Category: Erisa

The Third Circuit issued an opinion today, putting to rest the controversy that stemmed from several federal district court cases* in Pennsylvania which had held that ERISA does not preempt bad faith insurance claims brought under 42 Pa. C.S. section 8371**. The Third Circuit opinion issued today in Barber v. Unum Life Ins. Co. of Am., holds that, under the doctrine of conflict preemption, ERISA preempts the statute because it provides “a form of ultimate relief in a judicial forum that [adds] to the judicial remedies [already] provided by ERISA,” citing the very recent and well-known U.S. Supreme Court case of Aetna Health Inc. v. Davila, 124 S. Ct. 2488 (2004) as authority. (You can read about the Aetna case here and here.)

The Third Circuit opinion also provides that, under the doctrine of express preemption, the state statute is preempted as well. The court held that the statute does not constitute a law that “regulates insurance,” preventing the statute from being “saved” from preemption under ERISA’s “saving clause.” (ERISA’s saving clause–section 514(b)(2)(A) of ERISA–creates an exception to preemption of a state law when that state law proposes to regulate insurance.) The court relied on another recent U.S. Supreme Court case, Kentucky Association of Health Plans, Inc. v. Miller, 538 U.S. 329 (2003) in reaching its decision under the doctrine of express preemption. (You can read about the Miller case here.) The court applied the two-part test promulgated in Miller that a statute “regulates insurance” and satisfies the saving clause only if it (1) is “specifically directed toward entities engaged in insurance” and (2) “substantially affect[s] the risk pooling arrangement between the insurer and the insured.” The Third Circuit in Barber ruled that the Pennsylvania statute satisfied the first prong of the test, but not the second, in reaching its decision that the statute was not “saved” from preemption.

Read more about the history of the legal controversy in this article from Law.com: “ERISA and Bad-Faith Claim Debate.”

*Rosenbaum v. UNUM Life Insurance Co. of America, No. 01-6758, 2002 U.S. Dist. LEXIS 14155 (E.D. Pa. July 29, 2002); Barber v. UNUM Life Insurance Co. of America, No. 03-3018 (E.D. Pa. filed Sept. 9, 2003); Stone v. Disability Mgmt. Servs., 288 F. Supp. 2d 684 (M.D. Pa. 2003).

**42 Pa. C.S. § 8371 provides:

In an action arising under an insurance policy, if the court finds that the insurer has acted in bad faith toward the insured, the court may take all of the following actions:

(1) Award interest on the amount of the claim from the date the claim was made by the insured in an amount equal to the prime rate of interest plus 3%.
(2) Award punitive damages against the insurer.
(3) Assess court costs and attorney fees against the insurer.

The Associated Press is reporting (via Forbes.com): “Judge OKs McDonnell Douglas Settlement.” The settlement being approved here is $8.1 million in back wages for affected plaintiffs terminated as a result of a plant closing. Last year, plaintiffs in the case had prevailed on ERISA section 510 claims against the company for $36 million with respect to the loss of pension and health benefits. The Tenth Circuit had ruled 2-1 back in May that plaintiffs were not entitled to back pay via their section 510 claims under ERISA. According to the Associated Press, settlement discussions followed.

Read previous posts about the lawsuit here and here.

The Wall Street Journal (subscription required) today has this article: “Mutual-Fund Suit On Marketing Fees Clears Hurdle.” The article reports that “[a] lawsuit accusing a mutual fund of charging investors excessive fees has cleared a legal hurdle and could spell a new round of legal woes for fund companies.” According to the article, “[t]he suit questions how it could be reasonable for the firm to collect twice as much money from shareholders for marketing the fund after it was shut to new investors as it was collecting when the fund was still open and looking for new shareholders.”

The article predicts that the outcome of the lawsuit could prove worrisome to other fund companies because the fees it targets are commonplace in the industry, and quotes John Freeman, a professor at the University of South Carolina Law School and a critic of mutual fund fees, as saying: “Plaintiffs lawyers are going to start teeing up 12b-1 fees and taking a hard look at the logic of how that money is being spent.”

