I have blogged several times previously about litigation over employer’s non-qualified deferred compensation plans, but the litigation just keeps coming. Generally, the litigation separates into two types:

  1. Litigation by former employees who left before becoming eligible for vested benefits (or otherwise forfeited their benefits) under a plan, alleging that that they should have been vested and received benefits because the plan did not qualify as a top hat plan, exempt from ERISA, and
  2. Litigation by former plan participant who did receive their benefits, but not at the time or in the forms they elected, alleged damages due to adverse tax consequences.

We will share future posts on the second category, but today we will talk about the first.

A non-qualified deferred compensation or supplemental retirement plan is exempt from the requirements of ERISA if it qualifies as a top hat plan under DOL Reg. Sec. 2520.104-23, “a plan or plans primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” The reason this definition has become so critical is that non-qualified plans that qualify for the exemption do not need to adhere to ERISA’s vesting and other provisions. Former employees who terminate employment after having satisfied the minimal vesting requirements of ERISA, but before satisfied the more restrictive vesting requirements of their former employers’ non-qualified plans, have figured out (actually, their lawyers have figured out) that challenging a non-qualified plan’s status as a top hat plan can be an effective way to collect additional dollars. And some federal courts, including Texas, of all places, have been sympathetic to these challenges. Unfortunately, these types of allegations have become fairly common in recent years.

Two recent federal court cases have shed some light on this issue.

A Thorough Discussion: The recent decision in Sikora v. UPMC (12/22/15 W.D. PA) is more noteworthy for its thorough discussion of the definition of top hat plan than for its actual decision, which is consistent with the understanding of most compensation professionals. However, those seeking to become familiar with the regulatory and case law that has grown up around this issue should consider reading the Sikora case.

In Sikora, the court declared that it must consider both quantitative and qualitative factors to determine whether the deferred compensation plan is primarily maintained for the “purpose of providing deferred compensation for a select group of management or highly compensated employees.” The Third Circuit has boiled this down into a pretty simple formula: “The plan must cover relatively few employees . . . [and] the plan must cover only high level employees.” The court also rejected the plaintiff’s attempt to argue that “bargaining power,” an element once referenced in a DOL Opinion Letter in 1990, was a critical element of employees considered part of a top hat group. The court found that Opinion Letter “not entitled to deference.” Finally, the court found that the requirement that a plan be maintained “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees” is disjunctive, that is high-level employees can be either management or highly compensated employees.

In the end, the court concluded that, “The infinitesimally small number of participants in this Plan means, by any measure (UPMC’s or Sikora’s), it was primarily maintained for a ‘select group.’”

Fourth Circuit Does not Accept the DOL’s Interpretation: In an unpublished opinion released January 29, 2016, Bond v. Marriott International, Inc., the Fourth Circuit Court of Appeals dismissed as untimely plaintiffs’ lawsuit alleging that they should have been vested in certain accrued benefits under Marriott’s deferred compensation plan. That alone is not big news. However, this decision is newsworthy because of what the Court did not do.

Plaintiffs had filed this lawsuit alleging that the company’s Deferred Stock Incentive Plan violated the vesting requirements of ERISA. The key issue was whether the deferred plan qualified as a top hat plan exempt from ERISA’s requirements. Plaintiffs argued that the plan was not a top hat plan because it covered too many employees and thus failed the requirement that a top hat plan be maintained “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” If the plan was not a top hat plan, plaintiffs’ argued, then it would be subject to ERISA’s vesting requirements and many of the former employees would be entitled to some benefit.

Many executive compensation professionals watched this case closely for two reasons. First, the plaintiffs’ lawyers had attempted to qualify the suit as a class action brought on behalf of all plan participants – ever. Class actions are more difficult and costly to defend. In 2015, the federal district court had refused to grant class action status to participants’ diverse claims.

Second, the case then became more prominent because the U.S. Department of Labor filed a lengthy and strident amicus brief with the Fourth Circuit in support of plaintiffs, arguing, among other things, that to qualify for the top hat exemption, the plan must be maintained “exclusively” for the purpose of providing deferred compensation for a group of management or highly compensated employees. According to the DOL, participation in the plan by just one individual who was neither management nor highly compensated would cause the plan to fail to qualify as a top hat plan.

The DOL argued that, in providing relief for “top hat” plans from the broad remedial provisions of ERISA, Congress recognized that certain individuals, by virtue of their position or compensation level, have the ability to affect or substantially influence, through negotiation or otherwise, the design and operation of their deferred compensation plan, taking into consideration any risks attendant thereto, and, therefore, would not need the substantive rights and protections of Title I. DOL made the following specific arguments as to the language of the ERISA regulations, “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees”:

  • This language “does not mean that the ‘select group’ may be primarily composed of management or highly compensated individuals.”
  • This language does not mean that “a top hat plan can have a secondary purpose that is inconsistent with the primary purpose, such as a secondary purpose of covering individuals who are outside the ‘select group’ set by statute.”
  • The language means that the plan must be maintained “only” for a select group of management or highly compensated employees.

Technically, the Fourth Circuit did not reject the DOL position; it just decided the case on other grounds. However, the fact that the court could have accepted the DOL’s interpretation and chose not to do so should be encouraging to employers and executive compensation professionals.