When a tax-qualified retirement plan is terminated, the Internal Revenue Code (Code) generally requires that all participants in the plan be fully vested in their plan benefits. The Code also requires full vesting for those participants affected by a partial termination of a plan, i.e., the reduction of a group of employees covered by a plan, by reason of a plan amendment or severance by the employer. As the Code does not prescribe a specified percentage reduction that constitutes a partial termination, various courts and the IRS have developed standards for when a partial termination has occurred.
The Matz Saga
Last month the Seventh Circuit revisited the topic of partial termination in a class action that had been litigated for almost 19 years and involved five appeals. In Matz v. Household Int’l Tax Reduction Inv. Plan, Nos. 14-1683 and 14-2507, 2014 U.S. App. LEXIS 24448 (7th Cir. Dec. 24, 2014), the court affirmed the lower court’s dismissal of the case, and in doing so it reiterated its views on various issues relating to partial terminations.
In a 2004 opinion in the Matz litigation, the Seventh Circuit had adopted a rebuttable presumption that a 20-percent-or-greater reduction in plan participants was a partial termination and that a reduction of below 10 percent was conclusively not a partial termination. In Rev. Rul. 2007-43, the IRS adopted the 20-percent rebuttable presumption, but did not adopt the view that a less-than-10-percent reduction is conclusive evidence that a partial termination has not occurred.
The plaintiff in Matz, who had been employed by a subsidiary of a conglomerate, Household International, Inc. (Household), argued that in 1993 Household adopted a restructuring plan that directed the sell-off of various subsidiaries that began the following year and concluded in 1996, by which time the elimination of subsidiaries, plus layoffs of some workers in retained subsidiaries, had reduced the total number of participants in Household’s retirement plan by at least 20 percent.
The Latest Matz Opinion
In its latest opinion in the Matz litigation, the Seventh Circuit addressed the following issues:
Period Over Which a Partial Termination is to be Determined
The Seventh Circuit reiterated that the period over which plan participant reductions may be aggregated to determine whether a partial termination has occurred is generally a single plan year. However, the court reaffirmed its prior holding in a 2000 Matz decision that a significant corporate event need not occur solely within a single plan year, and that corporate events that occur over a multi-year period can be combined for purposes of measuring the percentage by which plan participation was reduced, if those events are related. This, the court said, reflects the realities of the modern corporate world, where mergers and corporate reorganizations have grown into large and complex events, and often cannot be completed in one year. Furthermore, the court observed, to establish a rigid rule that only terminations in individual plan years can be counted would allow an unscrupulous employer to terminate some participants in December of one year and some in January of the next year, thereby eviscerating the purpose of protecting employee benefits, which appears to be the rationale for the full-vesting rule.
The Seventh Circuit agreed with the district court that Household’s sales of multiple subsidiaries over multiple years were not all part of a single restructuring plan. The district court concluded that Household’s decisions to sell particular subsidiaries had been made sequentially, on the basis of economic conditions in the particular market in which each subsidiary operated, and that those conditions had varied from market-to-market. Moreover, focusing on 1994, the year in which the plaintiff had been terminated, the district court found that the number of plan participants had fallen by less than 5 percent — far below both the 20-percent cutoff for a rebuttable presumption of partial terminations and below the 10-percent irrebuttable presumption that no partial termination occurred.
Lack of Class Representative
The Seventh Circuit also noted that the plaintiff was a class representative and that ordinarily when a class representative is dismissed on grounds applicable to him but not to all other members of the class, the suit is not dismissed but rather another member of the class is substituted as class representative. Here, however, the court concluded that there was no other eligible class representative:
Employees of seven subsidiaries of Household International were terminated. Matz was terminated by Hamilton Investments in 1994; the percentage of Hamilton’s employees who were terminated was as we said below 5 percent of the plan participants in that year. Household’s sale of another subsidiary, Household Bank, resulted in the termination of an additional 9.5 percent of plan participants. As for the other five subsidiaries, their percentages of plan participants terminated were even lower than Hamilton’s.
Matz, supra , at *7. Finally, the court noted that even if all the terminations were deemed to constitute a single termination, the percentage terminated would be only 17 percent, still below the 20-percent cutoff and with no justification shown for waiving it.
Policy Rationale for the Full-Vesting Requirement.
Interestingly, the court announced that it had mistakenly interpreted the rationale for the partial vesting rule in its prior decisions. It had originally held that the rule was designed to prevent asset reversions to the employer, which would be a tax-windfall because the employer would have taken deductions for contribution to the plan in prior years. The court indicated that this reasoning failed to consider that asset reversions are subject to both ordinary income tax and an excise tax. In light of this, the Seventh Circuit announced that it instead considers the rule necessary to “protect employees against uncertainty” (i.e., employees would not be able to insure against the risk that they could be prevented from vesting in their plan benefits if the employer could cause forfeiture of their benefits by terminating the plan). This clarification did not, however, change the court’s opinion on the appropriate standards for evaluating whether a partial termination has occurred.
The latest Matz opinion does not change the law on partial termination. Rather, it affirms earlier holdings in the Seventh Circuit and illustrates when a series of reductions in the number of participants in a plan will not be aggregated to demonstrate that a partial termination has occurred.
An employer that reduces the number of participants in its qualified plan in a series of separate actions in connection with restructuring its operations must determine whether it has caused a partial plan termination. The determination of whether subsidiary or asset sales, or workforce layoffs, over successive years can be treated as sufficiently related to one another to allow for aggregation in determining the level of reduction in plan participation is highly factual in nature. As guidance as to partial terminations is limited, the employer should take Matz into account in making this determination even when the situs of the plan is outside the Seventh Circuit.