The thought that came to my mind when reading the article, however, was that the litigation could have an impact on ERISA fiduciaries. For years, lawyers have been predicting lawsuits against fiduciaries based upon excessive fees in retirement plans. Moreover, the DOL has been concerned about excessive fees as well, as indicated in this statement on their web page devoted to retirement plan fees:

Plan fees and expenses are important considerations for all types of retirement plans. As a plan fiduciary, you have an obligation under ERISA to prudently select and monitor plan investments, investment options made available to the plan’s participants and beneficiaries, and the persons providing services to your plan. Understanding and evaluating plan fees and expenses associated with plan investments, investment options, and services are an important part of a fiduciary’s responsibility. This responsibility is ongoing. After careful evaluation during the initial selection, you will want to monitor plan fees and expenses to determine whether they continue to be reasonable in light of the services provided.

In recent years, there has been a dramatic increase in the number of investment options, as well as level and types of services, offered to and by plans in which participants have individual accounts. In determining the number of investment options and the level and type of services for your plan, it is important to understand the fees and expenses for the services you decide to offer. The cumulative effect of fees and expenses on retirement savings can be substantial.

The DOL in this July 28, 1998 Information Letter stated:

In choosing among potential service providers, as well as in monitoring and deciding whether to retain a service provider, the trustees must objectively assess the qualifications of the service provider, the quality of the work product, and the reasonableness of the fees charged in light of the services provided.

See also Advisory Opinion 97-16A dated May 22, 1997 which addresses 12b-1 fees received by a non-fiduciary service provider. The DOL outlines in the Opinion Letter the duties and responsibilities of the “responsible Plan fiduciaries” for the plan as follows:

Finally, it should be noted that ERISA’s general standards of fiduciary conduct also would apply to the proposed arrangement. Under section 404(a)(1) of ERISA, the responsible Plan fiduciaries must act prudently and solely in the interest of the Plan participants and beneficiaries both in deciding whether to enter into, or continue, the above-described arrangement with [the provider], and in determining which investment options to utilize or make available to Plan participants and beneficiaries. In this regard, the responsible Plan fiduciaries must assure that the compensation paid directly or indirectly by the Plan to [the provider] is reasonable, taking into account the services provided to the Plan as well as any other fees or compensation received by [the provider] in connection with the investment of Plan assets. The responsible Plan fiduciaries therefore must obtain sufficient information regarding any fees or other compensation that [the provider] receives with respect to the Plan’s investments in each Unrelated Fund to make an informed decision whether [the provider’s] compensation for services is no more than reasonable.

Sounds like the same sort of determination being made in the recent non-ERISA lawsuit. According to the WSJ article, for plaintiffs to prevail, they will have to demonstrate that the fees were “so disproportionately large that they bore no reasonable relationship to the services actually provided.”

The bottom line is that plan fiduciaries should understand what fees are being charged to the plan and make a determination that they are reasonable in light of the services rendered.

Helpful links on the subject:

• 401(k) Plan Fee Disclosure Form
• Study of 401(k) Plan Fees and Expenses

(Section 404(a) of the ERISA provides: “[A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and – (A) for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan . . . “)

ASPA has posted on their website some very interesting testimony presented to the 2004 ERISA Advisory Council on Employee Welfare and Pension Benefit Plans Working Group on Health and Welfare Form 5500 Requirements. The testimony was given by Janice M. Wegesin, President of JMW Consulting. Dittos on this statement from her testimony:

Engagement of my firm often starts with a compliance review. The client delivers to me all of the benefits communication materials that are normally provided to its new employees and, from that, a list of plans subject to ERISA is developed. The next step in the review involves collection of the plan documents, summary plan descriptions, and Form 5500 filings for those plans. A client typically has no difficulty presenting the documentation and filings relating to its qualified retirement plans; however, it is frequently an entirely different story for its welfare benefit plans. Although a §125 cafeteria plan document may exist, the “documents” for the medical, dental, and life plans may consist solely of the employee booklet issued by the insurance carrier. For some benefits, the only “document” may be the information presented in the employee handbook.

