Outsourcing: ERISA Trap for the Unwary

With all of the political debate and media attention over employees losing their jobs due to outsourcing*, it is important to remember the possible exposure to liability that can occur as employers consider the option of outsourcing in its many…

With all of the political debate and media attention over employees losing their jobs due to outsourcing*, it is important to remember the possible exposure to liability that can occur as employers consider the option of outsourcing in its many forms. While time will not permit going into all of the legal exposure that can arise, one such area of vulnerability under ERISA comes to mind.

ERISA section 510 prohibits an employer from discharging an employee for the purpose of interfering with the attainment of any right to which the employee may become entitled under an ERISA plan. Courts have held that such practices as terminating employees based on benefits cost to the employer or changing the status of an individual from “employee” to “independent contractor” for such purposes have violated ERISA. What this means is that employers who terminate employees for the wrong reasons can be exposed to section 510 claims from disgruntled employees under ERISA. The issue is particularly relevant in today’s work environment as employers are faced each year with the daunting and reoccurring task of containing benefits costs.

How does the issue apply to employers who outsource work to outside contractors? According to the U.S. Supreme Court in the case of Inter Modal Rail Employees Ass’n v. Atchison, Topeka & Santa Fe Railway Co. , an employer cannot outsource work to a sub-contractor where the purpose of the outsourcing is to interfere with the benefit plan rights of plan participants. The employer in that case outsourced its employees to another company that did not provide equal health and pension benefits, and allegedly did so for the purpose of cutting its own health and pension benefits cost. The court held that the employer could be held liable for violation of section 510 of ERISA.

While it is true that oftentimes it is difficult for employees to prove that an employer terminated an employee for the purpose of interfering with benefits, employees have prevailed in many instances. A well-known example of the type of evidence that can prevail in a section 510 case appears in McLendon v. Continental Can Company, 749 F. Supp. 582 (D.N.J. 1989), aff’d sub nom., McLendon v. Continental Can Co., 908 F.2d 1171 (3d Cir. 1990) in which a sophisticated benefits liability avoidance system was utilized by the employer. Employees were able to show that the employer had devised a computer program which identified employees who were close to meeting the age and service requirements for certain pension benefits so that such employees could then be targeted for termination. The court in McLendon had no trouble in finding that the employer had violated section 510 of ERISA.

Others may recall the recent case of Millsap et al. v. McDonnell Douglas Corporation (read about it here and here) in which plaintiffs achieved a $36 million settlement for claims brought against their employer, alleging that the employer closed one of its plants for purposes of preventing employees from attaining eligibility for benefits under their pension and health care plans. The damaging evidence in that case were memos from the actuaries analyzing the reduction in benefits which would occur if the plant were closed. One such memo prepared by the actuaries (which was apparently not protected by attorney-client privilege) considered “various what if scenarios, analyzing the effect on costs and savings if the company decided to reduce heads.” The kinds of costs analyzed included “pension cost, savings cost, savings plan cost, health care cost, and just direct overhead cost.” According to the court in that case, the employees were only required to show that the employer’s alleged desire to block the attainment of benefits rights was a “determinative factor” in the challenged decision, i.e. the claimant was not required to show that it was the sole reason for closing the plant.

Conclusion: While there are many business reasons for embarking upon a path of outsourcing, the case law demonstrates how, under ERISA, making the decision to outsource for the wrong reasons could come back to haunt the employer. When considering this option, employers need to be wary that, while outsourcing may save costs, it could also lead to unexpected lawsuits and result in exposure to liability in some circumstances.

(*Outsourcing is the delegation of a business process to an external service provider. The service provider is then responsible for the hiring of employees to accomplish the delegated business process.)

2003 PwC Securities Litigation Study

PricewaterhouseCoopers has released its 2003 Securities Litigation Study. The 10b-5 Daily reports on a number of interesting statistics here as follows: (1) Of the 175 securities class actions filed in 2003, 107 were accounting-related. The primary allegation in accounting-related cases…

PricewaterhouseCoopers has released its 2003 Securities Litigation Study. The 10b-5 Daily reports on a number of interesting statistics here as follows:

(1) Of the 175 securities class actions filed in 2003, 107 were accounting-related. The primary allegation in accounting-related cases continues to be revenue recognition issues, alleged in over 50% of these cases.

(2) The percentage of cases with union/public pension funds as lead plaintiffs has grown steadily from 1996 (less than 3% of cases) to 2003 (28% of cases).

(3) Average settlement values for all cases settled in 2003 was $23.2 million, up 20% from 2002. There were an increasing number of large settlements, including 6 settlements of more than $100 million.

(4) PwC has begun to track “triple jeopardy” cases, where companies are subject to securities class actions along with SEC and DOJ investigations. There was an all-time high of over 40 of these cases in 2002, but last year saw this number fall to 8 cases (closer to historic norms).

The Study also had this to say about lawsuits against officers and directors:

Chief Executive Officers (“CEOs”) were named as defendants in 98 percent of all cases filed in 2003, up from 94 percent of cases filed in 2002. Chief Financial Officers (“CFOs”) were named as defendants in 86 percent of total cases filed in 2003, while the chairman of the board of directors was named as a defendant in over two-thirds of such cases. Other than not serving at all as a director or officer of an SEC registrant, the safest director or officer positions appear to be general counsel or members of the audit committees of boards of directors – very few cases filed in 2003 named either as defendants in private securities litigation

Also, the Study reports that “the largest numbers of cases filed in 2003 were in the Second and Ninth Federal Circuits, where the litigation epicenters are New York, San Francisco (and the Bay Area), Los Angeles and San Diego.”

Blogs, Wikis, and Blikis

Last week, the Wall Street Journal ran this very interesting article entitled "'Wiki' May Alter How Employees Work Together." According to the article, a wiki (the Hawaiian word for "quick") is a type of Website "that many people can revise,…

Last week, the Wall Street Journal ran this very interesting article entitled “‘Wiki’ May Alter How Employees Work Together.” According to the article, a wiki (the Hawaiian word for “quick”) is a type of Website “that many people can revise, update and append with new information.” The article describes wikis as a “giant bulletin board on an office wall to which employees can pin photos, articles, comments and other things.” Sounds sort of like a collaborative blog, doesn’t it? In fact the article mentions blogs as follows:

Getting average people to think about controlling the Web as comfortably as they might an e-mail or a Word document has not been easy. But the rise in popularity of Web logs known as blogs and other “social software” is changing that. Blogging, say wiki proponents, has revived the idea that a Web site can be an ever-changing organism that can be linked with other Web sites to create a larger and more informative picture. But if the blog is a soloist, a wiki is an orchestra. . .

The article goes on to discuss the enormous potential that the wiki has for the business workplace:

Now, venture capitalists are funding several startups that are attempting to take the idea to a bigger and more lucrative general-business audience. Their goal is to try to solve one of the workplace’s most vexing problems: how to have employees collaborate and communicate better electronically.

Perhaps wiki skills will soon be featured in the 21st century employee’s resume. (That thought reminds me of this comic here from the TaxGuru.) And wouldn’t wikis be a wonderful tool for law firms? Firms could have their own internal wikis on various legal topics so that knowledge could be cataloged and utilized by others in the firm and added to as statutes, regulations and case law change.

By the way, Dave Baker at Benefitslink has started a wiki here which readers can use. I believe if you go here, you can view what readers have posted so far, including this great tool–Free Sites For Keeping Current.

(Apparently, a “bliki” is a cross between a blog and a wiki. Read about it here.)

Director Liability for CEO Pay

This interesting op-ed by Geoffrey Colvin for Fortune magazine (via LexisNexis) entitled-"CEO pay meets its match: plaintiffs lawyers"-suggests that under recent Delaware case law, directors could be personally liable if they fail to analyze and monitor a CEO's compensation. Previous…

This interesting op-ed by Geoffrey Colvin for Fortune magazine (via LexisNexis) entitled–“CEO pay meets its match: plaintiffs lawyers“–suggests that under recent Delaware case law, directors could be personally liable if they fail to analyze and monitor a CEO’s compensation. Previous posts here and here discuss director liability in the ERISA arena for failure to monitor plan fiduciaries–a topic which has been a major focus of ERISA litigation in the last few years.

DOMA Under Fire

In this post yesterday, I discussed the interplay between the Defense of Marriage Act ("DOMA") and ERISA. This article here at Findlaw.com states that last week, a lawsuit was filed in federal district court in Florida challenging the constitutionality of…

In this post yesterday, I discussed the interplay between the Defense of Marriage Act (“DOMA”) and ERISA. This article here at Findlaw.com states that last week, a lawsuit was filed in federal district court in Florida challenging the constitutionality of DOMA. You can read more about the lawsuit here. This latter article suggests that “[n]umerous lawsuits nationwide are already challenging the constitutionality of DOMA.”

DOMA Under Fire

In this post yesterday, I discussed the interplay between the Defense of Marriage Act ("DOMA") and ERISA. This article here at Findlaw.com states that last week, a lawsuit was filed in federal district court in Florida challenging the constitutionality of…

In this post yesterday, I discussed the interplay between the Defense of Marriage Act (“DOMA”) and ERISA. This article here at Findlaw.com states that last week, a lawsuit was filed in federal district court in Florida challenging the constitutionality of DOMA. You can read more about the lawsuit here. This latter article suggests that “[n]umerous lawsuits nationwide are already challenging the constitutionality of DOMA.”

