The complexity and frequency of U.S. qualified plan amendments makes occasional drafting errors hard to avoid, but correcting good faith errors without jeopardizing plan qualification has always been harder than you think. Although there are official programs to easily fix many common plan mistakes, the IRS has always been suspicious of correcting “scrivener’s errors” because it could undermine the rule that the terms of qualified plans must be in writing. As a result the IRS has never permitted them to be self-corrected. And although the IRS’ formal correction program has some flexibility to permit amendments to correct scrivener’s errors, spokesmen for the program say that they rarely grant such relief. The IRS looks not only at whether a plan was operated as intended but at whether participants reasonably relied on the error, whether the amendment would discriminate in favor of highly compensated employees and whether benefits would be cut back.
Up to now, a handful of courts have permitted reforming the plan document to correct the error after reviewing evidence of intent. The Seventh Circuit Court of Appeals recently weighed in on this question to permit Verizon to correct an obvious error in its plan - that the IRS might not have permitted to be fixed - in a well-reasoned decision. We hope that Verizon will be followed by other courts and motivate the IRS to liberalize its correction program.
The Verizon mistake involved calculation of the lump sum value of a pension benefit when converting a traditional defined benefit plan to a cash balance plan in which benefits are expressed as a hypothetical account balance. The value of the opening “balance” was to be multiplied by a factor that was inadvertently repeated in the relevant plan section. Applying the formula with the mistake would have increased the named plaintiff’s opening “account balance” from $240,000 to $638,000. Verizon corrected the mistake in a later version of the plan, but the plaintiff still pursued the higher benefit in a class action.
The Verizon court found authority for reformation under Section 502(a)(3) of ERISA, which authorizes participants, beneficiaries and fiduciaries to bring civil actions for “appropriate equitable relief”, where it is shown by clear and convincing evidence that a plan has a scrivener’s error that does not reflect “participants’ reasonable expectations of benefits.” The Verizon court noted that the sponsor always described the intended benefits (without the mistake) in correspondence with participants and in their personalized benefit statements and found convincing evidence of intent to apply the factor only once. The court found that it did not further ERISA’s purpose to allow ambiguities to be filled in by courts, while prohibiting the correction of other drafting errors.
Another district court in Pennsylvania recently permitted reformation of the Foamex 401(k) plan fund on application of the committee and Fidelity to correct a mistake in an amendment that incorrectly prohibited participants from moving money out of the employer stock fund. Ironically, it appeared that, participants actually wanted the amendment followed because they would have made money had the fund been frozen, but they had been permitted to make these transfers, as provided in their SPDs. The court, relying on helpful prior authority in the Third Circuit, and on the Verizon case, found that intent had been proved, and that the error could not have been relied upon by participants. Perhaps we have the start of a trend…
Can you correct a drafting mistake without going to court? As mentioned, the IRS’ program will approve correction of some errors, and you should always seek legal advice about how to deal with scrivener’s errors. Once you catch a drafting mistake, it can be corrected at least prospectively to limit the potential damage.
Note that different rules apply if the error is a mistake in the SPD describing the plan’s terms so that there is a conflict between the official plan description and the plan. Courts are generally reluctant to undermine participant’s ability to rely on plan descriptions that promise benefits not spelled out in the plan document, even if there is a disclaimer. In fact, the US Supreme Court has taken a case in which it will decide whether reliance is necessary in order to give higher benefits described in plan communications. What if your administrator makes a mistake? Common administrative problems such as excluding eligible employees can usually be fixed easily under the IRS correction program so long as you catch the mistake before the IRS does.
The consequences of inadvertent mistakes can taint non-qualified plans as well, as evidenced in Sandra Cohen’s recent post on the consequences of failure to follow the specified amendment procedure requiring formal Board approval. All of which is a very potent reminder of the importance of carefully reviewing all plan changes and amendment procedures before changes are put into place and all plan communications before they are distributed. Until document correction is permitted on reasonable terms, vigilance and careful prior review are the only clear ways to avoid providing unintended benefits or failing to provide intended benefits under your plan.