ARIZONA WAGES OR ERISA BENEFITS

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1 ARIZONA WAGES OR ERISA BENEFITS The Treatment of Retention Bonuses and Severance Payments Nearly 25 years after the passage of the Employment Retirement Income Security Act of 1974 (ERISA), 1 the basic issue of ERISA coverage of retention bonuses, severance payments and similar forms of compensation is still subject to considerable controversy and continuing litigation. Because reductions in force are a fundamental tool of strategic business planning, the use of retention bonuses and severance payments to facilitate the outplacement of employees will not decrease during the coming years. Corporate counsel, employment lawyers and sole practitioners frequently face questions regarding the proper forum in which to litigate a dispute arising out of payments made to exiting employees. Accordingly, the issue of ERISA coverage versus state wage law must be understood and handled appropriately, both at the plan design stage and the litigation analysis stage, in order to avoid costly and embarrassing mistakes. This article examines the facts and circumstances that cause retention bonuses and severance payments to be either wages under Arizona law or employee benefits subject to ERISA. With proper plan design and appropriate employee communication, as well as adequate due diligence by employee s counsel prior to commencing litigation, costly jurisdictional disputes relating to these types of payments can be minimized. Because unpaid wages in Arizona are subject to treble damages, while ERISA damages are generally limited only to the payment of the benefits themselves, the economic differences can be significant for the exiting employee. Retention Bonuses and Severance Payments Retention bonuses reward employees for staying with the employer until their positions are eliminated, thereby lessening the business disruption of a merger or a downsizing. Retention bonuses are commonly called stay-on bonuses or stay-put bonuses. Severance payments provide terminated employees with income while they search for new positions. Often both types of payments are combined in a single program, and both types of payments are subject to similar analysis for purposes of determining ERISA coverage. The use of retention bonuses and severance payments encompasses a wide variety of programs, ranging from informal, ad hoc arrangements with one-time, lump sum payments to formal, funded plans with ongoing administrative requirements. Consequently, this variety has generated continuing litigation because the issue of ERISA coverage is driven by an analysis of all the facts and circumstances. 2 ERISA Coverage Rules A retention bonus or severance payment is covered by ERISA only if it is part of a plan, fund or program established or maintained by an employer to provide employee benefits to employees. 3 At the plan design stage, it is important to remember that the issue of embracing ERISA coverage or avoiding it is generally in the hands of the employer. 4 Also, this article assumes the employer is providing a retention bonus or severance payment that does not exceed two years of an employee s annual rate of compensation, so that the payment falls within the Department of Labor s safe harbor rule for welfare benefits. Accordingly, the payment, if it is covered by ERISA at all, will not be part of a pension plan, but rather it will be a welfare benefit plan. 5

2 In general, an ERISA welfare plan exists if the employer establishes a retention or severance arrangement in writing and administers it in conformance with ERISA s statutory requirements. 6 Therefore, if the employer desires to have ERISA coverage, there should be little reason for litigation relating to state versus federal jurisdiction if the employer formally adopts a plan, administers it appropriately, and clearly communicates to employees that the payments are being made pursuant to an ERISA plan. While an employer is generally able to embrace ERISA coverage, a gray area involves the distinction between accidental (i.e., unintentional) ERISA plans and non-erisa compensation arrangements. A body of law, discussed in detail below, has developed that lump sum payments made pursuant to informal arrangements without an ongoing administrative scheme constitute wages under state law, not employee benefits subject to ERISA. There are three steps to determine if a retention bonus or severance payment is part of an ERISA-covered plan. First, the payment must be an employee benefit. Second, the payment must be part of a plan, fund or program. Third, the plan, fund or program must involve an ongoing administrative scheme. If an analysis of the facts and circumstances fails to find any one of the steps, then the payments are not covered by ERISA. Retention and Severance as Employee Benefits Severance payments are covered in the statutory definition of a welfare plan so that it is clear that severance payments can be employee benefits. 7 While retention bonuses are not mentioned and while they are more likely to be deemed compensation as opposed to employee benefits, there is no reason why they cannot be paid pursuant to an ERISA plan, either in combination with severance payments or on a stand-alone basis. 