New Website

There is a new website sponsored by the National Human Genome Research Institute with information on "Genetic Discrimination in Health Insurance or Employment." The website allows you to research federal legislation on the topic as well as search a legislative…

There is a new website sponsored by the National Human Genome Research Institute with information on “Genetic Discrimination in Health Insurance or Employment.” The website allows you to research federal legislation on the topic as well as search a legislative database for state legislation.

The “Deductible Lifestyle”

Go read RothCPA.com's review of Ollett v. Commissioner, T.C. Summ. Op. 2004-103 and how Special Trial Judge Wolfe put a damper on the "deductible lifestyle" of taxpayers engaged in an unprofitable Amway business….

Go read RothCPA.com‘s review of Ollett v. Commissioner, T.C. Summ. Op. 2004-103 and how Special Trial Judge Wolfe put a damper on the “deductible lifestyle” of taxpayers engaged in an unprofitable Amway business.

The interplay of DOMA, ERISA, and other federal laws

Recent events in Massachusetts regarding marriage have spawned a plethora of law firm publications on the implications of same-gender marriage as it relates to benefit plans. You can access three of such publications here (Jackson Lewis), here (Ropes & Gray)…

Recent events in Massachusetts regarding marriage have spawned a plethora of law firm publications on the implications of same-gender marriage as it relates to benefit plans. You can access three of such publications here (Jackson Lewis), here (Ropes & Gray) and here (Goodwin Procter). However, this recent article published by the Congressional Research Service (“CRS”) of the U.S. Library of Congress (via Benefitslink.com)–“The Effect of State-Legalized Same-[Gender] Marriage on Social Security Benefits and Pension“– makes an interesting point regarding the interplay between ERISA and the Defense of Marriage Act (“DOMA”):

DOMA provides that, in interpreting any federal statute, ruling, or regulation —including, for example, ERISA and the Internal Revenue Code — a spouse can only be a person of the opposite [gender] who is a husband or wife. Consequently, a pension plan cannot be required to recognize a same-[gender] spouse even if same-[gender] marriages are permitted under state law. Some benefits specialists have suggested that because Section 514(a) of ERISA preempts state laws that relate to employee benefits covered by ERISA, ERISA would therefore preempt any state law requiring the plan to recognize same-[gender] marriage for purposes of administering pension benefits. However, whether ERISA alone would preempt state laws recognizing same-[gender] marriage is irrelevant because DOMA prohibits recognition of same-[gender] spouses in the interpretation and application of federal law.

While the technical points of whether DOMA prevails or ERISA preempts provide for interesting thought and discussion, one of the main concerns that the marriage issue raises with respect to benefit plans has to do with the fact that, for income tax purposes, the IRS has historically maintained that an individual is considered to be a “spouse” if the applicable state law recognizes the relationship as a marriage. If, for example, state law recognizes common-law marriages as legal, an employer in that state would be required to recognize an employee’s common-law spouse as his or her legal spouse and IRS would recognize the marriage as valid.

Similarly, many plan documents have defined the term “spouse” as looking to state law as well. This is important for qualified plans as it impacts such matters as pre-retirement survivor annuity and joint and survivor annuity requirements as well as requirements pertaining to spousal consent and qualified domestic relation orders. Now, after recent events regarding marriage, plans which still contain this language of defining the term “spouse” as looking to state law or plans which do not define “spouse” at all, are problematic in affected states since the language, if left unchanged, is confusing, implying that same-gender marriages might be recognized under the plan document when, in fact, DOMA would dictate otherwise. This is why it is important to amend plan documents and revise Summary Plan Descriptions to clarify the issue, particularly for companies with employees in affected states.

The CRS article goes on to discuss how Social Security, the Federal Employees Retirement System, and the Civil Service Retirement Systems are also governed by DOMA and, therefore, would not be affected by state law changes pertaining to the definition of marriage.

Additional note: The Ropes & Gray article also has this interesting discussion regarding the interplay of DOMA and the Family Medical Leave Act (“FMLA”):

The FMLA defines “spouse” as “a husband or wife, as the case may be.” The U.S.Department of Labor’s regulations implementing the FMLA add the following unusual gloss to that statutory definition: “’Spouse’ means a husband or wife as defined or recognized under State law for purposes of marriage in the State where the employee resides.” The FMLA regulations (unlike the statute on which they are based) thus command employers to look to state law to determine the meaning of “spouse” for purposes of applying the FMLA.

The article notes that an argument might be made that the FMLA requires employers to provide leave to employees to care for a same-gender spouse, were it not for DOMA which was passed three years after the FMLA’s enactment, arguably replacing the definitions of “spouse” set forth in the FMLA. The article goes on to note that this interpretation is supported by a 1998 Department of Labor opinion letter in which the Department’s Wage & Hour Division explicitly advised that DOMA restricts the FMLA’s definition of “spouse” to opposite-gender spouses.