Besides the documentation probems, she goes on to note how few clients fulfill ERISA filing requirements either with respect to such plans:

Many tax form preparers do not have the skills necessary to properly advise the plan sponsor about welfare plan reporting, so merely continue to prepare only those Form 5500 filings that the plan sponsor has historically filed. Large employers often prepare Form 5500 filings for welfare plans (but not qualified retirement plans) in-house and, again, the SALY (same as last year) principal applies. No thought is given to changing circumstances and benefit structures and the impact on Form 5500 reporting.

After the Sixth Circuit’s decision in Rhiel v. Adams rocked the benefits and bankruptcy world late last year, most of us figured that it was a far-gone conclusion that 403(b) plans would, for the most part, be henceforth included in the bankruptcy estate, at least in states governed by the Sixth Circuit (i.e. Michigan, Ohio, Kentucky and Tennessee), unless the case were somehow overturned by the Supreme Court. (You can read about the case in this previous post–403(b) Plans Take a Turn for the Worst in the Sixth Circuit and More on the Sixth Circuit’s Bankruptcy Decision.) However, there is some disturbing albeit predictable news from the bankruptcy trenches—I have received word from bankruptcy attorneys that, even in states not governed by the Sixth Circuit, bankruptcy trustees are taking the Rhiel v. Adams decision to heart and trying to rely on the Rhiel case to include 403(b) plan assets as part of the bankruptcy estate. As you may recall, the Rhiel case held that a husband and wife’s interests in 403(b) plans were included in the bankruptcy estate and not exempt under section 542(c)(2) of the Bankruptcy Code. The case was a departure from the general rule that participants can exclude their interests in “ERISA qualified plans” from the bankruptcy estate in a bankruptcy proceeding.

The TaxGuru has posted a cartoon here which illustrates in humorous fashion how an ERISA section 510 claim* might arise. The caption of the cartoon reads: “I know you’re three weeks away from retirement, but it’s either fire you now or I have to fork out for another gold watch.” Sadly enough, similar sorts of scenarios involving pension and health benefits have been the subject of much litigation as you can read about in this previous post here. I suppose one would argue that in the cartoon, the watch is not really a “benefit” protected by ERISA. However, that issue–when are in-kind benefits covered by ERISA?–reminds me of the well-known “grocery voucher” case decided last year–Musmeci et al. v. Schwegmann Giant Super Markets, Inc. et al.–in which the employer provided regular grocery vouchers to retirees when they retired from the employer with certain age, service, and position. When a qualifying employee retired, the employer would send the retiree a set of four grocery vouchers worth a total of $216 each month. These vouchers were valid for a period of thirty days, redeemable only at stores owned by the employer.

When the employer terminated the grocery voucher program due to financial difficulties and a sale of the business, the retirees sued claiming they were vested in a pension benefit plan under ERISA. The district court held that the voucher program did indeed qualify as a pension benefit plan under ERISA. On appeal, the Fifth Circuit agreed and upheld the district court’s opinion that the CEO and others were liable as fiduciaries of the plan and that the plaintiffs were entitled to monetary relief for benefits denied.

In reaching its decision, this is what the court had to say about in-kind benefits:

To determine whether ERISA applies to the Voucher Plan, we begin our analysis with an examination of the language of the statute itself. ERISA defines an “employee pension benefit” plan as:

any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that by its express terms or as a result of surrounding circumstances such plan, fund, or program . . . provides retirement income to employees. . . 29 U.S.C. § 1002 (2) (A) (i).

The parties agree that [the employer] established a “program.” Thus, the primary issue this court must resolve is whether the vouchers issued pursuant to [the employer’s] Voucher Plan provided the Plaintiffs with “retirement income.”

