Severance Plans and ERISA Compliance: Limiting Liability in Design and Implementation of Severance Arrangements

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Severance Plans and ERISA Compliance: Limiting Liability in Design and Implementation of Severance Arrangements TUESDAY, JUNE 12, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Kenneth J. Laverriere, Partner, Shearman & Sterling, New York Cydni Waldner, Of Counsel, Hawley Troxell, Boise, Idaho The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 1.

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5 SEVERANCE PLANS: ERISA AND SECTION 409A COMPLIANCE KENNETH J. LAVERRIERE PARTNER AT SHEARMAN & STERLING LLP CYDNI WALDNER OF COUNSEL AT HAWLEY TROXELL June 12, 2018

6 TOPICS ERISA framework Pension vs. welfare plans Severance arrangements vs. plans Issues, benefits and burdens of ERISA compliance Application of Section 409A of the IRC to severance plans Overview Application to severance plans Exceptions Compliance 6

7 APPLICATION OF ERISA TO SEVERANCE ARRANGEMENTS 7

8 WELFARE PLANS VS. PENSION PLANS ERISA regulates both pension plans and welfare benefit plans. Employee Welfare Benefit Plan: defined under section 3(1) of ERISA to include plans providing (i) medical, surgical, or hospital care or benefits, or benefits in the event of sickness, accident, disability, death or unemployment, or vacation benefits, apprenticeship or other training programs, or day care centers, scholarship funds, or prepaid legal services, or (ii) any benefit described in section 302(c) of the Labor Management Relations Act, 1947 (other than pensions on retirement or death, and insurance to provide such pensions). Employee Pension Benefit Plan: any plan, fund or program established or maintained by an employer that provides retirement income to employees, or results in a deferral of income by employees for periods extending to the termination of covered employment or beyond [emphasis added]. Presentation and Pitch Template Instructions Shearman & Sterling LLP 8

9 REQUIREMENTS GENERALLY APPLICABLE TO ALL PLANS Reporting Disclosure Fiduciary/prohibited transaction rule Claim procedures 9

10 PENSION BENEFIT PLANS ARE SUBJECT TO SPECIAL REQUIREMENTS Minimum participation standards Minimum funding requirement Vesting requirements 10

11 SEVERANCE PLANS: WELFARE OR PENSION PLANS? If certain conditions are met, severance plans will be treated as welfare plans Must provide payments that: Are not contingent, directly or indirectly, upon the employee s retiring Do not exceed the equivalent of twice the employee s annual compensation during the year immediately preceding the termination of service Are generally completed within 24 months after the termination of the employee s service (or, in the case of a limited program of terminations, 24 months after the employee reaches normal retirement age, if later) 11

12 WHEN IS A SEVERANCE ARRANGEMENT A PLAN SUBJECT TO ERISA? The Supreme Court has held that in order to constitute a plan, an arrangement must require an ongoing administrative program to meet the employer s obligation [emphasis added]. Fort Halifax Packing Co. v. Coyne, 482 US 1 (1987) 12

13 RECENT LITIGATION DEFINING A PLAN Second Circuit The Second Circuit District Court considers three factors in determining whether a severance plan is an ERISA plan: The employer s undertaking must have a commitment requiring managerial discretion A reasonable employee would perceive an ongoing commitment by the employer to provide employee benefits The employer is required to analyze the circumstances of each employee s termination, separable in light of defined criteria New York Times Co. v. Newspaper & Mail Deliverers Union of N.Y. & Vicinity, 2017 U.S. Dist. LEXIS

14 RECENT LITIGATION DEFINING A PLAN (CONT.) Fourth Circuit District courts in the Fourth Circuit generally analyze four factors to determine whether there is an ongoing administrative program: The payments are one-time lump-sum payments or continuous payments The employer undertook any long-term obligation with respect to the payments The severance payments came due upon the occurrence of a single, unique event in the course of business or on a recurring basis The amount of managerial discretion granted in paying the benefits and whether a case-by-case review of employees is needed Miller v. Driven Brands Shared Services, LLC, 2015 BL at 7 14

15 RECENT LITIGATION DEFINING A PLAN (CONT.) First Circuit In the First Circuit, courts have held that where an employee asserts claims for benefits provided outside of a formal ERISA plan, the claims are not subject to ERISA where: Eligibility for benefits can be characterized as employing a mechanical standard that is not subject to abuse The benefit is provided in a lump sum calculated by simple arithmetic The employer is not required to oversee any fund or a long-term financial commitment The employer is not otherwise subject to ongoing administrative burdens Gehrman v. Twin Rivers Paper Co., 2016 U.S. Dist. LEXIS , 2016 WL at 30 Presentation and Pitch Template Instructions Shearman & Sterling LLP 15

