Does ERISA Apply to Your Separation Agreements?
Many employers utilize separation agreements and offer severance to certain employees, whether through a structured separation plan adopted by the employer or individualized separation agreements negotiated at the time of separation. An often overlooked component of such separation arrangements is the potential application of the Employee Retirement Income Security Act (“ERISA”). We have compiled a few frequently asked questions that employers might find helpful when considering such arrangements.
Does ERISA apply to our separation agreements?
ERISA may apply to your separation arrangements. ERISA applies to any plan, fund, or program established or maintained by an employer to provide severance benefits to employees. Courts and governmental agencies have released opinions and guidance surrounding ERISA’s application to separation arrangements. Generally, one-time, non-recurring events that trigger severance payments will not be subject to ERISA. However, if your separation arrangements are more formalized (e.g., are based on a written or unwritten policy) and/or require an ongoing administrative scheme, then ERISA may apply to your separation arrangements. An ongoing administrative scheme may arise when a business has formal management or administrative controls surrounding separation arrangements with former employees. Additionally, in limited circumstances a severance arrangement could be considered a pension plan under ERISA implicating further regulatory concerns; however, such limited possibilities are beyond the scope of this Article.
If ERISA does apply, what are we required to do?
In the event your separation arrangements are subject to ERISA, your organization will need to comply with ERISA’s requirements that relate to ERISA welfare plans. The requirements include the adoption of a written plan document, a summary description that must be provided to employees, and a potential requirement to file a Form 5500. Although these requirements may apply, they are not as onerous as other ERISA covered plans, such as 401(k) plans or pension plans. In the event of a failure to comply with the requirements of ERISA, certain penalties can apply, such as a penalty for failing to provide a summary description to employees of $110 per day per violation.
Are there any benefits if ERISA applies?
There are certain benefits that result if your separation arrangement is subject to ERISA. In the event your separation arrangement is subject to ERISA, federal law will preempt any state law claims that arise under your separation arrangements. For example, ERISA will preempt state law breach of contract claims. Additionally, if drafted properly, your separation arrangement will provide deference to you for any administrative decisions and interpretations you make under the plan, which will generally be respected by courts. Finally, issues that arise under the plan can only be resolved in federal court, as opposed to resolution in state courts.
For example, in Fort Halifax Packing Co. v. Coyne, the United States Supreme Court ruled that a one-time severance payment that resulted from a single event was not a severance plan subject to ERISA. In Fort Halifax, a state statute in Maine required employers to pay certain terminated employees one week’s wages for each year of service upon termination. The employer in that case terminated certain employees and was obligated to pay severance, pursuant to the Maine state statute. The Supreme Court analyzed whether ERISA applied to such arrangement. Ultimately, the Supreme Court reasoned that the obligation to pay a one-time lump sum payment as a result of the occurrence of a single event does not constitute a plan subject to ERISA because such arrangement does not create the need for an ongoing administrative scheme.
Alternatively, in Blair v. Young Phillips Corp., a federal district court in North Carolina found that an agreement entered into between an employer and a former employee that contained severance pay did constitute a employee benefit plan subject to ERISA. In Blair, the former employee was entitled to severance in the event his employment was terminated without cause, which included sixty percent (60%) of base salary and certain fringe benefits to be paid over a two (2) year period and it contained a two (2) year non-competition provision, which required repayment of certain profits if it was violated. Ultimately, the employer terminated the former employee with cause and the former employee sued alleging the termination was without cause entitling the former employee to severance. The North Carolina federal district court concluded the arrangement was subject to ERISA because (i) the employer had discretion to determine if the former employee was terminated for cause; (ii) the employer had discretion to determine if the former employee was in compliance with the non-competition provision for two (2) years after employment, and if not, the former employee was required to repay certain profits as a result of the violation; and (iii) the agreement at issue created the need for a new ongoing administrative scheme to “pay medical premiums, process medical claims, pay medical benefits, and make a monthly payment for two years” after the former employee’s employment.
Employers should be mindful of employee benefit considerations as they apply to separation arrangements, especially with respect to the application of ERISA. Failure to understand the employee benefit implications on separation arrangements may result in unintended consequences if not properly considered and addressed. When these matters do arise, our team of attorneys is well versed in handling employee benefit matters in connection with structuring compliant separation arrangements and negotiating and drafting separation agreements on behalf of employers.