Chicago-based Cragin Bank for Savings retained loan originators to obtain mortgage loan business. Each loan originator entered into an agreement with Cragin that established the conditions of the loan originator's work and compensation. The agreements stated that the individuals were independent contractors and not employees.
Cragin maintained an Employee Stock Ownership Plan ("ESOP"), but the loan originators were not allowed to participate in the plan. Cragin was purchased by ABN AMRO North America, Inc., which led to the termination and liquidation of the ESOP. This event prompted the loan originators to challenge their exclusion from participation in the ESOP. Cragin's ESOP was administered by a committee that was given discretion under the terms of the plan to manage the plan and to interpret its terms. The loan originators appealed to the committee and were allowed to present their claims, being represented by counsel, at a hearing before the committee. The committee determined that the loan originators were not employees within the meaning of the plan's definition and, therefore, were not entitled to ESOP benefits.
The Seventh Circuit Court of Appeals (Chicago) upheld the committee's decision in Trombetta v. Cragin Federal Bank for Savings Employee Stock Ownership Plan. The court noted that decisions of ERISA fiduciaries will be overturned only if they are arbitrary and capricious, so long as the fiduciaries are given discretion to interpret the plan. In this case, the plan explicitly allowed the committee to interpret its terms. The court would find the committee's decision arbitrary and capricious, it stated, only if no plausible basis existed for the committee's decision. In fact, the court observed, the committee considered the nature of the loan originators' jobs, their independence in obtaining customers and the intent of the parties in entering into the agreements. While some factors may have demonstrated an employer/employee relationship, there were sufficient other elements of independent contractor status to support the committee's decision.
Despite Cragin's success in this instance, employers that carelessly exclude individuals from participation in plans on the assumption that they are independent contractors may run some risk. In a widely publicized decision, the Ninth Circuit Court of Appeals recently held that Microsoft erroneously excluded so-called "freelancers" from participation in its 401(k) plan. Vizcaino v. Microsoft Corporation. Freelancers were supplemental employees who were integrated into Microsoft's regular work force and performed the same duties under the same supervision as regular employees. Microsoft learned to its considerable regret that it was not as free as it thought to exclude these employees from participation in its plan.
The irony is that Microsoft might well have been able to exclude freelancers from participation if it had used the right words. Employers are free to design plan coverage to cover some and exclude other employees, so long as discrimination rules of the Internal Revenue Code are satisfied. The trick in the first instance is to make it perfectly clear who is intended to be covered by the plan.
There are several lessons for employers in these cases.
First, don't be casual about independent contractor status. Misclassification of employees as independent contractors can have serious ramifications in a number of areas-payroll and employment taxes, labor law issues, and employee benefit coverage. Make sure that you have scrutinized your independent contractor relationships carefully and can justify independent contractor status according to strict legal tests.
Second, be certain that your employee plans clearly define who is covered and who is not
covered.
Third, make sure your employee plans grant fiduciaries-committee, administrator, or whoever-the discretion to interpret the terms of the plans.
Fourth, follow businesslike procedures in interpreting your employee plans and handling employee claims. Cragin did; Microsoft didn't.
Fifth, make a clear record of your decisions as plan fiduciaries and the reasons for your decisions. You may even be wrong on occasion, but if you make a good faith effort to examine the facts and to come to a reasonable, unbiased decision, chances are you won't be found arbitrary and overturned.