Understanding Employee Benefits and key developments in the employee benefits field and items of interest to our clients. MORE

Employers are generally aware that medical plans are subject to continuation coverage under the federal law known as COBRA.  They may forget that COBRA extends to all group health plans, including dental, vision and medical flexible spending account plans. A recent federal district court decision highlighted the risk to employers who forget those facts.

The case, Evans v. Books-A-Million, from the Northern District of Alabama involves an employee who at the time she terminated employment was covered by the group dental plan, but not the group medical plan. She obtained new employment about five months later that provided her with dental coverage and during the time she did not have dental coverage, she did not incur any dental claims.

Sometime after her termination, the former employee called the employer to say that she had not yet received her COBRA notice. The employer’s COBRA processes were complicated and the employer’s explanations and excuses for failure to provide the COBRA notice were inconsistent. The employer could not prove that the notice was ever sent. The case went to trial, presumably because other issues besides the COBRA notice for dental coverage were at stake. With respect to the COBRA notice, however, the court concluded that the plaintiff was entitled to a statutory penalty for the employer’s failure to provide the notice from the 45th day following her termination of employment (because the plan administrator had 44 days to generate and mail a COBRA notice) to the end of the 18 month COBRA continuation period, a total of 506 days. The penalty can be as much as $110 a day; the court determined to impose a penalty of $75 a day in order to penalize the employer and to deter both it and other employers from similar conduct. The penalty to the employer: $37,950 for failure to give a dental COBRA notice. On top of this, the plaintiff was awarded $42,192.50 for attorney’s fees and $2,910.87 for costs for an aggregate of $83,063.45. Those amounts would have been even higher had the plaintiff not changed her position regarding the proper length of the penalty period between the beginning of trial and the end of trial, a change in position not supported by a change in law and which the judge viewed as an inappropriate gaming of the system.

The lesson for employers: Monitor COBRA processes because a failure to provide appropriate COBRA notices can be quite expensive, even if it is just for dental coverage.

Small employers (those who normally employ fewer than 20 full-time equivalent employees during the preceding year) are not subject to health care continuation requirements under the law known as “COBRA.” (Some states have their own “mini-COBRA” laws; this post is speaking only about the federal requirements.) A recent district court decision from Ohio considered the situation of a small employer that issued a COBRA notice to a former employee who then elected and paid for COBRA coverage. After the former employee had been covered under COBRA for at least 12 months, the former employee filed a complaint with the U.S. Department of Labor (DOL) on some issue relating to the COBRA coverage. The DOL informed the employer that it was not subject to federal COBRA law because of its small size. The employer at that point terminated the COBRA coverage retroactively and refunded the premiums to the former employee who, not surprisingly, sued to be reinstated to the coverage. The district court determined that the employer had superior knowledge of whether the employer was covered by COBRA and so was equitably estopped from now denying COBRA coverage to the former employee. The former employee had clearly relied on the offer of COBRA coverage and it was unfair for the employer to decide more than a year later that it did not have to provide the coverage.

Employers should pay attention  to COBRA requirements and to the provisions of their health insurance contracts to make sure that they are following the terms of the contracts and providing accurate information about those requirements to plan participants. Employers who make errors in that regard may be held to the information that they gave the employees.

Employers should also note that under the Affordable Care Act, the new healthcare reform law, the retroactive termination of coverage in this situation would likely not be permitted.

I blogged earlier in the year about a decision in which a district court concluded that various related companies were part of a controlled group of trades or businesses and therefore liable for the withdrawal liability of one of the companies. In that case, the court noted that to be a trade or business the taxpayer’s activities had to be different from “investment activities or hobbies.” Now comes a different district court opinion that reaches a contrary conclusion. The case is Sun Capital Partners III L.P. v. New England Teamsters and Trucking Industry Pension Fund from the District of Massachusetts.

The Sun Capital case involves a private equity fund that had made an investment in a company that participated in a multiemployer pension plan. When that business withdrew from the pension fund and was unable to pay the withdrawal liability, the pension fund sued seeking to hold the private equity fund and its other investments liable for the withdrawal liability. The district court rejected the pension fund’s contention and held that the private equity fund’s investment in a trade or business did not cause the fund’s activities to constitute a trade or business. Therefore, there was no controlled group of trades or businesses and the equity fund was not liable for the unpaid withdrawal liability.

In reaching this conclusion, the district court rejected as unpersuasive a Pension Benefit Guaranty Corporation (PBGC) Advisory Opinion from 2007 that had concluded that a private equity fund that invested in other businesses was itself conducting a trade or business.

This new case provides support to hedge funds and other private equity funds that their portfolio companies are not part of a controlled group of trades or businesses for withdrawal liability and possibly other controlled group testing purposes. It will be interesting to see how these cases play out at the appeals court level.

A standard part of an executive compensation package can be participation in a nonqualified deferred compensation plan. This is a plan not subject to tax code limitations on qualified retirement plans and not subject to many provisions of ERISA, including the requirement that plan assets be set aside in a trust, protected from company creditors. To be exempt from ERISA requirements a nonqualified deferred compensation plan must be unfunded and maintained “primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” This group of higher level employees is sometimes called the “top hat” group.

Unfortunately, ERISA does not contain a definition of “select group of management or highly compensated employees.” There have been court cases over the years defining the term. A recent decision from the federal district court for the Eastern District of Kentucky considered the percentage of the total workforce invited to join the plan (less than 1%) and the nature of the plan members’ employment duties (generally high ranking management personnel) to determine that the plan constituted a top hat plan.

What was interesting about the decision was the court’s consideration of an argument that the plan did not qualify as a top hat plan because a few plan participants were not “high ranking management personnel.” The court rejected that argument, holding that so long as the plan was maintained “primarily” for the purpose of providing the deferred compensation for the top hat group, the plan met the “top hat” group requirement.

Although the better practice is to limit participation in nonqualified plans to those who are clearly within the top hat group, this case provides support for an employer who, for whatever reason, finds that a few of the plan’s participants might not meet the top hat requirements.

Pactiv Corporation sponsored a severance plan subject to ERISA. The plan required an employee to sign a separation agreement and release in a “form acceptable to the company” in order for the employee to be entitled to a payment under the plan. The severance plan itself did not contain a no compete provision. When an employee terminated employment, the employee was presented with a separation agreement that contained a no compete provision. The employee refused to sign and sued instead for the severance payment of $99,676. The court found in favor of the employee. Even though the employer had some discretion with respect to the form of separation agreement, the court would not permit the employer to condition the severance payment on compliance with a no compete. To add such a requirement, the employer should have amended the severance plan; the proposed separation agreement was not itself such an amendment.

Employers wishing to impose a no compete as a condition for an employee to receive severance pay should make sure that the no compete is part of the severance plan. Of course, the employer should also make sure that the no compete is consistent with applicable state laws (to the extent those state laws are not preempted by ERISA – which is another whole topic).

Although our main office is in Minneapolis, Minnesota, we have clients located in other parts of the country, and ourselves have an office in Washington, D.C. Some of our clients have employees who have been hard hit by Hurricane Sandy. Employers want to help their employees, and employees not affected by the hurricane want to help their colleagues.

Section 139 of the Internal Revenue Code allows employers to give aid and assistance to employees and others adversely affected by a presidentially declared disaster. Hurricane Sandy is a presidentially declared disaster. Under Section 139, an employer can pay or reimburse employees or other individuals for unreimbursed reasonable and necessary personal, family, living or funeral expenses, such as medical, temporary housing, or transportation expenses, that they incur as a result of the disaster. The amounts so reimbursed are excluded from gross income of the employees and the employees do not have to account to the employer for how the amounts were spent.

We would be happy to assist employers in establishing programs to help employees struggling in the aftermath of Hurricane Sandy.

A recent tax court decision considered the impact on a highly compensated participant of an ESOP that was disqualified retroactively for the period 2000-2004. The highly compensated participant was fully vested in the ESOP from its inception to its disqualification. The highly compensated participant argued that only the portion of the benefit that accrued during 2004, which was the only year for which the statute of limitations was still open, could be included in his income. The IRS argued that under Section 402(b)(4)(A) of the Internal Revenue Code the entire vested accrued benefit should be included in the participant’s income in the year that the plan was disqualified. In other words, even though the benefits had accrued over a number of years, according to the IRS, the participant should be taxed on the entire vested benefit in the year the plan was disqualified. The court agreed with the IRS: Because the participant had never paid tax on any of the accrued benefit, the entire vested benefit was included in income in that year. The case highlights the fact that plan disqualification can result in adverse tax consequences to highly compensated plan participants, in addition to the adverse tax consequences experienced by the plan sponsor.

