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Drafting Severance Provisions To Avoid ERISA Preemption

Employers have been struggling for some time to understand under what circumstances severance arrangements will be deemed by courts to be “employee welfare benefit plans” and, therefore, subject to the Employee Retirement Income Security Act of 1974, as amended, 29 U.S.C. §§ 1001-1961 (“ERISA”).1  For instance, under certain circumstances, informal severance practices may be treated as ERISA-qualified plans and, therefore, governed by ERISA, regardless of the intent of the employer.  ERISA provides both additional protections and obligations and thus employers may or may not wish their severance arrangements to be preempted, and therefore governed, by ERISA.  For example, employers may prefer ERISA-qualified plans because in an ERISA action (i) plaintiffs are not entitled to a jury trial;2  (ii) plaintiffs are not entitled to extra-contractual damages, such as punitive, consequential, and compensatory damages;3  and (iii) there is a limited scope of review.4  On the other hand, employers may wish to avoid being governed by ERISA because of its (i) stringent reporting and disclosure requirements;5 (ii) civil penalties for failure to comply with these requirements;6 (iii) criminal fines and possibly even imprisonment for failure to comply with these requirements;7 and (iv) potentially cumbersome administrative requirements found throughout the Act.8

Recent developments in the case law suggest that the employer actually may have some degree of control over whether particular severance arrangements might be deemed an ERISA plan.  Employers may, through drafting appropriate language, choose the type of treatment they feel more beneficial: ERISA preemption or state law governance.  Such language can be included within individual written employment agreements.  Under certain circumstances, a severance provision in an employment agreement may be considered an “employee welfare benefit plan” within the meaning of ERISA and, therefore, governed by ERISA, while under others, an employment contract will be treated as just that, a contract governed by state law.

Background
ERISA preempts “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan.”   Although the term “employee benefit plan”9 is defined by ERISA, the definition provides little guidance as to what actually constitutes a covered “plan” and when such a “plan” exists.10   For that reason, case law controls whether a particular severance arrangement constitutes a plan within the meaning of ERISA.11  


The United States Supreme Court held, in Fort Halifax Packing Co. v. Coyne, 482 U.S. 1, 12 (1987), that a plan exists for ERISA purposes when the benefits provided require the employer to institute an “ongoing administrative program” to meet the employer’s obligation.12  Other courts have explained that because ERISA is primarily concerned with the regulation and administration of plan funds, the statute presumes that some type of administrative activity is taking place.13 An ERISA plan, therefore, must have an administrative program.  Thus, from Fort Halifax and its progeny,14  the following test has developed to determine whether a plan is covered by ERISA: does the severance package implicate an ongoing administrative program for processing claims and paying benefits?  

While courts consider a variety of factors in determining whether a severance benefit arrangement in an employment agreement implicates an ongoing administrative program, the one overriding element has been the degree of discretion given to an employer in administering severance benefits and deciding employee eligibility.15  Because one of the underlying purposes of ERISA is to prevent employer abuse in administering benefits, and it is employer discretion which creates the opportunity for such abuse, if an employer is given no discretion in an employment contract’s severance provisions most reported decisions to date indicate that no ERISA plan has been established.16   The courts have held that severance provisions with a total lack of employer discretion are not plans within the meaning of ERISA because they do not create a need for an ongoing administrative program.


In Kulinski v. Medtronic Bio-Medicus, Inc., 21 F.3d 254 (8th Cir. 1994), for example, the court held that golden parachute agreements executed with various employees were not plans under ERISA because under the agreements, the employees were given sole discretion to decide whether a good reason existed to resign, which would trigger the severance payment.  The court found that no ERISA plan existed because the agreements explicitly gave sole discretion to the employee, and there was nothing for the employer to decide.  

