As employers have become more attuned to their fiduciary responsibilities, plaintiffs’ attorneys have had to dig deeper to find a basis for suing plan sponsors. Two recent court decisions (Hutchins v. HP Inc and Perez-Cruet v. Qualcomm Inc) reflect diametrically opposing judicial responses to the same new litigation strategy,

The Claims

Both Hutchins and Perez-Cruet raise the same challenge. In both cases:

• There was an employer sponsored defined contribution plan. Each plan had a vesting schedule.
• Each plan generated forfeitures from the termination of unvested participants.
• Each plan had a provision allowing forfeitures to be used to reduce employer contributions or to pay for administrative expenses.
• In each case the plan fiduciary used these forfeitures to reduce employer contributions and not to pay for plan administrative expenses. And, in each case the participants paid the plans’ administrative expenses.

Each of these scenarios seems unremarkable and is consistent with the actions of many (if not most) plan administrators. Each of these employers was following their plan document and their actions reflected the provision of ERISA that plan fiduciaries  shall act “or the exclusive purpose of: providing benefits to participants and their beneficiaries; and defraying reasonable expenses of administering the plan” ERISA, Section 404 (emphasis added).

However, the plaintiffs viewed this situation differently. According to the plaintiffs, by using the forfeitures to reduce employer contributions (and not for plan expenses) each of these employers were relieved of the obligation to pay plan administrative expenses–in effect (according to the plaintiffs), each of these employers used the forfeitures (e.g., plan assets) for the employers’ financial benefit. And, in so doing (according to the plaintiffs) committed a slew of fiduciary breaches.

North vs South

These two cases—decided within a month of each other—both came from Federal district courts in California: Hutchins from Northern and Perez-Cruet  from Southern California.

As noted, these two courts reached opposite conclusions:

• The Hutchins court dismissed all claims, in effect determining that there was no legal basis for the claims. More specifically, the court concluded that the plaintiffs’ claims were so broad that they were, in effect, claiming that forfeitures could never be used for plan expenses (in conflict with “the settled understanding of Congress and the Treasury Department regarding defined contribution plans”). The court also concluded that the plaintiffs were effectively seeking to create a benefit—the payment of administrative costs (in conflict with ERISA’s statutory framework of not requiring any particular benefits, but only of protecting contractually provided benefits). The court also dispatched the legal theories behind the plaintiffs’ other claims.
• The Perez-Cruet court more readily accepted the plaintiffs’ claims that use of forfeitures to pay plan administrative costs could be seen as the employer improperly using plan assets for its own financial benefit—and, therefore, as a breach of fiduciary duties. Accordingly, this court denied the defendants’ motion to dismiss.

Reading these two cases almost gives the sense that these courts were interpreting different statutes. That said, the Hutchins decision reflects the ERISA that employers have been applying for the past fifty years and (in my opinion) represents a more thoughtful and correct interpretation of the statute.

In Closing

A few closing observations.

• These two decisions are definitely not the end of this discussion. Plaintiffs in Hutchins have already filed an amended complaint and the defendants in Perez-Cruet must now engage in a full defense of these claims. So, stay tuned.

• If the Perez-Cruet approach prevails, we can anticipate employers will scramble to address this new liability threat. Some food for thought—employers could obviate much (if not all) of the fiduciary risk surrounding plan expenses by (i) paying plan expenses out of employer assets, and (ii) making a commensurate reduction in  employer contributions. In effect, employers could convert a fiduciary judgement about plan expenses into a settlor decision about the amount of employer contributions.

• Section 404 ERISA states that fiduciaries shall discharge their duties “for the exclusive purpose of: (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan.” In effect, under ERISA both funding of benefits and paying plan expenses are equally valuable to participants. The plaintiffs’ attorneys disregard this and, in effect, seek to read ERISA as requiring that plan assets can only be used to pay plan benefits. Congress could have drafted such a structure—but did not.

• The Hutchins court noted that while the decision to apply funds to forfeitures (versus employer contributions) was a fiduciary decision, the decision to put a specific provision in a plan document (such as a provision mandating that forfeitures can only be used to reduce plan expenses) is a “settlor” function and, therefore, is not subject to fiduciary rules. Accordingly, if the Cruet-Perez perspective prevails, employers could (in theory) change their plan documents to specifically limit the use of forfeitures to plan expenses. There may be some obstacles to this approach—current volume submitter plan documents tend to include a “hard-wired” provision allowing use of forfeitures either for reducing employer contributions or payment of plan administrative expenses.

As noted above, stay tuned.