In these economic times, employers routinely explore ways to manage costs, including the costs of benefits. Deferred compensation arrangements provided pursuant to plans that employers established and maintained in a more robust economic environment may now be seen as unsustainable burdens that need to be limited or discontinued. In exploring their options, employers should first consider whether their deferred compensation arrangements fall within ERISA's coverage.
Employers should understand the consequences of a decision to modify or terminate a deferred compensation arrangement that may be governed by ERISA, since there are both positive and negative implications to ERISA coverage. Ordinarily, employers may regard deferred compensation arrangements that are not subject to ERISA as advantageous, because the employer may avoid ERISA's funding, vesting, and fiduciary requirements. With respect to arrangements limited to a select group of highly compensated employees, however, ERISA coverage may be viewed as an advantage. Such plans, known as "top-hat" plans, are exempt from ERISA's funding, vesting, and fiduciary requirements and are subject to minimal reporting and disclosure requirements. ERISA's preemption and enforcement provisions nevertheless still apply to these top-hat plans. Thus, while an employer terminating top-hat plan benefits could be subject to potential common law claims under ERISA, state law claims—which could differ by state and entail more expansive remedies—would be preempted.
Recent case law on ERISA coverage for deferred compensation plans should assist employers in navigating through these complex issues and in framing strategies on how best to reduce costs for their benefit coverage without incurring undue risk of liability exposure.
Statutory and Regulatory Criteria for ERISA Coverage of Deferred Compensation Arrangements
ERISA Section 3(2) defines an employee pension plan as any plan, fund, or program established or maintained by an employer providing, by its express terms or as a result of surrounding circumstances, for retirement income or for the deferral of income to termination of employment or beyond. As this definition makes clear, the express terms of the plan may not be determinative of this inquiry if the "surrounding circumstances" demonstrate that the plan meets the criteria to be covered under ERISA.
The Department of Labor has provided interpretive guidance on the types of "surrounding circumstances" that may result in a plan being covered by ERISA. In an advisory opinion, the DOL has opined that whether a plan is governed by ERISA may depend on four general factors relevant to the "surrounding circumstances." Applying these factors, a plan will not be governed by ERISA where: (1) the manner in which deferred amounts are determined does not, in effect, allocate the economic benefits earned in a year disproportionately to retirees and participants reaching retirement age as defined under the plan; (2) the group of eligible participants who benefit from the arrangement does not consist of an inordinate percentage of employees who are or are likely to be at or near retirement age; (3) payments under the plan or arrangement are not made often enough at periods before retirement so that they do not actually serve as retirement income; and (4) the plan is not communicated to participants in a manner that causes them to act under the plan as if they were only deferring income until retirement. Notably, these considerations do not address whether the plan would be tax-qualified, but simply whether the plan would be governed by ERISA.
Judicial Interpretation of What Constitutes an ERISA-Governed Plan
In addition to the statutory text, the applicable regulations and DOL guidance, courts have also attempted to explain what criteria must be met for a deferred compensation arrangement to constitute an ERISA-governed pension plan. In Fort Halifax Co. v. Coyne, the U.S. Supreme Court held that ERISA did not preempt a state statute requiring employers to provide a one-time severance payment in the event of a mass layoff. An employer closed its plant and laid off employees without providing the required severance payments. As a result, state authorities filed suit to recover unpaid severance on behalf of the employees affected by the plant closing. The employer argued that the statute was preempted by ERISA because it concerned severance benefits, and thus constituted the regulation of an employee benefit plan. The court rejected this argument, finding that the statute neither established, nor required employers to maintain, an employee benefit plan. The court explained that a plan covered by ERISA is a commitment to pay benefits systematically, which includes ongoing administrative responsibility to determine eligibility, calculate benefit levels, and monitor funding for benefit payments. Relying on Fort Halifax, later court decisions have emphasized the existence of ongoing plan administration to determine whether a deferred compensation arrangement constitutes an ERISA-governed plan.
Prior to the Fort Halifax decision, the U.S. Court of Appeals for the Eleventh Circuit set forth a test to determine whether a plan falls within the scope and coverage of ERISA, even in the absence of a written plan document, in the seminal case of Donovan v. Dillingham. The issue in that case was whether an employer that purchased life insurance through a group policy had established and maintained a plan that was covered by ERISA. In finding that an ERISA-governed plan existed, the Eleventh Circuit held that a plan will constitute an ERISA-covered plan if, from the surrounding circumstances, a reasonable person could ascertain the intended benefits, the beneficiaries, the source of financing, and the procedures for obtaining benefits. This standard has been widely accepted and applied by numerous circuit and district courts, along with the Supreme Court's decision in Fort Halifax.
