Wait! Stop! Is Your Severance Arrangement Subject to ERISA?

Suppose your company, Wonderful World of Widgets, Inc., finds itself needing to lay off some employees. You are tasked with effectuating the terminations, making sure they go smoothly, including offering severance benefits. You read The EmpLAWyerologist’s previous posts on severance agreements (click here, here, here and here for review). You have taken those points to heart and even gone beyond that, offering a package that you believe will take care of your terminated employees. But wait. There may be more. Could the benefits you have offered be subject to ERISA? Let’s take a look — after the jump…

Before we get into the nitty-gritty, we need some definitions. First, what is ERISA? The acronym stands for the Employee Retirement Income Security Act. ERISA is a federal law, enacted on September 2, 1974 that establishes minimum standards for pension plans and sets forth extensive federal income tax rules for transactions associated with employee benefit plans. Its mission is to protect employee beneficiaries of pension and benefit plans. It includes disclosure and reporting requirements, standards of conduct for plan administrators (also known as fiduciaries) and to provide for appropriate remedies and access to federal courts.  Unlike many other federal laws, ERISA applies to all employers whether they have 1 employee or billions of employees. 

Now let’s discuss some terms that look and sound alike, but carry some significant differences. You already know that a severance agreement is the actual contract between the employer and the terminated employee that a) governs the post-termination relationship; and b) discusses the severance benefits that the employer has agreed to provide the former employee. A severance package is the entire set of benefits provided to the terminated employee(s). Severance  packages may include without limitation pay, stock options and medical/dental benefits to name a few things.

Many people are aware that ERISA applies to pensions, 401k’s and health benefits. The same  people are often surprised to hear that a severance arrangement could qualify under ERISA as a welfare plan. If your severance pay arrangement is in fact a severance plan it will be subject to ERISA requirements, including without limitation:

1. You must file a Form 5500 with the IRS, unless the plan has fewer than 100 participants and all payable benefits are either paid by an insurance company or from the employer’s general assets. (Note that “participants” include all employees who would be entitled to benefits if a termination occurred, not just those employees actually terminated.
2. Plans must be in writing and provide for detailed claims procedures;
3. All participants must receive a Summary Plan Description.
4. All participants must receive a summary annual report, unless the plan is exempt from filing a Form 5500 annual report.
5. Other reporting and disclosure requirements.

If your severance arrangement qualifies as an ERISA  plan,  and you do not comply with ERISA requirements you will be subject to penalties, which include without limitation: a) criminal penalties for wilful violation of reporting and disclosure requirements of up to $500,000 and  possibly imprisonment; b) civil penalties of up t $110 per day per violation for failure to provide documents to participants upon request; c) civil penalties of $1,100 per day for failure to file a Form 5500.

So how do you know whether your severance arrangement is an ERISA plan?  Fort Halifax Packing Co v Coyne a US Supreme Court case set the standard, holding that a one-time lump sum payment triggered by a plant closing was not a severance plan, because it did not necessitate an “ongoing administrative scheme”. Sounds great. How do we determine if a severance arrangement involves an ongoing administrative scheme? The terms of your plan and how it is administered are key here.  Here are some factors courts consider in determining whether an ongoing administrative scheme exists:

• Amount and form of payments;
• Level of discretion in determining eligibility for participation and benefits;
• Length or term of plan (is it indefinite or single event only?);
• Level of administration.

In general, the less discretion and administration necessary to implement the arrangement, the more likely it is simply a payroll practice, rather than an ERISA plan. Conversely, the more discretion and administration necessary for implementation, the more likely it is an ERISA plan.

While we have established that an ERISA plan is subject to reporting, disclosure and greater administrative requirements (which in turn could add to the cost of the plan), employers with ERISA plans reap some benefits too. the biggest advantage is that regarding employee claims, ERISA is very employer-friendly. If you set up your plan correctly, you will have your own internal claims procedure that your employees must exhaust before they can file suit. Those who do file suit must do so in federal court and any trial will be decided by a judge, not a jury. Moreover, the decision of the Plan Administrator is usually entitled to great deference in court.

So, should you actually consider creating an ERISA plan, or should you take steps to ensure that your severance arrangements do not fall under ERISA? That will depend on your specific circumstances. You should consult with either your in-house counsel or competent outside counsel. If you wanted to create an ERISA plan, what should you consider and what might you avoid doing? Similarly, what might be some do’s and don’ts if you don’t want your severance arrangements to be subject to ERISA? That will be the subject of next week’s post. Toodeloo!

Disclaimer: This post’s contents are for informational purposes only, are not legal advice and do not create an attorney-client relationship. Always consult with competent employment counsel on any issues discussed here.

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