Similarly, when an employment agreement calls for a severance calculation that is a straightforward arithmetical computation of a one-time lump-sum payment, and all of the details are established in the agreement with no uncertain terms, no discretion is granted to the employer.  In such cases, courts have held that an ongoing administrative program is not required to meet the employer’s obligation and the employment agreement is not preempted by ERISA.17  Even when payments are distributed over time and can continue over a period of years, courts have held that if they are merely simple arithmetic calculations and the employer has no discretion with respect to the amount or timing of payments, the benefits do not constitute a plan, and are not preempted by ERISA.18  


On the other hand, courts have held that if there is a discretionary component, the employment agreement will be scrutinized more carefully, and an ERISA plan may be found depending on the level of discretion placed in the hands of the employer.  Accordingly, the more discretion granted to an employer, the stronger the likelihood that the provision implicates an on-going administrative program and that it is, therefore, a plan preempted by ERISA.  Difficult cases arise when the degree of discretion granted to an employer is neither so significant as to clearly constitute an ERISA plan, nor so minimal as to clearly not constitute an ERISA plan.  The question, therefore, is how much discretion is enough to trigger ERISA preemption?

Some discretion may not be not enough for ERISA preemption
At least one court has decided that some discretion is not enough to turn a severance agreement into an ERISA plan.  The United States Court of Appeals for the Ninth Circuit, in Velarde v. PACE Membership Warehouse, Inc., 105 F.3d 1313, 1317 (9th Cir. 1997), has held that the amount of discretion required for an employer to determine whether an employee’s employment was terminated with or without cause was “minimal” and failed to rise to the level of “ongoing particularized discretion” required for an ERISA plan.  


The owner-employer in Velarde, in anticipation of the permanent closing of its business, entered into agreements with 25 of its employees, providing that if the employees worked through a certain date they would receive severance pay.  Under the agreement, the employees would receive the severance pay unless they were terminated for cause, or they voluntarily separated, prior to the agreed upon date.  After most of the employees had accepted the offer, the employer decided not to close the business but, rather, to sell it.  All 25 of the employees ultimately accepted the offer and continued working for the employer, who sold the business four days prior to the date agreed upon in the agreement to trigger the severance pay.  On the agreed upon date, the employees demanded their severance pay.  The employer refused to pay, and the employees brought suit in state court for breach of contract.  The defendant-employer removed the case to federal court based on diversity of the parties.

In granting summary judgment to plaintiff-employees on their breach of contract claims, the court held that the severance agreements did not rise to the level of ERISA plans and therefore were not preempted by ERISA.  The court said that the employer was required to make a single arithmetical calculation to determine the amount of the severance benefits, and therefore did not need an ongoing administrative program to carry out its obligations.  And although a “for cause” determination would change the benefits due to the employee, such a determination, according to the court, did not entail discretion sufficient to turn the severance agreement into an ERISA plan.  The level of discretion, “if any,” required in implementing the agreements would be minimal.19  Therefore, the court held, the agreement did not implicate an ongoing administrative program, the agreement did not constitute an ERISA plan, and plaintiffs’ state law contract claims were not preempted.20


How much discretion is enough for ERISA preemption?
If a “for cause” determination is not enough employer discretion to safely guarantee the protections of ERISA, then how far must an employer go?  How much discretion must an employer give itself when attempting to draft a severance arrangement which will fall safely within ERISA?  


The United States District Court for the Middle District of North Carolina has offered some guidance.  That court has held, in Blair v. Young Phillips Corporation, 158 F. Supp. 2d 654 (M.D.N.C. 2001), that a “for cause” determination, similar to the one at issue in the Ninth Circuit’s Velarde decision, weighed in favor of finding an ERISA plan when it was coupled with another discretionary component granted to the employer in the same employment agreement.21  The employment agreement in Blair provided for severance compensation in the event of termination without cause.  In the agreement, the company maintained the right to terminate the employee “for cause” at any time.22  The agreement also contained a non-compete clause under which the employee agreed not to compete with the company for two years following his term of employment and which provided for specific performance of the clause and that the employee would repay to the company any profits he received in violation of it.  The company terminated the employee for cause and refused to pay him any of the contractual severance benefits.  The employee filed suit in state court for breach of contract, the defendant-company filed a notice of removal claiming that the plaintiff-employee’s action was preempted by ERISA and in response, the plaintiff-employee filed a motion to remand.


