Should You 'ERISA-fy' Your Severance Plan?

If ERISA applies to the plan, then it is necessary to determine whether it is an ERISA “retirement plan” or an ERISA “welfare plan.” Although it may seem that a severance plan is neither for retirement (like a 401(k) plan) or welfare (like a health plan), a severance plan will be an ERISA retirement plan (whether or not that is the intention) if it provides for any of the following:

• payments exceeding two times the employee's annual compensation; or
• payments over a period time exceeding 24 months; or
• payments that are contingent upon the employee reaching retirement age (instead of just upon termination).

What Are the ERISA Requirements?

All ERISA-covered severance plans, whether welfare plans or retirement plans, must satisfy three requirements. First, the plan administrator must deliver a summary plan description (SPD) to all participants. Second, the plan administrator must file an annual report (Form 5500) for the plan, either on its own or as part of the welfare “wrap plan,” if the employer uses a wrap plan to document all the ERISA-required language and plan terms for the employer's welfare benefits. Third, the severance plan must set forth the ERISA claims procedures ' largely boilerplate language ' for participants who wish to appeal a denial of their claims.

Severance plans that are ERISA retirement plans are subject to additional requirements. For example, ERISA-covered retirement plans must satisfy the ERISA funding rules, including that plan benefits vest over a specific period of time and that the plan satisfy certain participation requirements. To satisfy these rules, the plan must generally be funded through a trust. These rules are in addition to the SPD, annual reporting and claims procedure requirements that apply to all ERISA plans. For these reasons, most employers try to avoid characterizing their severance plan as a retirement plan.

Are There Benefits to Being Subject to ERISA?

Yes. Even though ERISA imposes some requirements, there are significant benefits. First, having a plan subject to ERISA means that it may not be subject to state law severance requirements, because ERISA generally preempts similar state laws. This is particularly important if an employer has employees in two or more states or wants to design a plan that differs from the applicable state's law. Second, if the plan gives the administrator discretion to make decisions (as is required for the plan to qualify under ERISA), those decisions will generally be respected by a court unless they are arbitrary or capricious. Third, if the plan is sued, the right to a jury trial is very limited under ERISA. Fourth, the employer can require a release of claims and compliance with non-compete and confidentiality restrictions in exchange for the severance benefits offered, which may not be allowed under state law. Fifth, a plan subject to ERISA can provide an offset for WARN payments, which may not otherwise be possible under state law. Sixth, there is great flexibility in designing eligibility provisions, provided that there is no discrimination against any protected class of employees.

How to 'ERISA-fy' the Severance Plan

To create an ERISA-compliant plan (or convert an existing one), the first step is to design the plan terms, including eligibility and benefits to be provided (which may include cash, accelerated equity-award vesting, outplacement service, etc.). In the design phase, employers must also consider whether adjustments need to be made to comply with Section 409A of the Internal Revenue Code or employment discrimination laws. Next, employers must document these decisions in a written document that also includes the ERISA claims procedures and certain other provisions, and then create an SPD describing the plan for distribution to participants. To keep things as simple as possible, some employers opt to create a document that serves as both the plan document and the SPD. Finally, the employer needs to assign responsibility to a person or group to file the annual report and provide participants with summary annual reports.

Conclusion

For the reasons described above, all employers with severance plans should consider whether it would be beneficial to bring those plans within the scope of ERISA. While the employer may incur some additional administrative “housekeeping” inconvenience by doing so, “ERISA-fying” the plan will provide some valuable legal benefits that non-ERISA plans do not enjoy.

John D. Shyer, a member of this newsletter's Board of Editors, is a partner in the New York office of Latham & Watkins LLP, and co-chair of the firm's global labor and employment law practice group. Sandhya P. Chandrasekhar is a benefits and compensation counsel in the firm's Chicago office.