Phantom Stock Plans.
Companies award phantom stock to give employees a stake in the equity growth of the company without actually letting them own shares. In a typical plan, an executive is awarded a number of phantom stock units with a notional value equal to the value of the same number of shares of company stock. The units are supposed to make the executive work hard to increase the value of the stock. If he succeeds, at some future date he is paid out either the increase in the value of the phantom units or the entire value of the units.
So, the Bull Moose Tube Company had such a plan whose salient features permitted executives to exercise their units any time after a five-year vesting period or to wait to cash out until their termination, retirement, death, disability, or a change of control. Unfortunately, something went bump in the night and three long-term executives, with long since vested options, were discharged and Bull Moose refused, contrary to the terms of the plan, to cash out their units. The executives sued under ERISA, claiming that the plan fit ERISA’s definition of an employee pension benefit plan, i.e., a plan that either pays retirement income or defers income to termination of employment or beyond. Their focus on the right to exercise at retirement was bought by a lower court. The appellate court reversed, holding that ERISA’s exemption of bonus plans from the definition of an employee benefit plan applied. Emmenegger v. Bull Moose Tube Company, 1999 U.S. App. LEXIS 30579 (8th Cir. 11/24/99). The court focused primarily on the fact that while income could be deferred to termination of employment or beyond, the plan design did not require such deferral and many other executives did in fact receive income currently by exercising their units prior to termination. The upshot is that no relief is available under ERISA and the executives are left to pursue their Bull Moose under state contract law.
Severance Plans.
In addition to being denied their phantom stock benefits, the dismissed Bull Moose executives were also denied severance pay. Whether severance arrangements are covered by ERISA involves more hair-splitting reasoning than is true of the phantom plans. If you recall that the definition of an ERISA pension plan is a plan that defers income to termination of employment or beyond, you can be excused for thinking that severance might be a pension plan because benefits invariably are paid at termination rather than before. It is not that easy because ERISA expressly defines severance to be a welfare benefit rather than a pension benefit, but in any event to be covered by ERISA.
The principal legal issue that has arisen with severance is not whether it is an ERISA benefit but whether the severance arrangement is an ERISA plan. Interestingly, although ERISA applies only to plans, maybe in an effort to keep lawyers busy, it never defines the term “plan.” This leads to interesting results. Some years ago the Supreme Court looked at a Maine statute requiring employers who shut down a plant to pay all affected employees a prescribed lump sum payment. Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987). Presumably miffed because an employer simply ignored the state law, the Supremes held that the Maine-mandated payments were not a “plan” because a plan requires some sort of ongoing administration that was not present. Fort Halifax, has played right into the hands of employers who would rather not treat severance arrangements as ERISA plans (the list of reasons is long: not wanting to create expectations, not wanting to hand out SPDs to employees because severance is a negative thought best left in the closet, believing severance is just a policy like a bonus policy rather than a plan, too much work, etc.). Not surprisingly, severance policies often fail to comply with ERISA — there often are no plan documents, no SPDs, no Form 5500 filings, etc. From a legal perspective, this is not a place one wants to be. First, despite Fort Halifax, courts almost uniformly distinguish this case when dealing with employer-sponsored (as opposed to state-mandated) arrangements. This was true in Bull Moose where the court found that there was sufficient on-going Bull Moosing for the arrangement to constitute a “plan:” (1) payments were not made due to a one-time event, such as a plant shut down, but periodically over time as employees terminated and (2) discretionary judgments (i.e., an administrative effort) had to be made over who did and who did not qualify for a benefit.
Besides the fact you are likely to lose the issue in court, we think an employer almost always gains more control over its own destiny if its severance plan complies with ERISA: you will be forced to put things in writing, which means you can establish the terms of any dispute (for example, by having the plan say that all benefits are payable subject to the employer’s sole discretion), you pick the law that applies in any dispute (federal), you pick the forum in which the dispute will be resolved (federal court), and you avoid the embarrassment (to say nothing of getting off on the wrong foot) of having to face a judge who wonders why you never gave employees an SPD or why you can’t produce a plan document, etc. Hence, we recommend putting severance into your ERISA compliance to-do list.
Top Hat Plans.
A top-hat plan is an unfunded deferred compensation plan for a select group of management or highly compensated employees. Because such a plan defers compensation to termination of employment or beyond, it fits ERISA’s pension plan definition. However, because such plans cover only big boys who are presumed to have enough clout to protect their interests without big brother’s help, none of ERISA’s substantive protections apply. The plans are subject only to a modest filing requirement and to ERISA’s enforcement proceedings. Hence, if an employer tries to stiff an executive, it can end up on the receiving end of an ERISA lawsuit. Example: Koenig, an executive of Waste Management, was covered by a SERP (#147Supplemental Executive Retirement Plan”) valued at $2.6 million. The SERP had one provision permitting forfeiture for certain bad acts and another provision that prohibited any plan amendment that would reduce or impair benefits without a participant’s consent. About the time of a change in control, Koenig resigned. About this same time, the SERP was terminated and all participants except Koenig and three others were paid their benefits in a lump sum. Koenig was not paid because the SERP was amended to require that his benefit be put in an escrow account while a committee looked into whether he had engaged in bad acts of the type requiring a forfeiture of benefits. Koenig sued under ERISA, claiming that the delay in paying his benefits violated the plan’s provision requiring his consent to any amendment that impaired benefits. The court agreed that this was a valid claim under ERISA and refused the employer’s motion to dismiss the action. Koenig v. Waste Management, Inc., 1999 U.S. Dist. LEXIS 19240 (N.D. Ill. 12/6/99). The case contains some object lessons for executives about deferred compensation: (1) you can easily get stiffed by your employer; all deferred comp really gives you is a right to sue your employer on the benefit promise; (2) changes in control are often dangerous to your deferred compensation health; (3) if you decide to do legal battle to get your benefit, your first reaction will probably be to sue in state court for a breach of contract, which will probably result in your getting jerked around by your employer’s claim that the action is covered by ERISA and you sued in the wrong court. In other words, while there is a certain cachet in being covered by deferred compensation, a cache of current cash can be a surer thing. The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require and further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative.