Be Careful Before Amending Your Severance Arrangement

In light of these uncertain times, it is likely that employers may be contemplating amending their severance arrangements, particularly to reduce benefits.  Before doing so, a severance arrangement should be analyzed to determine whether it constitutes an “employee benefit plan”, as defined under and subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA).  If the severance arrangement is considered an “employee benefit plan” and thus subject to ERISA, the severance plan and any amendments made thereto will be subject to ERISA’s disclosure and fiduciary requirements.  Although a consideration of tax issues is beyond the scope of this article, we note that any amendments made to a severance plan will require analysis of certain tax implications under Section 409A of the Internal Revenue Code of 1986, as amended.  Our compensation and benefits team is experienced in these issues and available to discuss them with you and answer any specific questions you may have.

In general, a severance arrangement constitutes an “employee benefit plan” under ERISA when the benefits provided require the employer to institute an “ongoing administrative program” to meet the employer’s obligation.1  This standard is open to interpretation, as courts generally follow a facts and circumstances test and do not always apply uniform standards.  Review of case law shows that the principle typically driving the court’s reasoning is the degree of direction given to an employer in administering severance benefits and deciding employee eligibility.2  In general, greater employer direction over administration means that the severance arrangement will be considered an ERISA plan.

ERISA’s disclosure requirements with respect to severance plans are generally after-the-fact disclosures, meaning that the employer will not have to disclose any potential amendment until a certain point after it becomes effective.  The written severance plan document and summary plan description must be furnished to newly eligible employees, and any amendments to the summary plan description are required to be provided every five years.  In addition, any material modifications to the severance plan are required to be provided within 210 days following the close of the plan year in which the material modification was made, and in some cases, certain changes require additional Form 5500 filing requirements by the plan sponsor.  Failure to follow ERISA disclosure requirements may result in steep civil penalties and potential criminal penalties.

The fiduciary duties imposed under ERISA with respect to severance plans include the general duties of loyalty and of prudence, which include a duty not to mislead or misrepresent and potentially an affirmative duty to disclose.  Employer fiduciaries of severance plans must consider these fiduciary duties prior to amending its severance plan to reduce benefits.  Currently, it is unclear as to whether there is an affirmative duty to disclose to participants proposed changes to an ERISA-subject benefit plan.  The argument for such a duty is grounded in the principle that transparent and timely disclosure protects the interests of plan participants, while the argument against such a duty is based on ERISA’s “two hats doctrine”, which recognizes that a plan sponsor employer engaged in amending an ERISA plan is acting solely as a “settlor” and not a fiduciary.  Review of case law shows a line of cases holding that ERISA plan fiduciaries have a duty to inform participants about possible changes to a plan if they are under serious consideration,3 suggesting that if an employer is seriously considering an amendment to reduce benefits under a severance plan this amendment should be disclosed to eligible employees prior to becoming effective.  This is particularly important because, if a court were to find that an amendment was not properly disclosed and a participant is terminated in reliance on severance benefits that are no longer in effect, this could be a potential fiduciary breach and any fiduciaries of the severance plan could be held liable.  The employer will be liable to pay any participant who was terminated during the period in which the amendment should have been disclosed the amount such participant was entitled to under the plan prior to the amendment effective date.  In addition, a finding of a fiduciary breach by a court may affect the operation of the amendment and could render it entirely void.

We recommend that any employers that are seriously considering amending their severance arrangements to reduce benefits first reach out to their counsel to determine whether their severance arrangements are subject to ERISA.  If the severance arrangement is subject to ERISA and it is likely that participants may experience the reduction in benefits sooner rather than later (i.e., the employer is also contemplating a reduction in workforce), it is highly recommended that the employer disclose the potential amendment to eligible employees as soon as possible.  While certain employers may not want to disclose this information, it is particularly important for employers to be proactive during these troubling times in protecting themselves from any breaches of fiduciary duties and related claims.

Endnotes    (↵ returns to text)
  1. Fort Halifax Packing Co. v. Coyne, 482 U.S. 1, 12 (1987).
  2. See Blair v. Young Phillips Corporation, 158 F. Supp. 2d 654, 658 (M.D.N.C. 2001); Kulinski v. Medtronic Bio-Medicus, Inc., 21 F.3d 254 (8th Cir. 1994); Delaye v. Agripac, Inc., 39 F.3d 235 (9th Cir. 1994); and Janover v. Bernan Foods, Inc., 901 F. Supp. 695, 699 (S.D.N.Y. 1995).
  3. See Fischer v. Phila. Elec. Co., 96 F.2d 1533, 1539 (3d Cir. 1996); McAuley v. IBM, 165 F.3d 1038, 1043 (6th Cir. 1999); Vartanian v. Monsanto Co., 131 F.3d 264, 268 (1st Cir. 1997); and Kovarikova v. Wellspan Good Samaritan Hospital, No. 1:15-CV-2218, 2018 WL 2095700 (M.D. Pa May 7, 2018).