Neither ERISA’s statutory provisions nor the federal regulations define the term “income.” However, they do not affirmatively require that the pension benefit be paid in cash. Moreover, the Department of Labor (DOL) refused to declare as a general policy whether in-kind benefits are regulated by ERISA. See ERISA Advisory Op. (March 26, 1999), 1999 ERISA LEXIS 11. We have likewise found no controlling case law directly addressing the issue. . .

Even if we were to adopt the plain or ordinary meaning of “income,” our conclusion would be the same. As noted by the Supreme Court in Lukhard v. Reed, the term “income” is commonly understood to mean a “gain or recurrent benefit usually measured in money.” Lukhard v. Reed, 481 U.S. 368, 374 (citing Webster’s Third International Dictionary 1143(1976)). Because the vouchers provided a gain or benefit to . . . employees and could readily be measured in money, they would constitute income as the term is generally understood.

In addition to holding that the voucher program constituted a benefit plan subject to ERISA, the Fifth Circuit affirmed the lower court’s decision that the CEO and other defendants were fiduciaries of the “plan” or voucher program, stating that the term “fiduciary” was to be “liberally construed in keeping with the remedial purposes of ERISA” and that “the term should be defined not only by reference to particular titles, but also by considering the authority which a particular person has or exercises over an employee benefit plan.

The DOL has filed an amicus brief here supporting a petition for en banc rehearing in this case–QualChoice, Inc. v. Rowland–decided by the Sixth Circuit last May. (Thanks to Benefitslink.com for the pointer.) The case involved the common scenario of a health plan advancing money to a participant for medical expenses arising from an accident, with the participant then obtaining a settlement against a third-party tortfeasor, and the health plan seeking reimbursement for the medical expenses under the health plan’s reimbursement provision. The case involves the legal controversy over the Great-West case and what a plan can recover as “appropriate equitable relief” under the Supreme Court’s 2002 decision in Great-West.

The DOL argues in its brief that the Sixth Circuit in QualChoice was wrong in holding “that a fiduciary’s action to enforce a plan reimbursement provision is a legal action, regardless of whether the plan participant or beneficiary recovered from another entity and possesses that recovery in an identifiable fund.” The DOL goes on to state that such a holding is inconsistent with the Supreme Court’s analysis in Great-West. The DOL then emphasizes how the Sixth Circuit’s decision could exacerbate the conflict in the circuit courts over the issue (i.e. the circuit courts are split) and could negatively impact health plans in general:

In addition to being in conflict with the decisions of other circuits and in significant tension with Supreme Court precedent, the panel’s decision is of exceptional importance for other reasons: by reading section 502(a)(3) to disallow enforcement of subrogation provisions because they are grounded in contract, the decision is likely not only to add significantly to the costs borne by ERISA health care plans, but could also prevent participants and fiduciaries from bringing suit under section 502(a)(3) to enforce the terms of the plan.

As of 2002, an estimated 137 million people participated in private sector employer-sponsored health care plans covered by ERISA. Many of these plans contain reimbursement/subrogation provisions. Indeed, in 2000, the largest provider of subrogation services in the United States reported subrogation recoveries that averaged $4.8 million for every one million persons covered by its client. See Healthcare Recoveries, Inc., SEC Form 10K (Mar. 27, 2001). By flatly prohibiting such recoveries, the panel’s decision is likely to have a large economic impact on health care plans in this Circuit, and may lead some employers to respond by dropping or decreasing coverage.

Furthermore, under the logic of the panel’s reasoning that section 502(a)(3) does not allow enforcement of a plan subrogation provision because it is grounded in contract, no attempt to enforce a plan term would be permissible. This reads out of section 502(a)(3) the right to “enforce . . . the terms of the plan.” 29 U.S.C. § 1132(a)(3). Such a construction may have unforeseen consequences on the enforcement of ERISA beyond the subrogation context, and should be avoided under ordinary rules of statutory construction.

It will be very interesting to see how the court responds to the petition for rehearing and whether or not the Supreme Court will eventually step in again to try to make sense out of this very muddled area of the law.