8 On the other hand, because retention bonuses look more like compensation and are often easier to administer than severance payments, a stand-alone retention program is more likely not to be covered by ERISA than a severance program. 9 Definition of a Plan, Fund or Program It is important to remember that a payment may look like an employee benefit but the payment is not covered by ERISA unless it is made pursuant to a plan, fund or program. The leading decision relating to the definition of an ERISA-covered plan, fund or program is Donovan v. Dillingham. 10 The subtle distinction between compensation and employee benefits and the fact that ERISA does not contain a statutory definition of a plan, fund or program create the potential for litigation, as plaintiffs and defendants jockey for jurisdictional advantages. Dillingham established a four-part test for an ERISA-covered plan: A plan exists if, from the surrounding facts and circumstances, a reasonable person can ascertain (1) the intended benefits, (2) a class of beneficiaries, (3) the source of financing, and (4) the procedures for receiving benefits. Because this test has a low threshold, it was considered for a number of years that ERISA coverage for retention bonuses and severance payments was hard to avoid. For example, articles discussed the dangers associated with employment contracts being construed as accidental, i.e., unintended, ERISA plans. 11 Consequently, ERISA coverage was found for arrangements covering just a few employees 12 or even one employee, 13 for unwritten plans and even undisclosed ones, 14 for plans that the employer did not even want subject to ERISA coverage, 15 and for situations in which the employer did not comply with the ERISA requirements. 16 Because the issue of ERISA coverage is driven by a facts and circumstances analysis, the results with respect to ERISA coverage are mixed, and employee s counsel needs to carefully review a number of factors if ERISA coverage is not immediately clear. For example, with respect to the class of beneficiaries, a one-person plan, while possible, is not a consistent result. In Curtis v. Nevada Bonding Corp., 17 for example, the Ninth Circuit held that an oral promise to a prospective employee regarding the right to health insurance did not result in an ERISA-covered plan. However, a key element in the conclusion not to find ERISA coverage in Curtis may be the fact that a mere promise without more may not create an ERISA-covered plan. 18 Also, when

3 there is a promise to only one person or a few persons who are also senior executives and those promises are encompassed in an employment contract, a court may be more likely to consider the promises covered by state contract law rather than by ERISA. 19 Fort Halifax Rule Ongoing Administrative Scheme Since 1987, the Dillingham test has been simplified with respect to retention bonuses and severance payments due to the fact that a number of circuits, including the Ninth Circuit, have concluded that retention bonus arrangements and severance payment arrangements, if made simple enough, do not constitute ERISA-covered plans. The rule, first articulated in Fort Halifax Packing Co. v. Coyne, 20 is that an arrangement without ongoing administration is not an ERISA-covered plan. In Fort Halifax, the Supreme Court held that a Maine statute requiring employers who closed their plants to pay a one-time severance benefit to employees was not preempted by ERISA because there was no plan. For a plan to exist, there needs to be an ongoing administrative scheme. Therefore, recent decisions have focused their analysis on the complexity, or lack thereof, of the retention or severance arrangement. The Ninth Circuit Trilogy In the context of retention bonuses and severance payments, the Fort Halifax rule may now be the standard by which a plan is determined for purposes of ERISA coverage. Three cases in the Ninth Circuit demonstrate how these types of payments would be analyzed by a court in Arizona. The Ninth Circuit first examined the Fort Halifax concept of the lack of ongoing administration in Bogue v. Ampex Corp. 21 In Bogue, the Ninth Circuit held that the severance arrangement was an ERISA-covered plan because, although the payment of severance benefits was triggered by a single event, namely a job elimination, that event could occur more than once and could occur at different times for each employee. The severance arrangement in Bogue covered 10 senior executives. More important than the number of participants was the fact that a plan administrator needed to determine if an affected employee s new job was not substantially equivalent to his or her former duties before the employee was eligible for severance benefits. In Bogue, the Ninth Circuit opined that this analysis could not be done without discretion and without administration. Accordingly, the Ninth Circuit in Bogue did not find the Fort Halifax exception of the lack of ongoing administration to apply. Next, the Ninth Circuit reviewed a severance arrangement in Delaye v. Agripac, Inc., 22 and held that a written employment contract providing severance payments to an executive officer was not an ERISA-covered plan because the payment process