Severance plans are back in the news. Recently, an executive with Cardone Industries (Cardone) sued his employer for $1.5 million in unpaid severance benefits he claimed were due under the terms of his employment agreement. Zgrablich v. Cardone Industries, Inc. (E.D. Penn. 2016). The court ruled that Zgrablich’s claim for severance payments was preempted by the Employee Retirement Income Security Act (ERISA). The court determined that the severance provision in his employment agreement was actually an ERISA severance plan, albeit, a non-compliant one.
Initially, Zgrablich entered into an employment agreement that entitled him to severance benefits in the amount of $ 1.5 million—five times his annual base pay—if he were terminated without cause. Seven years later, when he was terminated without cause, his employer refused to pay. Zgrablich filed a breach of contract claim in state court for $1.5 million. In response, Cardone argued that the severance provision of the employment agreement was an ERISA severance plan. It argued that as a federal law, ERISA preempted the state-court contract claim. Essentially, Cardone’s argument was that the state court did not have jurisdiction over the case, because a federal law (ERISA) was involved.
While this may have been a convenient defense to the $1.5 million claim, it was not without risk. Why? By claiming this was an ERISA severance plan, Cardone exposed itself to a number of fines and penalties for running a plan that was not compliant with IRS and Department of Labor requirements. Cardone probably concluded the fines and penalties for a non-compliant ERISA plan would be far less than the $1.5 million severance payment it was liable for in state court.
In holding for Cardone, the court referred to Gruber v. Hubbard Bert Karle Weber, Inc. (3d Cir. 1998), which provides that “an employer can establish an ERISA plan rather easily.” To determine whether the severance provisions in Cardone’s employment agreement were an ERISA plan, the court asked whether a reasonable person could determine the following:
1. the intended benefits,
2. the class of beneficiaries,
3. the source of financing,
4. the procedures for receiving benefits, and
5. whether an ongoing administrative scheme was involved.
The court’s decision showed how it reached the conclusion that the severance payment provision in this case did, in fact, create an ERISA plan. The five areas they analyzed are summarized below:
1. Intended Benefits: The employment agreement provided a “comprehensive description” of the potential severance benefits available to Zgrablich at base salary for five years.
2. Beneficiaries: Any person who read the agreement could see that Zgrablich or his beneficiaries would be the beneficiaries.
3. Source of financing: The employer was solely responsible for paying out the benefits.
4. Procedures for receiving benefits: The agreement clearly stated the payment would only be upon termination “not for cause.”
5. Ongoing administrative scheme: Even if informal, the severance provisions required the “establishment and maintenance of a separate and ongoing administrative scheme.” Simply writing a check for a one-time, lump-sum payment may not have implicated ERISA. But here, the executive’s eligibility for severance payments over five years turned first on whether his employment was terminated “for cause,” which required the employer’s review and judgment. Second, the provisions required continuous monitoring, because the payments could be terminated if the executive violated one of the restrictive covenants in the agreement. These two facts presented “strong proof” that the provisions involved a determination of eligibility for benefits and thus constituted an ERISA plan.
So should all employers who pay severance consider adopting an ERISA plan? No, not necessarily. For employers who provide only an occasional one-time payment in exchange for a release of claims, requiring no administrative scheme or discretion, there may be no advantage. However, employers who periodically lay off groups of employees and who follow a formula based on length of service to determine the amount of severance could benefit. It can also benefit employers who tend to pay severance with each difficult termination to obtain a release and those who offer window programs of voluntary reductions in staff.
Exactly what are the benefits of adopting an ERISA severance plan? A former employee who challenges the employer for severance payments using breach of contract or another state-law claim can receive a number of remedies from the court, including punitive and compensatory damages. Additionally, a district court judge has broad discretion when hearing this type of claim. The judge may decide what sort of or size payment from the employer would be reasonable and equitable for the plaintiff under the facts presented.
But an employer who sponsors an ERISA plan will typically have any state district court claim dismissed or “removed” to federal court, because ERISA preempts state-court jurisdiction. If the case makes it to federal court, the federal judge must defer to the ERISA plan document, thereby removing discretion to make a monetary award to the plaintiff. In an ERISA case, punitive and compensatory damages are not allowed, providing another advantage to the employer. Finally, the employer removes all risk of inadvertently sponsoring an ERISA plan. Employers found to have a plan unbeknownst to them may be saddled with serious fines and penalties for failing to file the required Form 5500 and failing to provide a summary plan description to participants.
MSEC recommends that employers who offer severance payments frequently review their “arrangements” against the five criteria above to determine whether they may be sponsoring a non-compliant ERISA severance plan. If so, contact MSEC to discuss steps for bringing your severance plan into compliance.