Court Rules Employment Agreement Severance Provisions Can Constitute ERISA Plan

Earlier this month, in Zgrablich v. Cardone Industries, Inc., the U.S. District Court for the Eastern District of Pennsylvania held that an executive’s claim to recover $1.5 million in severance benefits under his employment agreement was preempted by ERISA because the severance provisions in that agreement constituted an ERISA-governed benefit plan.

Zgrablich arose after an executive’s employment was terminated by his employer and the employer refused to pay him any severance benefits under his employment agreement. The executive had entered into an individual employment agreement with his employer that entitled him to severance payments equal to five times his annual base salary (over $1.5 million) in the event of a termination of employment “without cause.” The executive sued his employer in Pennsylvania state court, arguing that he was owed the $1.5 million severance benefit under the contract because he had been terminated “without cause.” However, the employer argued that the executive’s breach of contract claim under state law was completely preempted by ERISA because the severance portion of the employment agreement constituted an ERISA employee benefit plan.

The District Court ultimately agreed with the employer and found that the severance provisions in the executive’s individual employment agreement established an ERISA plan. The court’s analysis focused on five main points:

• Intended benefits: The employment agreement provided a “comprehensive description” of the potential severance benefits available to the executive (salary continuation for five years and continued medical coverage).
• Class of beneficiaries: The agreement plainly set forth who was entitled to receive those benefits (the executive or his beneficiaries). Any person who read the agreement would be able to readily ascertain the benefits offered under the plan and the intended beneficiaries of such benefits.
• Source of financing: The employer was clearly responsible for paying out any benefits under the severance provisions.
• Procedures for receiving benefits: The agreement was straightforward about when and how the severance benefits would be distributed to the executive or his beneficiaries.
• Ongoing administrative scheme: The severance provisions required the “establishment and maintenance of a separate and ongoing administrative scheme.” Simply writing a check for a one-time, lump sum payment would not have implicated ERISA. But the fact that the executive’s eligibility for severance benefits under the agreement, including payments over the course of five years, turned on whether or not his employment had been terminated “for cause”—a standard requiring the employer to exercise judgment on a case-by-case basis and to apply a set of subjective criteria—was “strong proof” that the severance provisions involved a separate determination of eligibility for benefits and thus constituted an ERISA plan. The District Court also noted that the severance provisions of the agreement required continuous monitoring and administration (e.g., in the event that the executive violated the restrictive covenants in the agreement, the employer could cease salary continuation payments and continued healthcare benefits).

While other courts have considered the issue (including the Fourth, Seventh, Eighth, and Eleventh Circuits), this case serves as an important reminder to employers to proceed with caution when attempting to bring executive severance arrangements under the ERISA umbrella. A court’s finding that such an arrangement is subject to ERISA may be beneficial to an employer in certain respects, e.g., making available to plaintiffs a more limited menu of remedies than under state law and subjecting benefits determinations to a deferential standard of review (a federal court generally will uphold a plan administrator’s decision on review unless it finds that the decision was arbitrary and capricious). But a finding like this one could also arguably trigger a need to comply with ERISA’s extensive reporting and disclosure requirements, such as the requirement to furnish a summary plan description. Because a severance arrangement like the one in Zgrablich is not typically implemented or maintained as a formal ERISA plan, an employer is not likely to be in compliance with such requirements on an ongoing basis and could expose itself to additional risk on the basis of such noncompliance.