Financial Service Company’s Nonqualified Plan Found to be an ERISA Pension Plan

by Eversheds Sutherland (US) LLP
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In Tolbert v. RBC Capital Markets (July 14, 2014), the U.S. Court of Appeals for the Fifth Circuit held that a deferred incentive compensation plan maintained by a financial services company for certain employees was an “employee pension benefit plan” (pension plan) for purposes of the Employee Retirement Income Security Act of 1974, as amended (ERISA).

By way of background, many businesses across all industries commonly offer executive compensation plans. In addition, many financial services companies offer similar plans for their agents, financial consultants or advisers, or other client-facing representatives. These “nonqualified” plans (i.e., plans that are not tax-qualified retirement plans under Internal Revenue Code § 401(a)) generally serve the same business purpose – to provide additional compensation reflecting the full value of the services provided by the covered participants, the receipt of which is postponed to incent performance or retention or to achieve other business objectives. Generally, these plans are structured so as not to constitute pension plans subject to ERISA, for at least two reasons:

  • These plans conventionally are intended to defer the tax recognition of income until actually received by the participants, making them “deferred compensation plans” in tax parlance. In contrast, if such a plan is subject to the ERISA trust and funding requirements applicable to pension plans, compliance with those requirements will cause participants to be taxed immediately on their plan benefits once funded and vested, even if they have not yet received those benefits; and

  • These plans often condition payment on the future attainment of performance objectives, ongoing services for a period of time, compliance with valid non-compete provisions, or other similar business terms. The employer may very well scale the compensation commitments it makes under the plan in reliance on those conditions. ERISA requires, however, that benefits in a pension plan vest within a specified period of time and thereafter may not be forfeited for any reason, which would override these otherwise legitimate business conditions in the plan.

At least in part to accommodate these types of nonqualified arrangements, Congress limited the scope of ERISA in three ways on which these plans rely:

  • ERISA is inapplicable to plans that cover independent contractors rather than common-law employees. Nationwide Mutual Ins. v. Darden, 503 U.S. 318 (1992). Indeed, the facts in Darden involved a deferred incentive plan for independent contractor insurance agents that had design similarities to the program in Tolbert;
  • The ERISA trust, funding and vesting requirements are also inapplicable if the plan is not a “pension plan,” i.e., a plan that “(i) provides retirement income to employees or (ii) results in a deferral of income by employees for periods extending to the termination of covered employment or beyond.” ERISA § 3(2); Darden, supra; and
  • A pension plan nonetheless is not subject to the ERISA trust, funding and vesting requirements that conflict with the business and tax objectives for nonqualified plans described above if such a plan is a “top hat” plan, i.e., an unfunded plan “maintained by the employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.” ERISA §§ 201(2), 301(a)(3), 401(a)(1); Alexander v. Brigham & Women’s Physicians Organization Inc., 513 F.3d 37 (1st Cir 2008); Duggan v. Hobbs, 99 F.3d 307 (9th Cir 1996).

Disputes about the ERISA status of these programs arise from time to time, which can present difficult challenges for the courts. Plaintiffs typically are former participants who are no longer in service with the employer and have forfeited benefits in a manner they assert is both inequitable and contrary to the statute. Employers find it troubling that the former participants at least indirectly benefited from the non-ERISA status of the plan and its conditions on payment while in service and now seek to avoid those essential conditions when applied to them. The authority on the pertinent ERISA definitions has been developed primarily in judicial decisions, with the usual limitations of that process including differing perspectives on the methodology a court should properly bring to applying the statute to a particular set of facts.

Tolbert proved to be such a case. The deferred incentive plan offered by RBC to eligible financial consultants and certain other employees included the following, familiar elements:

  • A voluntary, elective deferred compensation component, which was nonforfeitable at all times;
  • A mandatory deferred compensation component designated by RBC, which was subject to vesting requirements; and
  • A company-provided component tied to productivity, length of service and/or elective deferrals, which was also subject to vesting requirements.

The mandatory deferred compensation and company-provided components vested after a specified period of service or upon death or disability or upon voluntary termination meeting certain conditions. In general, these amounts were immediately payable upon vesting. In some cases, however, the plan participant could choose to defer payment until or after he or she left RBC, but if the participant was later terminated for cause then the outstanding deferred balance would be forfeited.

The plaintiffs in Tolbert were participants who either terminated before fully vesting or were terminated for cause after deferring a portion of their payments, and asserted that the forfeiture of their plan benefits was contrary to ERISA. The district court granted RBC’s motion for summary judgment, holding that the program was not an ERISA pension plan on the basis that any deferral of income resulted from the participant’s election rather than the express terms of the plan and that nothing in the surrounding circumstances supported a different result. On appeal, the Fifth Circuit reversed. The court agreed that the plan did not provide retirement income, but found that by its express terms the plan did provide for the deferral of income to the termination of covered employment or beyond because of the following:

  • The plan document referred to the plan as a “deferred compensation plan”;

  • Components of the plan were referred to as “Voluntary Deferred Compensation” and “Mandatory Deferred Compensation”; and
  • The plan by its terms included provisions for distributions on separation from service or later.

That conclusion precluded, in the court’s view, any need to consider the surrounding circumstances, RBC’s reliance on a prior Fifth Circuit decision concerning a bonus plan, or amicus arguments about policy considerations. The court also declined RBC’s invitation to affirm on the basis that the plan was a top hat plan, leaving that issue to be determined on remand.

Tolbert thus makes another contribution to the not easily reconcilable body of case law that applies the definitional provisions of ERISA to nonqualified plans. Its distinctive characteristic may be its strict text-based analysis of both the statute and the plan. For example:

  • The opinion cites at one point Justice Scalia’s Reading Law: The Interpretation of Legal Texts; and
  • The decision rests significantly on descriptions and defined terms in the plan document that conventionally are intended not to have analytic import. (In the usual manner, the Fifth Circuit did not credit the statement in the plan document going to the issue for decision – that the plan was not intended to be an ERISA pension plan. Had instead the dispute been about the tax consequences of the plan, one wonders whether the Tax Court would have accepted the statement in the plan about its ERISA status.)

To the extent such a circumscribed judicial methodology is gaining traction, it should, at a minimum, be taken into account in the drafting of nonqualified plans.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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