was non-discretionary and did not require an ongoing administrative scheme. Delaye involved the president of an Oregon company who was denied enhanced severance benefits under an employment contract after he was terminated. In Delaye, if the executive was terminated for cause, up to one year of severance pay was provided. If the termination was without cause, a larger, more comprehensive, benefit package was provided. The Ninth Circuit opined that there was nothing discretionary about the timing or the amount of payment, hence there was no need for an ongoing administrative scheme. The Ninth Circuit in Delaye appears to ignore the fact that the decision to terminate is highly discretionary. Perhaps a simpler reading of Delaye is that it is still possible to have an employment contract that provides payments that may look like employee benefits without triggering ERISA. A further distinction may be that the payments stand alone; they do not need to reference any ERISA plan in order to be implemented by the employer. The Delaye decision is unusual in that the employee sought ERISA coverage. Generally, employees seek the more expansive rights afforded by state law. Often if there is ERISA preemption, the employee finds that no equivalent ERISA remedy is available. 23 The third decision dealing with the Fort Halifax rule is Velarde v. Pace Membership Warehouse. 24 Velarde may represent the most favorable fact pattern of the three cases for applying the Fort Halifax rule. It may also reflect a trend that courts are becoming less likely to find accidental ERISA plans. In Velarde, a number of employees received a letter drafted by Pace and acknowledged by the employee, offering the employee the opportunity for the stay-on

4 team. If the employee remained with Pace until the affected warehouse was permanently closed, the employee would receive a stay-on bonus and severance pay. The bonus totaled four weeks of pay, and the severance payment amounted to one week of severance for each full year of employment. The situation changed after the letters were issued; the facility was purchased by Sam s Club and the affected employees were retained by the new employer. When the date passed for the plant closing, the affected employees demanded the stay-on bonus and the severance pay. Pace argued that the stay-on letter constituted an ERISA-covered plan and therefore preempted the employees Arizona claim for breach of contract. The Ninth Circuit, citing Bogue, Delaye and Fort Halifax, stated that a relatively simple test has emerged to determine whether a plan is covered by ERISA: Does the benefit package implicate an ongoing administrative scheme? 25 In Velarde, the Ninth Circuit discussed its earlier decisions and contrasted them with the facts in Velarde. With respect to Bogue, the Ninth Circuit stated that it concluded a special compensation program for 10 key executives was an ERISA-covered plan because it involved more than a theoretical possibility of a one-time obligation in the future. The Ninth Circuit also re-emphasized the discretionary analysis relating to a determination that the new position was substantially equivalent. By contrast, in Delaye, the Ninth Circuit stated that the employer only had to make a simple arithmetical calculation to determine the amount of the severance benefits. When the Ninth Circuit summarized Delaye in Velarde, it noted that the Delaye court did not deem the minimum quantum of discretion [relating to the for cause termination decision] sufficient to turn a severance agreement into an ERISA plan. It is difficult to understand how the determination of for cause in Delaye requires less discretion than the determination of substantially equivalent in Bogue. The distinction may merely underscore how murky a facts and circumstances analysis can be. Velarde presented a more straight-forward set of facts than Bogue or Delaye. In Velarde, once the employee was selected for the program, the employee merely had to reach the drop-dead date to receive the retention and severance payments. The Ninth Circuit noted that the stay-on letter contained no conditions that the employee be terminated, that there be a breach in employment, or that the warehouse actually close. The Ninth Circuit could find no language in this simple contract susceptible to competing interpretations or requiring the exercise of discretion or significant administration by the employer. Accordingly, the Ninth Circuit held that the plaintiffs had a valid state law breach-of-contract claim, subject to treble damages. 26 Further, the Ninth Circuit found that the award of attorneys fees under Arizona law was appropriate. 