With all of the political debate and media attention over employees losing their jobs due to outsourcing*, it is important to remember the possible exposure to liability that can occur as employers consider the option of outsourcing in its many forms. While time will not permit going into all of the legal exposure that can arise, one such area of vulnerability under ERISA comes to mind.

ERISA section 510 prohibits an employer from discharging an employee for the purpose of interfering with the attainment of any right to which the employee may become entitled under an ERISA plan. Courts have held that such practices as terminating employees based on benefits cost to the employer or changing the status of an individual from “employee” to “independent contractor” for such purposes have violated ERISA. What this means is that employers who terminate employees for the wrong reasons can be exposed to section 510 claims from disgruntled employees under ERISA. The issue is particularly relevant in today’s work environment as employers are faced each year with the daunting and reoccurring task of containing benefits costs.

How does the issue apply to employers who outsource work to outside contractors? According to the U.S. Supreme Court in the case of Inter Modal Rail Employees Ass’n v. Atchison, Topeka & Santa Fe Railway Co. , an employer cannot outsource work to a sub-contractor where the purpose of the outsourcing is to interfere with the benefit plan rights of plan participants. The employer in that case outsourced its employees to another company that did not provide equal health and pension benefits, and allegedly did so for the purpose of cutting its own health and pension benefits cost. The court held that the employer could be held liable for violation of section 510 of ERISA.

While it is true that oftentimes it is difficult for employees to prove that an employer terminated an employee for the purpose of interfering with benefits, employees have prevailed in many instances. A well-known example of the type of evidence that can prevail in a section 510 case appears in McLendon v. Continental Can Company, 749 F. Supp. 582 (D.N.J. 1989), aff’d sub nom., McLendon v. Continental Can Co., 908 F.2d 1171 (3d Cir. 1990) in which a sophisticated benefits liability avoidance system was utilized by the employer. Employees were able to show that the employer had devised a computer program which identified employees who were close to meeting the age and service requirements for certain pension benefits so that such employees could then be targeted for termination. The court in McLendon had no trouble in finding that the employer had violated section 510 of ERISA.

Others may recall the recent case of Millsap et al. v. McDonnell Douglas Corporation (read about it here and here) in which plaintiffs achieved a $36 million settlement for claims brought against their employer, alleging that the employer closed one of its plants for purposes of preventing employees from attaining eligibility for benefits under their pension and health care plans. The damaging evidence in that case were memos from the actuaries analyzing the reduction in benefits which would occur if the plant were closed. One such memo prepared by the actuaries (which was apparently not protected by attorney-client privilege) considered “various what if scenarios, analyzing the effect on costs and savings if the company decided to reduce heads.” The kinds of costs analyzed included “pension cost, savings cost, savings plan cost, health care cost, and just direct overhead cost.” According to the court in that case, the employees were only required to show that the employer’s alleged desire to block the attainment of benefits rights was a “determinative factor” in the challenged decision, i.e. the claimant was not required to show that it was the sole reason for closing the plant.

Conclusion: While there are many business reasons for embarking upon a path of outsourcing, the case law demonstrates how, under ERISA, making the decision to outsource for the wrong reasons could come back to haunt the employer. When considering this option, employers need to be wary that, while outsourcing may save costs, it could also lead to unexpected lawsuits and result in exposure to liability in some circumstances.

(*Outsourcing is the delegation of a business process to an external service provider. The service provider is then responsible for the hiring of employees to accomplish the delegated business process.)

In this post yesterday, I discussed the interplay between the Defense of Marriage Act (“DOMA”) and ERISA. This article here at Findlaw.com states that last week, a lawsuit was filed in federal district court in Florida challenging the constitutionality of DOMA. You can read more about the lawsuit here. This latter article suggests that “[n]umerous lawsuits nationwide are already challenging the constitutionality of DOMA.”

