Severance pay arrangements have become an increasingly popular tool for employers to soften the effect of reductions in force or other terminations of employment. Paying severance to departing employees is also often used by employers as a tool to avoid employment-related litigation by requiring exiting employees to agree to sign waivers of claims against the employer in exchange for a severance payment.1 Severance arrangements also serve the purpose of increasing morale and employee relations2 and can aid employers in attracting sought-after talent. Plans that provide severance benefits to employees are often subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). ERISA governs employee benefit plans that provide pension or welfare benefits. A severance arrangement, depending on several factors, may be treated as a welfare plan or a pension plan under ERISA or as an agreement between an employee and an employer that is not subject to ERISA.
According to regulations promulgated by the Department of Labor (the "DOL") under ERISA, a severance plan will be deemed to constitute a welfare plan subject to ERISA (and thus, not a pension plan) if: (i) such payments are not contingent, directly or indirectly, upon the employee's retiring, (ii) the total payments do not exceed the equivalent of twice the employee's annual compensation during the year immediately preceding the employee's termination, and (iii) all such payments are completed within 24 months of the employee's termination.3 If a severance plan is a welfare plan under ERISA, however, it is subject to a number of ERISA's requirements such as, for example, its fiduciary standards, its reporting and disclosure requirements (i.e., filing annual reports and distributing summary plan descriptions for funded plans or plans with over 100 participants), and its enforcement provisions. A severance plan that is a pension plan, is subject to the full panoply of ERISA requirements, which include the same requirements for a welfare plan plus participation and vesting requirements and certain funding and trust requirements.
Not all severance arrangements, however, are subject to ERISA. A number of court cases have analyzed whether certain severance arrangements, such as those provided in employment contracts, in nonqualified plans, and in informal arrangements, qualify as ERISA plans, subject to federal law or alternatively, as obligations governed under state laws. Recently, the US District Court for the Southern District of New York, in Sheer v. Israel Discount Bank of New York, analyzed whether severance benefits contained in a former employee's employment contract and in a supplemental executive retirement plan (a "SERP") constituted severance benefits subject to ERISA and its preemption of state law.4 In making its decision that the arrangements are not ERISA plans, the court analyzed a number of noteworthy court decisions regarding severance arrangements.
Case Law Precedent
The seminal case regarding the applicability of ERISA to severance arrangements is the US Supreme Court case, Fort Halifax Packing Co. v. Coyne, 482 US 1 (1987). The Fort Halifax Court, which reviewed a Maine statute that required employers to provide one-time severance payments to employees in the event of a plant closing, held that such statute did not create an obligation for employers to maintain an employee welfare benefit plan subject to ERISA. The Fort Halifax Court reasoned that the Maine statute, which required a "one-time, lump sum payment triggered by a single event requires no administrative scheme whatsoever to meet the employer's obligation" and that the Maine statute therefore did not create a benefit plan subject to ERISA.
In 1993, the Second Circuit Court of Appeals, in James v. Fleet/Northstar Financial Group, Inc., 992 F.2d 463, applied the Supreme Court's reasoning in Fort Halifax to determine that an employer's decision to give employees 60 days additional pay following their last day of work if such employees stayed on the job until an internal restructuring was completed, did not constitute an "employee welfare benefit plan" within the meaning of ERISA. The Second Circuit reasoned that while the employer's arrangement to pay the 60-days additional pay was different from the statutorily required benefits described in Fort Halifax, the fact that payments would occur over a short time and did "not require an ongoing administrative program to meet the employer's obligation" made the severance arrangement analogous to the arrangement in Fort Halifax. The Second Circuit in James also stated that despite the fact that the employees had different termination dates and different eligibility for receiving the payment which resulted in the need to calculate benefits individually and to individually determine deductions for social security taxes, health and medical benefits, etc., similar calculations would have been required under the Maine statute in Fort Halifax. In another Second Circuit case, Schonholz v. Long Island Jewish Medical Center, 87 F.3d 72 (2d Cir. 1996), the court held that a severance plan which required managerial discretion and separate analysis of certain criteria to determine whether an employee was involuntarily terminated and thus qualified for severance benefits, constituted an "employee welfare benefit plan" under ERISA. The Schonholz Court also applied the Supreme Court's reasoning that ERISA only applies to a severance arrangement where an obligation requires the creation of an ongoing administrative program. In concluding that the arrangement was subject to ERISA, the Second Circuit in Schonholz looked at a number of other court decisions to establish a three factor test. The three factors established by the Schonholz court include: (i) whether the employer's undertaking or obligation requires managerial discretion in its administration, (ii) whether a reasonable employee would perceive an ongoing commitment by the employer to provide employee benefits, and (iii) whether the employer was required to analyze the circumstances of each employee's termination separately in light of certain criteria. The Second Circuit stated that it did not decide which one or more of these factors would be determinative in every case because it held in Schonholz that all three factors favored its conclusion that the plan was subject to ERISA and noted that certain factors may or may not be relevant in other factual settings.