So if DOMA restricts FMLA to opposite-gender spouses, what does this mean for the employer who goes ahead and provides leave for same-gender spouses? It probably means that the leave cannot be designated as FMLA leave, and therefore an employee who took the leave to care for a same-gender spouse could be entitled to “double” leave where leave was later taken again in the same 12-month period for a purpose specifically covered by the FMLA, such as care of a child or a parent.

The interplay of DOMA, ERISA, and other federal laws

Recent events in Massachusetts regarding marriage have spawned a plethora of law firm publications on the implications of same-gender marriage as it relates to benefit plans. You can access three of such publications here (Jackson Lewis), here (Ropes & Gray)…

Recent events in Massachusetts regarding marriage have spawned a plethora of law firm publications on the implications of same-gender marriage as it relates to benefit plans. You can access three of such publications here (Jackson Lewis), here (Ropes & Gray) and here (Goodwin Procter). However, this recent article published by the Congressional Research Service (“CRS”) of the U.S. Library of Congress (via Benefitslink.com)–“The Effect of State-Legalized Same-[Gender] Marriage on Social Security Benefits and Pension“– makes an interesting point regarding the interplay between ERISA and the Defense of Marriage Act (“DOMA”):

DOMA provides that, in interpreting any federal statute, ruling, or regulation —including, for example, ERISA and the Internal Revenue Code — a spouse can only be a person of the opposite [gender] who is a husband or wife. Consequently, a pension plan cannot be required to recognize a same-[gender] spouse even if same-[gender] marriages are permitted under state law. Some benefits specialists have suggested that because Section 514(a) of ERISA preempts state laws that relate to employee benefits covered by ERISA, ERISA would therefore preempt any state law requiring the plan to recognize same-[gender] marriage for purposes of administering pension benefits. However, whether ERISA alone would preempt state laws recognizing same-[gender] marriage is irrelevant because DOMA prohibits recognition of same-[gender] spouses in the interpretation and application of federal law.

While the technical points of whether DOMA prevails or ERISA preempts provide for interesting thought and discussion, one of the main concerns that the marriage issue raises with respect to benefit plans has to do with the fact that, for income tax purposes, the IRS has historically maintained that an individual is considered to be a “spouse” if the applicable state law recognizes the relationship as a marriage. If, for example, state law recognizes common-law marriages as legal, an employer in that state would be required to recognize an employee’s common-law spouse as his or her legal spouse and IRS would recognize the marriage as valid.

Similarly, many plan documents have defined the term “spouse” as looking to state law as well. This is important for qualified plans as it impacts such matters as pre-retirement survivor annuity and joint and survivor annuity requirements as well as requirements pertaining to spousal consent and qualified domestic relation orders. Now, after recent events regarding marriage, plans which still contain this language of defining the term “spouse” as looking to state law or plans which do not define “spouse” at all, are problematic in affected states since the language, if left unchanged, is confusing, implying that same-gender marriages might be recognized under the plan document when, in fact, DOMA would dictate otherwise. This is why it is important to amend plan documents and revise Summary Plan Descriptions to clarify the issue, particularly for companies with employees in affected states.

The CRS article goes on to discuss how Social Security, the Federal Employees Retirement System, and the Civil Service Retirement Systems are also governed by DOMA and, therefore, would not be affected by state law changes pertaining to the definition of marriage.

Additional note: The Ropes & Gray article also has this interesting discussion regarding the interplay of DOMA and the Family Medical Leave Act (“FMLA”):

The FMLA defines “spouse” as “a husband or wife, as the case may be.” The U.S.Department of Labor’s regulations implementing the FMLA add the following unusual gloss to that statutory definition: “’Spouse’ means a husband or wife as defined or recognized under State law for purposes of marriage in the State where the employee resides.” The FMLA regulations (unlike the statute on which they are based) thus command employers to look to state law to determine the meaning of “spouse” for purposes of applying the FMLA.

The article notes that an argument might be made that the FMLA requires employers to provide leave to employees to care for a same-gender spouse, were it not for DOMA which was passed three years after the FMLA’s enactment, arguably replacing the definitions of “spouse” set forth in the FMLA. The article goes on to note that this interpretation is supported by a 1998 Department of Labor opinion letter in which the Department’s Wage & Hour Division explicitly advised that DOMA restricts the FMLA’s definition of “spouse” to opposite-gender spouses.

So if DOMA restricts FMLA to opposite-gender spouses, what does this mean for the employer who goes ahead and provides leave for same-gender spouses? It probably means that the leave cannot be designated as FMLA leave, and therefore an employee who took the leave to care for a same-gender spouse could be entitled to “double” leave where leave was later taken again in the same 12-month period for a purpose specifically covered by the FMLA, such as care of a child or a parent.