27 The Decision to Embrace ERISA Velarde represents the potential adverse consequences of using ERISA jurisdictional issues as part of strategic litigation planning. In Velarde, the plaintiff chose state court, relying a simple letter agreement with the affected employees. The defendant raised ERISA preemption in order to eliminate the treble damages claim under Arizona law. If Pace desired ERISA coverage, the time to make that decision was when the stay-on letters were drafted, not after litigation commenced. Pace could have taken a number of steps to increase the likelihood of ERISA coverage at the plan- design stage. Those steps would have included drafting plan documents that stated the plan was subject to ERISA, 28 compliance with the ERISA reporting and disclosure rules, the provision of periodic payments in lieu of or as an alternative to lump sums, the adoption of an ERISA claims procedure, the creation of an ERISA administrative committee, and the retention of discretion by the ERISA committee with respect to eligibility and administrative issues. These steps indicate that there is a business cost connected with embracing ERISA that needs to be balanced against the litigation risks of being subject to Arizona contract law, wage law or other Arizona remedies. Where this cost benefit analysis produces an acceptable result for the employer, an ERISA-covered plan can be drafted. 29 In Arizona, if the business costs of embracing ERISA are acceptable, it is more advantageous to the employer to draft an ERISA-covered plan. First, decisions regarding eligibility and benefits will

5 be subject to a deferential standard of judicial review if the plan is properly structured. Second, most state law claims will be preempted by ERISA. 30 Third, federal court jurisdiction is available, with more favorable summary judgment rules. 31 Fourth, punitive and extracontractual damages are generally unavailable to employees. 32 Finally, jury trials are generally unavailable under ERISA. 33 Conclusion While it is easy to articulate the steps necessary to embrace or avoid ERISA coverage, the lack of prior planning by employers and the significant substantive differences between employee rights under Arizona law and under ERISA will continue to make ERISA coverage a matter of dispute. However, in the Ninth Circuit, there may be a trend in the area of retention bonuses and severance payments for courts to rely more on the Fort Halifax rule. For example, in Fulkerson v. First Interstate Bank, Ltd., 34 an employee voluntarily resigned after being told that her position would not be eliminated after a merger and therefore she would not be eligible for severance benefits. Two days after her resignation, her position was eliminated. The former employee sued under California law for $51,530 in lost severance payments on the basis of the defendants breach of good faith and fair dealing implied in her employment contract. The defendants removed the case from state court and filed to dismiss the claim based on ERISA preemption. The plaintiff moved to remand the case to state court. The District Court ruled in favor of remand, distinguishing Bogue and Delaye. The District Court found that there was no ongoing administrative scheme and no requirement for a plan administrator to engage in particularized, administrative, discretionary analysis, but rather the case merely involved a straightforward computation of a one-time obligation. Accordingly, it appears less likely that the discovery of accidental ERISA plans will continue to plague employees counsel who commence state court litigation after failing to identify an ERISA-covered plan. William J. Kluwin is a sole practitioner licensed in Arizona, California and the District of Columbia. He advises businesses, fiduciaries and individuals on ERISA and employee benefit matters, including presenting and defending ERISA benefit claims and preparing QDROs. ENDNOTES: 1. ERISA Section 2; 29 U.S.C et seq. 2. Kanne v. Conn. Gen. Life Ins. Co., 867 F.2d 489, 492 (9th Cir. 1988), cert. denied, 492 U.S. 906 (1989); Fisher v. Prudential Ins. Co. of America, 842 F. Supp. 397 (N.D. Cal. 1993) U.S.C. 1002(3). 4. Cf., Modzelewski v. RTC, 14 F.3d 1374 (9th Cir. 1994)(intent of parties does not determine ERISA coverage). 5. See 29 C.F.R (b); ERISA Section 3(1); 29 U.S.C. 1002(1). 6. Joanou v. Coca-Cola Co., 26 F.3d 96 (9th Cir. 1994). 7. Hawaii Teamsters Local 996 v. City Express, Inc., 751 F. Supp. 1426, fn. 1 (D. Hawaii i 1990); 29 U.S.C. 1002(1); severance is an enumerated benefit under Section 302(c) of the Labor Management Relations Act; 29 U.S.C. 186(c). 8. Nevill v. Shell Oil Co., 835 F.2d 209, 211 (9th Cir. 1987) (holding that retention benefits are subject to ERISA); but see, Fontenot v. NL Industries, Inc., 953 F.2d 960 (5th Cir. 1992)(executive compensation is not an ERISA-covered plan). 9. James v. Fleet/Norstar Financial Group, Inc., 992 F. 2d 463 (2d Cir. 1993)(retention pay is not ERISA plan); see also, Dranchak v. Akzo Nobel, Inc., 88 F.3d 457 (7th Cir. 1996)(ERISA does not cover executive pay and bonuses); 29 C.F.R (c) F.2d 1367, 1373 (11th Cir. 1982)(en banc); Hansen v. Continental Ins. Co., 940 F.2d 971, 977 (5th Cir. 1991)(first step in determining ERISA coverage is whether there is a plan at all). 11. Employment Contracts as Accidental ERISA Plans, ERISA LITIG. ALERT, May 1995, at 1; Silverman v. Barbazon School of Modeling & Fashion, Inc., 720 F. Supp. 966 (S.D. Fla. 1989)(employment contract memorializing provisions of ERISA plans was governed by ERISA). 12. Modzelewski v. RTC, 14 F.3d 1374 (9th Cir. 1994) (individual employment contracts created ERISA plan for ten executives); cf., Cinelli v. Security Pacific Corp., 61 F.3d 1437 (9th Cir. 1995)(board resolution and letter to president did not create ERISA plan until insurance was purchased).