In Tischmann v. ITT/Sheraton Corporation, 145 F.3d 561 (2d Cir. 1998), the Second Circuit Court of Appeals applied the reasoning in Fort Halifax and Schonholz to hold that a severance package was an "employee welfare benefit plan" subject to ERISA (and thus the former employee's claim for benefits under New York law was preempted by ERISA), since, among other factors, the plan was designed to pay benefits when each covered employee left the company, and such payments were "expected to occur over a protracted period of time." In Kosakow v. New Rochelle Radiology Associates, P.C., 274 F.3d 706, the Second Circuit Court of Appeals held that the statement that employees will, "receive appropriate severance pay where applicable" in the employer's policy manual, constituted a severance pay plan subject to ERISA. The court looked to the Fort Halifax, James and Schonholz decisions to determine that since (i) the payments were not contingent on a single event (i.e., there was no date restriction and therefore could be viewed as an ongoing commitment), (ii) individual determinations were required to be made by the employer, and (iii) the amount of severance under the arrangement was not a fixed amount, the combination of factors made the severance arrangement a "plan" subject to ERISA. The US District Court of the Southern District of New York, in Taverna v. Credit Suisse First Boston (USA), Inc., 2003 WL 255250, held that severance benefits provided in a separation agreement and in a transition agreement did not constitute ERISA plans. With respect to the separation agreement, the District Court applied the reasoning set forth by the Fort Halifax and James courts and determined that since (i) the benefit required no ongoing administrative program, (ii) only simple mathematical calculations were required, and (iii) the employer was not required to analyze the circumstances of each employee's termination, such benefits did not constitute an ERISA plan. With respect to the transition agreement, while the District Court admitted that it presented a closer call due to the ability to pay a discretionary additional amount, the court held that it was also not an ERISA plan since (i) there was no need for an ongoing administrative program, (ii) only a simple arithmetical calculation was required, and (iii) employees could not have reasonably believed that the employer was committing to provide continuing benefits.
Courts outside of the Second Circuit have also analyzed whether particular severance arrangements were plans subject to ERISA. For example, the Seventh Circuit Court of Appeals, in Bowles v. Quantum Chemical Company, held that a severance plan that (i) provided covered employees with a one-year period in which they could make a demand for severance, (ii) required the employer to "budget for the possibility of making multiple payments throughout the course of the year," and (iii) required the employer to develop a mechanism for monitoring the conditions of the covered employees' employment during the one-year period, was a plan under ERISA. Similarly, the Ninth Circuit Court of Appeals, in Bogue v. Ampex Corp., 976 F.2d 1319 (9th Cir. 1992) held that ERISA applied when the employer could not fulfill its severance obligations with an, "unthinking, one-time, nondiscretionary application" of the severance arrangement's terms. The Ninth Circuit Court of Appeals distinguished Bogue in Delaye v. Agripac, Inc., 39 F.3d 235 (9th Cir. 1994), holding that severance benefits under an employment contract, which (i) required the employer to make a determination whether such employee's employment was terminated with or without "cause," (ii) were payable over a two-year period, and (iii) required a calculation of accrued vacation pay, did not rise to the level of an ongoing administrative scheme (and thus, such benefits did not constitute a plan subject to ERISA) since there was "nothing discretionary about the timing, amount or form of the [severance] payment."
In Simas v. Quaker Fabric Corp., 6 F.3d 849 (1st Cir. 1993), the First Circuit Court of Appeals reviewed a Massachusetts "tin parachute" law which provided that certain employees whose employment terminated within two-years of a change in control of an employer, would be entitled to one-time lump sum payments equal to twice their weekly compensation for each completed year of employment with such employer. The statute required that for an employee to be eligible for benefits, the employee must meet the eligibility standards for state unemployment benefits and must not be eligible for corporate severance benefits that are more generous than those provided under the statute. While the First Circuit acknowledged that the facts of Simas were very similar to Fort Halifax, the court held that the Massachusetts law was preempted by ERISA since, unlike in Fort Halifax, the Massachusetts law required an ongoing mechanism for determining (i) whether the employee was discharged within the time-frames required by the statute, (ii) whether the employee was discharged for "cause" and (iii) whether the employee was otherwise not eligible for state unemployment compensation. The Fifth Circuit Court of Appeals, in Fontenot v. NL Industries, Inc., 953 F.2d 960 (5th Cir. 1992), held that a golden parachute severance plan was not preempted by ERISA because it involved "a one-time lump sum payment triggered by a single event...that may never materialize," it "requires no administrative scheme whatsoever to meet the employer's obligation," and "[t]he employer assumes no responsibility to pay benefits on a regular basis." The Fifth Circuit, in Wells v. General Motors Corp., 881 F.2d 166 (5th Cir. 1989), also held that an employer's severance procedure under which its employees could elect to voluntarily terminate their employment and receive a one-time lump sum payment, was not a plan subject to ERISA since the plan was, "not ongoing, nor was there any need for continuing administration of the payment program (even though employees could elect a two-year installment payment option)."