In denying the plaintiff-employee’s motion to remand, the court held that the employment agreement was a plan within the meaning of ERISA and was therefore preempted.  The court first discussed how other courts had not always deemed the “for cause” determination in and of itself to implicate ERISA and cited a Ninth Circuit decision which pre-dated the Velarde decision, but which, like Velarde, held that a “for cause” determination alone did not grant sufficient discretion to the employer to implicate an ongoing administrative program.23  The Blair court went on to hold, however, that because the discretion granted to the employer in the employment agreement in that case involved “two significant discretionary responsibilities”-- (i) the “for cause” determination, and (ii) the continuous determinations the employer would have to make over the course of two years to ensure that the employee was not in violation of the non-compete covenant – it was sufficient to implicate ERISA’s concerns regarding the potential for employer abuse.  


It is not entirely clear from the decision whether the non-compete covenant, or a violation thereof, was related to whether or not the employee would receive his severance benefits.  The court did not directly discuss a link between the two provisions of the agreement.  However, one of the grounds to terminate the employee “for cause” and deny him severance was “failure or refusal to perform the services required of [plaintiff] under this Agreement.”25  Presumably, compliance with the non-compete clause constituted a requirement under the agreement and the employee’s failure to comply constituted cause for termination and denial of severance.26  The court reasoned that the need for continuous monitoring by the defendant-employer of the plaintiff-employee’s activities over an extended time period to ensure compliance with the non-compete clause created the potential need to establish an administrative program to determine whether the employee had violated the covenant.  Therefore, the agreement created a potential need for an ongoing administrative program, the agreement constituted an ERISA plan, and the plaintiff’s state law contract claim was preempted.27  

Conclusion
Whether or not an employer prefers to be subject to ERISA, it is important to be aware of the factors courts consider in determining whether a particular severance provision will be governed by ERISA.  With the foregoing principles in mind, employers can avoid unwittingly violating ERISA’s reporting and disclosure requirements or, alternatively, directly invoke ERISA’s protections.


Under these principles, an employer that is willing to utilize individual written employment agreements does have some degree of control over whether its severance provisions will fall under the ERISA umbrella.  If there is no discretion given to the employer in severance provisions contained in an employment agreement, courts have found that no ERISA plan exists.  Therefore, an employer who wishes to avoid ERISA treatment would be wise to draft employment agreements that grant no discretion to the employer in processing severance claims and paying benefits.  On the other hand, if there is any discretionary component, courts are likely to scrutinize the agreement more carefully, and an ERISA plan may be found depending on the level of discretion placed in the hands of the employer.  Therefore, an employer who wishes to invoke ERISA treatment should draft employment agreements giving the employer a significant amount of discretion in the administering of benefits, at the very least an amount comparable to that given in Blair.28



1.        29 U.S.C. § 1002(3).
2.        See, e.g., DeFelice v. American Intern. Life Assur. Co., 112 F.3d 61, 64 (2d Cir. 1997).
3.        See, e.g., Mertens v. Hewitt Assocs., 508 U.S. 248, 257-58 (1993).
4.        See Firestone v. Bruch, 489 U.S. 101, 111 (1989).
5.        29 U.S.C. §§ 1021-1031.
6.        29 U.S.C. § 1132(c).
7.        29 U.S.C. § 1131.
8.        29 U.S.C. §§ 1001-1961.
9.        ERISA § 514(a); 29 U.S.C. § 1144(a) (emphasis added).
10.        ERISA defines “employee benefit plan” as including “employee welfare benefit plan” and “employee welfare benefit plan” as a plan that, inter alia, pays benefits described in 29 U.S.C. § 186(c).  29 U.S.C.
§ 1002(3).  Section 186(c) includes severance or similar benefits.
11.        Blair v. Young Phillips Corporation, 158 F. Supp. 2d 654, 658 (M.D.N.C. 2001).
12.        Under this test, a statute requiring employers to provide a one-time lump-sum severance payment to employees who were terminated as a result of their plant closing did not require implementation of an ongoing administrative program to meet the employer’s obligation, and therefore did not implicate ERISA, because it required only a single event.  Fort Halifax Packing Co. v. Coyne, 482 U.S. 1, 12 (1987).