The Pension Protection Act of 2006 added Section 401(a)(35) to the Internal Revenue Code generally effective for plan years beginning after December 31, 2006. That section provides in general that defined contribution retirement plans that hold employer securities that are publicly traded must give plan participants the right to diversify their amounts out of the employer securities. There are exceptions to that rule for stand alone employee stock ownership plans and one participant plans. This Code section applies to the plan of an employer whose own shares are ”publicly traded”. It also applies to a plan if any member of the employer’s controlled group of corporations has issued a class of stock which is publicly traded.

In a recent private letter ruling, the IRS considered the situation of a company that had a class of preferred stock traded on the over-the-counter bulletin board. The IRS ruled that this stock was not publicly traded because the regulations under Section 401(a)(35) require that the employer security be traded on an exchange registered under Section 6(a) of the Securities Exchange Act of 1934 or under certain foreign exchanges. Under that Act, the New York Stock Exchange and NASDAQ, among others, are registered. However, the over-the-counter bulletin board and the so called “pink sheets” trading systems are not listed exchanges. Therefore, although shares of the employer were traded on the over-the-counter bulletin board, the shares were not treated as “publicly traded” and the plan was not required to meet the diversification requirements of Section 401(a)(35).

Private letter rulings cannot be relied upon by other employers. In addition, employers must be careful about relying on interpretations of a phrase under one tax code section when figuring out what another code section means.  For example, the regulations under Section 409A of the tax code, under which key employees of publicly traded companies must defer payment of deferred compensation for at least six months after separation from service, use a different definition of publicly traded securities that includes over the counter markets.  Nevertheless, this ruling gives an indication of the IRS’s thinking with respect to the definition of publicly traded securities for purposes of the diversification requirement. Employers whose only publicly traded stock is traded on the over-the-counter market or the pink sheets and whose stock is also held in the employer’s qualified defined contribution plan may be able to avoid the diversification requirement.

A recent Eighth Circuit Court of Appeals decision considered the situation of a participant covered under a self‑funded ERISA plan who sustained injuries in a slip and fall accident. The plan paid health benefits for that accident. The participant also obtained compensation by settling a civil lawsuit. Like many self‑funded medical plans, this plan required a participant who received such a settlement to reimburse the plan for the benefits it paid. However, the participant declared bankruptcy so did not repay the plan.

In connection with the civil suit, the plan had notified the participant’s attorney of the plan’s subrogation right. The attorney had twice acknowledged that right. However, the attorney did not sign a subrogation agreement with the plan. When the attorney received the settlement money, it retained the amount that was to be reimbursed to the plan for about a month but then paid the amounts to the participant. Because the plan was unable to obtain reimbursement from the participant, the plan sued the attorney for the money.

The Eighth Circuit Court of Appeals determined that the plan could not recover and in fact required the plan to pay the attorney’s fees of the attorney who was sued. Recent U.S. Supreme Court decisions have addressed the extent to which plans can recover damages from their participants. The Supreme Court has emphasized the fact that plans are entitled to “equitable relief,” which does not generally include money damages. The court of appeals found that the plan did not have an equitable claim against the attorney because the attorney had already disbursed the settlement amount to the participant. There was no specific fund that the plan could claim equitably belonged to it.

The plan also was not permitted to enforce its subrogation right directly against the attorney because the attorney had never agreed to it. Although the attorney had acknowledged the plan’s right to subrogation, the attorney had not signed a subrogation agreement so was not contractually bound by the subrogation obligation.

The message for self‑funded plans is to be diligent in protecting their subrogation rights. One alternative is to attempt to have attorneys representing plan participants in a civil suit sign an agreement to reimburse the plan from settlement proceeds. However, an attorney may decline to do so. Another alternative would be for the plan to join the civil suit so that it is involved directly in settlements and judgments. If the civil suit is not in federal court, the plan may bring its own federal court action to protect its subrogation rights.  While intervention will protect the plan, it may also result in higher costs to a plan to enforce its subrogation rights. It will be more difficult, at least in the Eighth Circuit, for plans to sit back, wait for the participants and the participants’ attorneys to recover from third parties, and then try to collect amounts that the plans have paid as medical benefits on behalf of participants.

The Supreme Court has accepted for review in its upcoming term a case that raises issues about subrogation and the right of an ERISA plan to recover from participants who are not fully compensated for their injuries. Plans that aggressively enforce their subrogation rights should watch for developments in this rapidly changing area of law.