In Cassidy v. Akzo Nobel Salt, Inc., 308 F.3d 613 (6th Cir. 2002), the Sixth Circuit Court of Appeals held that a severance program that (i) permitted employees to choose between a lump sum payment and a two-year salary continuation period, (ii) provided that the company's president had discretion to approve larger payment amounts, (iii) permitted some employees to alternatively elect to receive a series of payments at retirement age, (iv) which allowed employees to elect to extend medical, dental and life insurance benefits, and (v) entitled eligible employees to career transition services, displayed "a degree of administrative complexity that more closely resembles plans which [the court had] included in ERISA's scope," and held that this severance program was a plan subject to ERISA. Lastly, the Tenth Circuit Court of Appeals, in Lettes v. Kinam Gold, Inc., 2001 WL 55499 (10th Cir. 2001), held that a golden parachute agreement that was, "unfunded, contingent on a one-time event that might never happen, and is expressly limited to a narrow time period," and which required that a calculation of payments thereunder would be based on a mathematical formula, did not constitute a plan subject to ERISA. Citing Fort Halifax, the Tenth Circuit reasoned that a plan administrator's discretion for determining eligibility for benefits may be one factor to be considered in deciding whether an administrative scheme for processing claims is necessary, but it "says nothing about whether the plan is sufficiently ‘ongoing' to trigger ERISA regulation."
The District Court's Decision in Sheer v. Israel Discount Bank of New York
In Sheer, the plaintiff, Arie Sheer, was hired in 1996 by the Defendant, Israel Discount Bank of New York (the "Bank"), to serve as its president and CEO. Pursuant to the terms of Mr. Sheer's employment agreement, Mr. Sheer was entitled to a severance package equal to one year's base salary, payable in a lump sum upon a termination of his employment under certain circumstances. In addition, Mr. Sheer was also entitled to a supplemental benefit under the company's SERP in the event of a "change in control" of the Bank. Mr. Sheer's employment was terminated and he claimed that he was terminated "without cause" and therefore entitled to severance. Sheer also claimed that the Bank had a change in control prior to his termination and therefore he was entitled to benefits under the Bank's SERP. The Bank denied that Mr. Sheer was entitled to any relief and moved to have Mr. Sheer's state court action removed to federal court on the grounds that the benefits in question were established and maintained by the Bank in accordance with ERISA and therefore subject to ERISA's preemption of state law.5
The District Court examined the Fort Halifax, Kosakow, Taverna and Schonholz decisions in analyzing the Bank's severance arrangements. The District Court applied the three Schonholz factors and determined that (i) the Bank's undertaking did not require ongoing managerial discretion since there was no discretion as to the amount of severance and that there was nothing discretionary about the timing, form or amount of payments, (ii) a reasonable employee of the Bank would not conclude that the Bank was making an "ongoing commitment" to employees to provide benefits since there were no further Bank or employee obligations once benefits were paid, and (iii) while there was some amount of managerial discretion, as in the Taverna case, it was not the type of discretion ERISA covers since the determination of whether a "for cause" termination of employment had occurred was based on analysis of a fixed set of criteria set forth in Mr. Sheer's employment contract. As a result, the District court held that neither the severance benefits provided in Mr. Sheer's employment contract, nor the SERP, were plans subject to ERISA and accordingly, the court remanded the case to be heard in state court.
The development of case law precedent has provided guidance for employers who wish to provide severance benefits for their employees. While certain severance plans that are drafted to provide ongoing benefits to a number of eligible employees will almost certainly be treated as an ERISA plan, other severance arrangements, such as those found in employment contracts, can either be treated as a plan subject to ERISA or an arrangement not subject to ERISA depending on whether such arrangement contains certain factors (discussed above). As seen in the precedent cases discussed above, whether a severance arrangement is an ERISA plan depends on the facts and circumstances and it is difficult to predict how any one court would interpret such facts. Nevertheless, employers who do not wish to create an ERISA plan (and be subject to the various requirements under ERISA) should take precautions when drafting such arrangements (including, for example, employment contracts). Of course, White & Case LLP would be pleased to assist with analyzing and drafting any such severance arrangements.