’s claims and appeals procedures if somebody wishes to file a claim for benefits under the plan.
Reporting requirements and audits
Annually, the plan would need to file a Form 5500 if the severance plan covers 100 or more participants on the first day of the plan year. The ERISA plan can be subject to audit by the Department of Labor and there are statutory penalties for failing to provide plan documents when requested in writing by the participant.
Set up severance expectations
By setting up an ERISA plan, this may create an expectation with the employees that the employer will pay severance in more situations than the employer intends. Employers usually find this expectation as acceptable, particularly if the employer currently offers severance eligibility to a fairly broad group of employees.
ERISA provides for the payment of attorney fees to the prevailing claimant in a severance dispute. Attorney's fees under state or common law are generally not recoverable. However, under ERISA they are recoverable. Whether or not an employer has an ERISA severance plan, a claimant still has the right to file a discrimination claim against the employer.
If you’re considering developing an ERISA severance plan, the best practice is to have it designed to comply with the Department of Labor’s safe harbor. This will ensure that your plan is not treated as a pension plan since pension plans are subject to funding, so money would need to be set aside in a trust, and there's also some strict requirements about vesting and accruing the benefit. As a result, an employer would not want their severance plan to be a pension plan under the ERISA definition.
To avoid the pension plan designation, the payments cannot be contingent directly or indirectly upon the employee retiring. The total amount of the severance pay may not exceed the equivalent of two times the employee's annual compensation during the year immediately preceding the termination. In addition, the payments should be structured so that they're made within 24 months of termination from employment.
During the webinar we also cover 409A tax law and penalties as well as best practices for separation and benefits agreements in the context of reorganization and reductions in force. View the webinar in its entirety here.
Nicole D. Bogard is partner with Seyfarth Shaw LLP's Employee Benefits & Executive Compensation Department.