Recent events in Massachusetts regarding marriage have spawned a plethora of law firm publications on the implications of same-gender marriage as it relates to benefit plans. You can access three of such publications here (Jackson Lewis), here (Ropes & Gray) and here (Goodwin Procter). However, this recent article published by the Congressional Research Service (“CRS”) of the U.S. Library of Congress (via Benefitslink.com)–“The Effect of State-Legalized Same-[Gender] Marriage on Social Security Benefits and Pension“– makes an interesting point regarding the interplay between ERISA and the Defense of Marriage Act (“DOMA”):

DOMA provides that, in interpreting any federal statute, ruling, or regulation —including, for example, ERISA and the Internal Revenue Code — a spouse can only be a person of the opposite [gender] who is a husband or wife. Consequently, a pension plan cannot be required to recognize a same-[gender] spouse even if same-[gender] marriages are permitted under state law. Some benefits specialists have suggested that because Section 514(a) of ERISA preempts state laws that relate to employee benefits covered by ERISA, ERISA would therefore preempt any state law requiring the plan to recognize same-[gender] marriage for purposes of administering pension benefits. However, whether ERISA alone would preempt state laws recognizing same-[gender] marriage is irrelevant because DOMA prohibits recognition of same-[gender] spouses in the interpretation and application of federal law.

While the technical points of whether DOMA prevails or ERISA preempts provide for interesting thought and discussion, one of the main concerns that the marriage issue raises with respect to benefit plans has to do with the fact that, for income tax purposes, the IRS has historically maintained that an individual is considered to be a “spouse” if the applicable state law recognizes the relationship as a marriage. If, for example, state law recognizes common-law marriages as legal, an employer in that state would be required to recognize an employee’s common-law spouse as his or her legal spouse and IRS would recognize the marriage as valid.

Similarly, many plan documents have defined the term “spouse” as looking to state law as well. This is important for qualified plans as it impacts such matters as pre-retirement survivor annuity and joint and survivor annuity requirements as well as requirements pertaining to spousal consent and qualified domestic relation orders. Now, after recent events regarding marriage, plans which still contain this language of defining the term “spouse” as looking to state law or plans which do not define “spouse” at all, are problematic in affected states since the language, if left unchanged, is confusing, implying that same-gender marriages might be recognized under the plan document when, in fact, DOMA would dictate otherwise. This is why it is important to amend plan documents and revise Summary Plan Descriptions to clarify the issue, particularly for companies with employees in affected states.

The CRS article goes on to discuss how Social Security, the Federal Employees Retirement System, and the Civil Service Retirement Systems are also governed by DOMA and, therefore, would not be affected by state law changes pertaining to the definition of marriage.

Additional note: The Ropes & Gray article also has this interesting discussion regarding the interplay of DOMA and the Family Medical Leave Act (“FMLA”):

The FMLA defines “spouse” as “a husband or wife, as the case may be.” The U.S.Department of Labor’s regulations implementing the FMLA add the following unusual gloss to that statutory definition: “’Spouse’ means a husband or wife as defined or recognized under State law for purposes of marriage in the State where the employee resides.” The FMLA regulations (unlike the statute on which they are based) thus command employers to look to state law to determine the meaning of “spouse” for purposes of applying the FMLA.

The article notes that an argument might be made that the FMLA requires employers to provide leave to employees to care for a same-gender spouse, were it not for DOMA which was passed three years after the FMLA’s enactment, arguably replacing the definitions of “spouse” set forth in the FMLA. The article goes on to note that this interpretation is supported by a 1998 Department of Labor opinion letter in which the Department’s Wage & Hour Division explicitly advised that DOMA restricts the FMLA’s definition of “spouse” to opposite-gender spouses.

So if DOMA restricts FMLA to opposite-gender spouses, what does this mean for the employer who goes ahead and provides leave for same-gender spouses? It probably means that the leave cannot be designated as FMLA leave, and therefore an employee who took the leave to care for a same-gender spouse could be entitled to “double” leave where leave was later taken again in the same 12-month period for a purpose specifically covered by the FMLA, such as care of a child or a parent.