16 RECENT LITIGATION DEFINING A PLAN (CONT.) Third Circuit The Third Circuit will not find a plan to be an ERISA plan if the plan does not involve a new or ongoing administrative scheme. Simple or mechanical determinations do not necessarily require the establishment of an administrative scheme. The purpose of ERISA is to protect the administrative integrity of benefit plans. An ERISA plan should therefore exist when there is administrative activity potentially subject to employer abuse. Girardot v. The Chemours Co., No , 2018 BL (3d. Cir. April 30, 2018) 16

17 TYPES OF SEVERANCE PLANS Plans Typically Covered by ERISA: Broad-based severance plans Detailed policy statements (although often times they are not treated as such) Plans Not Typically Covered by ERISA: Employment agreements (unless there are many agreements) Individual separation agreements Non-binding statements of intent in personnel policies 17

18 KEY REQUIREMENTS A SEVERANCE ARRANGEMENT MUST SATISFY IF IT IS CONSIDERED A WELFARE PLAN GOVERNED BY ERISA A formal document plan and a summary plan description ( SPD ) Distribution of the SPD and other documents to participants, reflecting the plan in a clear manner so as to be understood by the average participant A Form 5500 annual report must be filed with the Department of Labor within seven months of the close of the plan year Adherence to a formal claims procedure 18

19 KEY REQUIREMENTS A SEVERANCE ARRANGEMENT MUST SATISFY IF IT IS CONSIDERED A WELFARE PLAN GOVERNED BY ERISA (CONT.) Plan must include a statement of ERISA rights Plan must be administered in accordance with ERISA s fiduciary obligations Summary Annual Report must be furnished to plan participants within nine months of the close of the plan year Exception: Any employee benefit welfare plan that has fewer than 100 employees at the start of the plan year is exempt from the Form 5500 requirement, as well as Summary Annual Report requirement. 19

20 ISSUES, BENEFITS AND BURDENS OF HAVING A PLAN SUBJECT TO ERISA Broad-based welfare plans are subject to ERISA s fiduciary, reporting and disclosure requirements, as discussed. This imposes an obvious burden on employers to meet those requirements. Compliance with these requirements minimizes the regulatory risk that an arrangement styled as a severance policy may not be in compliance with ERISA. ERISA preempts state laws, and therefore limits the types of claims that can be brought against an employer in respect of a severance plan. ERISA generally limits claims by employees to claims for benefits and breaches of fiduciary duty. 20

21 ISSUES, BENEFITS AND BURDENS OF HAVING A PLAN SUBJECT TO ERISA (CONT.) ERISA participants are required to exhaust a claims and appeals procedure before filing a lawsuit. Courts generally defer to the decision of the plan administrator following a proper review of a claim. In addition, the evidence presented to the court is typically limited to the evidence presented to the plan administrator. 21

22 ISSUES, BENEFITS AND BURDENS OF HAVING A PLAN SUBJECT TO ERISA (CONT.) ERISA litigation is usually decided by a judge, not a jury. A reasonable statute of limitations can be included to limit the time period in which a participant may file a suit. The plan document can generally dictate which state s law applies (to the extent a portion of the plan is not preempted by ERISA). The plan document can provide maximum discretion to determine eligibility and to calculate benefits. 22

23 TIPS TO SIMPLIFY ERISA COMPLIANCE Although ERISA contemplates both a plan document and a summary plan description, plan sponsors commonly use a single document to satisfy both requirements, and courts have blessed the practice (See Rhea v Alan Ritchey, Inc. Welfare Plan, 858 F.3d 340 at 344 (5 th Cir. 2017).) Determine whether you can take advantage of the exception from certain filings and deliverables for smaller plans. Consider including the severance policy as part of a wrap-around employee welfare benefit plan which would require the filing of only one Form Ensure your plan documents include the required claims procedure and statement of ERISA rights. 23

24 FAILURE TO COMPLY WITH ERISA REQUIREMENTS If your severance arrangement qualifies as an ERISA plan, and you do not comply with ERISA requirements, you will be subject to penalties, which include, without limitation: criminal penalties for wilful violation of reporting and disclosure requirements (29 USC 1131) civil penalties for failure to provide notice, or failure to implement regulations, for each day for which failure continues (29 USC 1452) civil penalties for failure or refusal to file the annual report (29 USC 1132) 24

25 ADDITIONAL CONSIDERATIONS Plan Provisions to Consider WARN Act: If the Company must provide 60 days notice due to a plant closing or mass layoff, severance amounts may be reduced by required notice (but not the reverse) State Laws: Many states have laws similar to WARN Amendment and Termination: Provide the plan administrator with the maximum amount of discretion to amend and/or terminate the plan Clawback Policies: Ensure amounts payable under the plan are subject to any company clawback or recoupment policy Release of Claims: Require plan participants to execute a release of claims prior to receiving any severance 25

26 APPLICATION OF SECTION 409A OF IRC TO SEVERANCE ARRANGEMENTS 26

27 SECTION 409A BACKGROUND Enacted as part of the American Jobs Creation Act of 2004 Covers non-qualified deferred compensation Amounts for which a legally binding right exists in one year and payment could occur in a future year Legally binding right Covers service providers ; broader than just employees 27