Recent Cases of Interest Involving Deferred Compensation Arrangements
Depending on the particular challenge to a deferred compensation arrangement (i.e., either under state law or ERISA), employers may take different positions on ERISA's application to their arrangement. For example, in Gabelman v. Sher, the court held that a "Salary Continuation Agreement" that provided a former executive employee with "monthly post-retirement payments" was not an ERISA-covered plan. The agreement specifically provided that the plaintiff would receive salary continuation payments for 10 years after his retirement. The defendant-employer terminated the plaintiff's employment and advised him that he would not be eligible to receive the retirement benefits as provided in the agreement. Plaintiff brought suit alleging that the defendant violated ERISA by interfering with his right to receive the contemplated benefit payments. The plaintiff also asserted a contract claim under state law. The defendant moved to dismiss the ERISA claim, arguing that the compensation arrangement was not subject to ERISA.
In dismissing the plaintiff's ERISA claim, the court first noted that "the touchstone for determining the existence of an ERISA plan is whether a particular agreement creates an ongoing administrative scheme" to administer the benefits. In conducting this analysis, the court applied a three-part test for determining whether an employer obligation or undertaking requires the creation of such an administrative scheme: (1) whether the employer's undertaking or obligation requires managerial discretion, (2) whether a reasonable employee would perceive an ongoing commitment by the employer to provide employee benefits, and (3) whether the employer was required to analyze the circumstances of each employee's termination separately to determine eligibility for compensation.
As to the first factor, the Gabelman court held that no managerial discretion was required because the payments were automatically triggered by the "one-time occurrence of specific events" explicitly set forth in the agreement. The court went on to explain that the payments were to be "doled out mechanically each month in an amount determined by `simple arithmetical calculation,' which is insufficient to show the presence of a discretionary administrative scheme." The court concluded that the mere issuance of a check each month during the course of the installment-payment period was not enough to show an ongoing administrative scheme.
The court noted that the second criteria was arguably satisfied because the defendant agreed to assume a potentially long-lasting financial commitment; yet, the court also noted that the perception of such a long-term commitment was diminished by the fact that the defendant would have no responsibility other than sending checks to the plaintiff. As to the third factor, the court concluded that the agreement did not require the defendant to make an individualized analysis of the plaintiff's termination to determine his eligibility for the benefits at issue. The court found that an administrative scheme was absent because the plaintiff's eligibility for benefits was mechanically determined by objective factors. Ultimately, the court concluded that the agreement did not constitute a pension plan under ERISA, and it dismissed the plaintiff's ERISA claim.
More recently, another court addressed a similar deferred compensation agreement and reached a similar conclusion. In Mothe v. Mothe Life Ins. Co., a widow filed a state contract claim to recover benefits under the terms of a deferred compensation agreement executed by her deceased spouse. The agreement suggested that the parties intended to provide the decedent "additional compensation for his services" in the form of "post-retirement income (or pre-retirement death benefits to his beneficiary) over and above what will be available to him" under the employer's existing pension and insurance programs. The agreement further provided that the decedent would receive set monthly payments for a 10-year period following his retirement. The agreement also provided that the beneficiary designated in the decedent's will would receive these monthly payments in the event he died while employed by defendant. After the plaintiff's husband died while employed, the defendant made monthly payments to his widow, as the surviving beneficiary, but eventually ceased after 27 months.
After the payments ceased, the decedent's widow filed suit to recover the remaining amounts due under the plan. Unlike the defendant in Gabelman, who argued that its deferred compensation arrangement was not covered by ERISA, the defendant in Mothe argued that the agreement was an ERISA top-hat plan that could be unilaterally terminated and on that basis moved for summary judgment. Although the agreement clearly was intended to provide decedent with post-retirement income, the court held that this deferred compensation arrangement did not constitute an ERISA plan. Invoking the framework set out in Donovan v. Dillingham, the court analyzed "whether, from surrounding circumstances, a reasonable person could determine the intended benefits, beneficiaries, source of financing, and procedures for receiving benefits." The court found that the agreement did not have any procedures for the administration of benefits and that it failed to constitute a plan because it did not provide enough guidance for a reasonable person to ascertain the procedures for receiving benefits, i.e., the fourth Dillingham factor. Consequently, the court found that the plaintiff's state law claims were not preempted by ERISA and she was allowed to continue her pursuit of state law claims.
There are arguments counseling for and against wanting deferred compensation plans being governed by ERISA. In many instances, an employer may argue that its deferred compensation arrangement is not governed by ERISA in order to avoid potential compliance costs and fiduciary liability.
However, there may be instances in which ERISA's coverage may be advantageous for an employer—for instance, to invoke ERISA's preemption provisions to avoid claims based on state law. Although the employer may still face claims under ERISA, those claims (and the corresponding remedies) should be uniform throughout the country.
Thus, when an employer has multistate operations, preemption would at least diminish the risk of being subject to different requirements and claims in different states. In other contexts, avoiding ERISA may prove to be more advantageous, as was the case in Gabelman when the employer was able to avoid exposure to a claim for unlawful interference with ERISA rights.
Whether the objective is to be governed by ERISA or not, it is important for employers to consider, in advance of litigation, whether their plan in fact satisfies the criteria for being governed by ERISA. The recent case law discussed in this article, and the underlying statutory and regulatory rules, provides useful guidance for making that assessment.