13.        See, e.g., Janover v. Bernan Foods, Inc., 901 F. Supp. 695, 699 (S.D.N.Y. 1995).
14.        See, e.g., Velarde v. PACE Membership Warehouse, Inc., 105 F.3d 1313, 1316 (9th Cir. 1997); Blair, 158 F. Supp. 2d 654, 658 (M.D.N.C. 2001).
15.        For a full analysis of the factors courts consider in determining whether an ERISA plan has been created from what employers might consider to be informal arrangements see Jeffrey S. Klein and Nicholas J. Pappas, Informal Severance Pay Plans, 214 N.Y.L.J. 3 (1995).
16.        See, e.g., Blair, 158 F. Supp. 2d 654, 659 (M.D.N.C. 2001).  
17.        See Delaye v. Agripac, Inc., 39 F.3d 235, 237 (9th Cir. 1994); Kulinski, 21 F.3d 254, 258 (8th Cir. 1994);Janover, 901 F. Supp. 695, 699 (S.D.N.Y. 1995); Fetterholf v. Harcourt General, Inc., No. 01-1112, 2001 WL 1622196, *3 (E.D. Pa. Dec. 18, 2001); Boardwalk Regency Corp. v. New Jersey Casino Control Commission, 800 A.2d 157, 173 (N.J. Super. Ct. App. Div. 2002).
18.        See Delaye, 39 F.3d 235, 237 (9th Cir. 1994); Janover, 901 F. Supp. 695, 699 (S.D.N.Y. 1995); Fludgate v. Management Technologies, Inc., 885 F. Supp. 645, 648 (S.D.N.Y. 1995).

19.        Velarde, 105 F.3d 1313, 1317 (9th Cir. 1997).
20.        Id.  See also Delaye v. Agripac, Inc., 39 F.3d 235, 237 (9th Cir. 1994), another Ninth Circuit decision in which the court did not consider a “for cause” determination to be a sufficiently discretionary analysis to implicate ERISA.  The court held that the severance provision did not implicate an ongoing administrative program because once the company decided to terminate the employee’s employment, the severance calculation became a straightforward computation of a one-time obligation according to the terms of his employment contract, either to (i) pay his regular salary prorated to the date of termination if he was terminated for cause, or (ii) pay him a fixed monthly amount for twelve to twenty-four months according to a set formula if he was terminated without cause.  The court said there was nothing discretionary about the timing, amount, or form of payment, and the necessary “for cause” determination required only a single discretionary decision rather than a series of ongoing decisions.  Therefore, ERISA was not implicated, and no federal question was presented.  Accordingly, the court dismissed the action due to lack of subject matter jurisdiction.  Id. at 238.

21.        See also Collins v. Ralston Purina Co., 147 F.3d 592, 596 (7th Cir. 1998), in which another federal court, after the case had been removed to it from state court, held that retention agreements, under which employees would receive six months salary if the company’s successor substantially reduced the employees’ job responsibilities, gave employer sufficient discretion to implicate ERISA safeguards.  The determination whether one’s job responsibilities had been substantially reduced (as a triggering event to payment of severance) was not an easily discernible standard, the court said, and required the exercise of discretion on an ongoing basis.  Accordingly, the court accepted jurisdiction and denied plaintiff’s motion to remand.  Id.
22.        The term “for cause” was defined in the employment agreement to include: chronic alcoholism, criminal dishonesty, misappropriation of any money or other assets or properties of the company, bankruptcy of the employee, willful violation of specific and lawful directions of the board of directors of the company or their designees, failure or refusal to perform the services required of the employee under the agreement and any other acts or omissions that constitute grounds for cause under the laws of the state.  Blair, 158 F. Supp. 2d 654, 656 (M.D.N.C. 2001).

23.         Id. at 660 (citing Delaye v. Agripac, Inc., 39 F.3d 235 (9th Cir. 1994)).
24.        Id. at 660.
25.        Id. at 656.
26.        Another possibility is that the court looked at the employment agreement as a whole, and the discretion it gave as a whole to the employer, and not the severance provision in and of itself.  It would seem a more direct strategy, however, based on the case law generally, for an employer wishing to implicate ERISA’s safeguards to incorporate all of the discretion for that purpose into the severance provisions themselves.
27.        Blair, 158 F. Supp. 2d 654, 656 (M.D.N.C. 2001).
28.        158 F. Supp. 2d at 660.

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