6 13. Biggers v. Wittek Indus., 4 F.3d 291, (4th Cir. 1993) (severance pay understanding with one employee constituted an ERISA-covered plan); Williams v. Wright, 927 F.2d 1540, 1545 (11th Cir. 1991)( one-person ERISA-covered plan where all other requirements are met ); U. S. Dep t of Labor Adv. Op A (one-person arrangement constituted an ERISA-covered plan). 14. Scott v. Gulf Oil Corp., 754 F.2d 1499 (9th Cir. 1984); Brown v. Ampco-Pittsburgh Corp., 876 F.2d 546 (6th Cir. 1989)(severance pay plan covered by ERISA even though not communicated); Whittemore v. Schlumberger Technology Corp., 976 F.2d 922 (5th Cir. 1992)(management policy manual regarding severance was a sufficient enough document to create an ERISA-covered plan). 15. Modzelewski, 14 F.3d at Blau v. Del Monte Corp., 748 F.2d 1348, 1352(9th Cir. 1984), cert. denied, 474 U.S. 865 (1985); Scott, 754 F.2d at 1503; Orozco v. United Air Lines, Inc., 887 F.2d 949 (9th Cir. 1989); du Mortier v. Mass. Gen. Life Ins. Co., 805 F. Supp. 816 (C.D. Cal. 1992) F.3d 1023, 1028 (9th Cir. 1995). 18. Carver v. Westinghouse Hanford Co., 951 F.2d 1083, 1087(9th Cir. 1991), cert. denied, 112 S.Ct (1992). 19. Fraver v. North Carolina Farm Bur. Mut. Ins. Co., 801 F.2d 675 (4th Cir. 1986), cert. denied, 480 U.S. 919 (1987); Jervis v. Elerding, 504 F. Supp 606, 608 (C.D. Cal. 1980) (holding that individual agreement was not a plan); cf., Pane v. RCA, 868 F.2d 631 (3d Cir. 1989) U.S. 1, 12 (1987) F.2d 1319 (9th Cir. 1992), cert. denied, 507 U.S (1993); see also, Peterson v. American Life & Health Ins. Co., 48 F.3d 404 (9th Cir. 1995) F.3d 235 (9th Cir. 1994), cert. denied, 514 U.S (1995). 23. Degan v. Ford Motor Co., 869 F.2d 889 (5th Cir. 1989)(the preemption of state claims without an ERISA remedy is called a betrayal without a remedy ); Olson v. General Dynamics, 960 F.2d 1418 (9th Cir. 1991), cert. denied, 504 U.S. 986 (1992) F.3d 1313 (9th Cir. 1997). 25. Id. 26. Arizona Revised Statutes (A.R.S.) ; Schade v. Dietrich, 760 P.2d 1050, 1061 (Ariz. 1988)(construing A.R.S (5), which defines wages for purposes of , to include severance pay and bonuses). 27. Arizona Revised Statutes (A.R.S.) But see, Kulinski v. Medtronic Bio-Medicus, Inc., 21 F.3d 254 (8th Cir. 1994), app. after remand, 60 F. 3d 830(a statement of ERISA coverage does not create ERISA coverage). 29. Parker v. Bankamerica Corp., 50 F.3d 757 (9th Cir. 1995)(a good model of an ERISA-covered severance plan). 30. Stone v. The Travelers Corp., 58 F.3d 434 (9th Cir. 1995)(state age discrimination claim preempted under ERISA-covered severance plan); but see, Varity v. Howe, 516 U.S. 489 (1996)(permitting fraud claim). 31. ERISA Section 502; 29 U.S.C. 1132(e). 32. But see, ERISA Section 510; 29 U.S.C Houghton v. SIPCO, Inc. 38 F.3d 953 (8th Cir. 1994) W.L (N.D. Cal. Feb. 20, 1998).