Putting on the Top Hat: Relying on ERISA to Protect Executive Deferred Compensation

Suppose the deferred compensation component of an executive’s change of control or employment agreement, or the company’s executive compensation plan, contains hurdles or exceptions to vesting or, even, a cliff vesting provision – such as requiring employment for at least five years before entitlement attaches. Suppose the executive is denied benefits based on disputed factual allegations, or is terminated after being employed for four years and ten months.  Is the compensation lost?  That may depend on whether the executive can successfully challenge the adequacy and fairness of the benefit denial process or, alternatively, prove that the reason for the termination was to prevent the vesting.

Under Massachusetts contract law, neither party is necessarily given deference in their decision making; and if the company terminated the executive to prevent vesting, the company may be held to have breached the covenant of good faith and fair dealing, as that covenant is applied to executive employment agreements under Massachusetts law. See, e.g., Williams v. B&K Medical Systems, Inc., 49 Mass. App. Ct. 563, 569 (2000) (such covenant requires that neither party do anything to rob the other of the fruits of the contract); see also Cataldo v. Zuckerman, 20 Mass. App. Ct. 731 (1985) (where identifiable, future benefit is reflective of past services and specifically related to such past services, covenant applied where employee terminated prior to completion of project in which he was to have received interest); Fried v. Singer, 242 Mass. 527, 531 (1922) (where performance is to be evaluated per the satisfaction of the employer, the employer must act in “good faith” in making such evaluation).  If the executive is forced to incur legal fees and other costs to enforce contractual rights, e.g. the covenant of good faith and fair dealing, those costs (including legal fees) may be recoverable against those who tortuously interfered with contractual rights. See, e.g., O’Brien v. New England Tel & Tel, Co., 422 Mass. 686, 696-97 (1996).

But what if Massachusetts law does not apply and the applicable law does not include comparable doctrines?

Top Hat Plans

Relying on Federal law, executives may allege that they are the beneficiaries of what are called top hat plans and seek the protections of the Employee Retirement Income Security Act of 1974 (ERISA). A top hat plan is a plan which is “‘unfunded’ and ‘maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.’” Alexander v. Brigham & Women’s Physicians Org., Inc., 513 F.3d 37, 43 (1st Cir. 2008) (quoting 29 U.S.C. § 1051(2)).  Even a single beneficiary plan – such as individual employment agreements – may be a top hat plan. See O’Leary v. Provident Life and Accident Ins. Co., 456 F. Supp. 2d 285, 294 (D. Mass. 2006).

ERISA §503

Top hat plans are exempt from many ERISA requirements, such as the fiduciary requirements imposed by ERISA on plan administrators; and the standard of review to be applied by a court in reviewing a benefit denial may be an enforceable provision of the plan. However, as held in a case recently decided in Massachusetts, top hat plans are subject to many of ERISA’s procedural requirements, including, but not limited to, those of 29 U.S.C. § 1133 (also known as ERISA § 503) regarding adequate written notice of the specific reasons for denial of benefits and a full and fair review. See McCarthy v. Commerce Group, Inc., Civil Action No. 09–CV–10161–PBS, 2011 WL 6357800, at *17-20, 27-28  (D. Mass. Dec. 16, 2011) (awarding attorney’s fees and ordering that such review be conducted by a neutral investigator approved by the court).  In McCarthy, the court held that, even though the contract in question provided deference to the plan administrator’s decisions, the standard of review would be deferential only to the extent that the plan administrator acted reasonably and in good faith. See id. at *16-17.  The court further held that procedural irregularities constitute an abuse of discretion when they are serious, have a connection to the substantive decision reached, and call into question the integrity of the benefits denial decision itself. See id.

Abuse of Discretion and the Structural Conflict of Interest

Furthermore, the court noted that “putting on a top hat doesn’t mean you can forget the conflict tails” and that the “structural” conflict of interest – i.e., the financial incentive of the plan administrator to deny the benefits claim—must be factored into the court’s determination regarding abuse of discretion. See id. at *21-22.  Specifically, “[t]his conflict of interest fundamentally undermines the integrity of the … decision-making process, in part, because [the plan administrator] took no steps to mitigate the effects of this conflict by walling off claims administrators from those interested in firm finances, or by imposing management checks that penalize inaccurate decision-making irrespective of whom the inaccuracy benefits….” See id. at *22 (internal citations omitted).   In so holding, the court applied, inter alia, MetLife Insurance Company v. Glenn, 554 U.S. 105, 108, 117 (2008) which holds that a structural conflict of interest – rising from a dual role as an ERISA plan administrator and the payer of plan benefits – is “a factor in determining whether the plan administrator has abused its discretion …” and that “[t]he conflict of interest … should prove more important (perhaps of great importance) where circumstances suggest a higher likelihood that it affected the benefits decision.”

ERISA § 510

A different strategy is dependent not on the company’s procedural failures but, rather, on proof of unlawful motive. If an executive’s employment is terminated so as to prevent vesting in benefits available under a top hat plan, such termination is unlawful, and, if not remedied as a result of the full and fair review,  actionable against both the company and any individuals who took part, because it is “unlawful for any person to discharge … for the purpose of interfering with the attainment of any right to which such participant may become entitled under” an ERISA-governed plan. 29 U.S.C. § 1140 (also known as ERISA § 510).

Suppose the company asserts that it had discretion to terminate the executive’s employment at will, or even good cause to do so. Neither assertion, in and of itself, defeats an ERISA § 510 claim.  If one or more lawful explanations for the termination are asserted, the executive need only prove that those accused of violating ERISA § 510 were “at least in part motivated by the specific intent to engage in activity prohibited by § 510.” Dister v. Continental Group, Inc., 859 F.2d 1108, 1111 (2nd Cir. 1988); see also Barbour v. Dynamics Research Corp., 63 F.3d 32, 37 (1st Cir. 1995) (citing Dister for the proposition that the § 510 plaintiff’s obligation was to prove that the interference with benefits was a “motivating factor”).  Moreover, if a structural conflict of interest exists, the holding of MetLife Insurance Company v. Glenn, discussed above, will apply.

ERISA § 502

Under 29 U.S.C. § 1132 (also known as ERISA § 502), in a civil action, an executive may obtain plan benefits, equitable relief, and attorneys’ fees and costs; provided, however, in an ERISA § 510 action, plan benefits are likely unavailable under the terms of the plan, e.g., if the terms of cliff vesting have not been met. Equitable relief may, however, take the form of a monetary award, e.g., the amount by which the wrongdoer was unduly enriched by the unlawful conduct. See, e.g., Great-West Life & Annuity Ins. Co., 534 U.S. 204, 215 (2002) (noting that restitution is amongst the “categories of relief typically available in equity”); Michaud v. Forcier, 78 Mass. App. Ct. 11, 16-17 (2010) (awarding equitable relief so as to prevent wrongdoer from benefiting from wrongdoing in reliance on general principle that “equitable remedies are flexible tools to be applied with the focus on fairness and justice”) (internal citations omitted).

In conclusion, by relying on ERISA § 503 and 510, and ERISA § 502, executives may successfully challenge factually disputed benefit denials and avoid the harsh consequences of cliff vesting provisions in deferred compensation arrangements.