28 SECTION 409A COMPLIANCE Non-qualified and deferred compensation plans: Must be in writing May only pay out upon certain specified distribution events Must restrict acceleration of payment Must comply with timing of deferral elections 28

29 SECTION 409A DISTRIBUTION TRIGGERS Death Specified date or time Unforeseeable emergency Disability Change of control Separation from service 29

30 ACCELERATION RESTRICTED Generally, amounts may not be paid any earlier than stated in plan Common exceptions 30-day rule QDRO (divorce) Limited cash-out Taxes Plan termination No exchanges 30

31 INCOME TAX CONSEQUENCES FOR NONCOMPLIANCE All non-qualified compensation deferred under the plan is includible in gross income Unless subject to substantial risk of forfeiture Unless previously included in income Interest (IRS underpayment rate + 1%) on underpayment from later of year of deferral or lapse of substantial risk of forfeiture Penalty of 20% of amount included in income 31

32 SECTION 409A SEVERANCE ARRANGEMENTS Severance is non-qualified deferred compensation unless an exception applies No legally binding right to payment Short-term deferral Severance negotiated at time of termination as long as payment complete within same year or 2½ months following the end of the calendar year in which the agreement is entered into For existing agreements, payment within the short-term deferral period 32

33 SUBSTANTIAL RISK OF FORFEITURE When is there a substantial risk of forfeiture ( SRF )? Section 409A defines SRF as a service condition or the occurrence of a condition related to the purposes of the transfer Earnings goals or other requirements YES Noncompete NO Continued employment (as employee or contractor) YES Forfeiture upon termination for cause RARELY 33

34 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Involuntary termination programs Paid by end of 2 nd year following involuntary termination Does not exceed 2 x the lesser of (i) base salary at end of year prior to termination or (ii) qualified plan compensation limit ($275,000 in 2018) Note contrast with similar rule under ERISA Can also apply to window program if above conditions satisfied Window available no more than 12 months Employees separate during window under specified circumstances 34

35 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) What is an involuntary termination? Termination by the employer Resignation by the employee with good reason if general definition is satisfied or safe harbor is met General definition: Material negative change in employment relationship; must consider notice required by employee and whether severance amount is same as for involuntary termination 35

36 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Safe Harbor for Good Reason Termination occurs within limited period of time (no more than 2 years) after one of the following conditions arise without employee s consent: Material reduction in base compensation, employee s authority, duties or responsibilities or supervisor s authority, duties or responsibilities, reporting structure from board to management, budget Material change in location Material breach of employment agreement 36

37 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Safe Harbor for Good Reason (cont.) Amount, timing and form of payment of severance must be substantially identical to payment made upon involuntary termination Employee must give notice of condition within 90 days and employer has 30 days to cure 37

38 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Disputed entitlement Lump sum payment in settlement Amount cannot exceed 75% of employee s claim Collectively bargained plans Severance upon involuntary separation or window program Exception only applies to union employees covered by the CBA 38

39 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Expense reimbursements Amounts employee could otherwise deduct under Code Section 162 or 167 Reasonable outplacement and moving expenses In-kind benefits Expense incurred or benefit provided by end of 2 nd year following year of separation Reimbursements paid by end of 3 rd year following year of separation 39

40 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Continued medical coverage and medical reimbursement that is not taxable to employee Potential issue for discriminatory self-insured medical plan Continued life and disability coverage Exempt as welfare benefits even though could be taxable 40

41 SECTION 409A EXCEPTIONS SEVERANCE (CONT.) Limited amount exception Any payment(s) not exceeding Section 402(g) limit in the aggregate ($18,500 in 2018) 41

42 HOW TO COMPLY WITH SECTION 409A Easiest use exceptions to avoid Section 409A Exceptions are stackable Avoid impermissible toggles Exception for multiple payments Complicating issues Payment over time Good reason Requiring release 42

43 COMPLICATIONS OF RELEASE Timing issues with respect to signing Failure to meet short-term deferral rule Violation of Section 409A Corrections Agreement does not specify when payment begins or is made Agreement specifies period longer than 90 days Agreement specifies period of 90 days or less but commences payment upon signing 43

44 HOW TO COMPLY WITH SECTION 409A (CONT.) Separation from service Definition Continued service in different capacity Change in control issues Good reason Payment timing No acceleration 30 days No substitution 44

45 HOW TO COMPLY WITH SECTION 409A (CONT.) Specified employee issues Who is a specified employee Six-month delay applies to: Payments subject to Section 409A Which are payable due to separation from service 45

46 BEST PRACTICES Review Section 409A compliance Document how exceptions apply (if they do) Implement compliance plan to the extent necessary Modify plans/agreements if required to meet Section 409A exception/compliance goals Assure both documentary and operational compliance 46