ERISA Advisory

Seventh Circuit allows employer to correct major plan drafting error. In Young v. Verizon’s Bell Atlantic Cash Balance Plan, 2010 U.S. App. LEXIS 16483 (7^th Cir., 8/10/10), the plaintiff claimed the benefit of a hugely expensive “scrivener’s error.” The plan, a cash balance plan converted from a traditional defined benefit plan, set up opening balances for participants equal to the lump sum actuarial equivalents of their accrued benefits multiplied by a “transition factor” based on age and length of service (designed to compensate for the fact that the new benefit formula was less generous for older workers).

Like many plan documents, this one was verbose and went through many drafts before reaching final form. At one point, an in-house lawyer tried to make the opening balance provision more readable by relocating the phrase “multiplied by the appropriate transition factor described in Table I.” Unfortunately, he didn’t strike it from its original place. Read literally, the opening balance was now the prior plan benefit times the transition factor, with the product multiplied by the transition factor again. Squaring the multiplier naturally had a dramatic impact on the result ($1.67 billion in the aggregate, by the court’s estimate), but not until a year later, after the plan had been adopted, did anyone notice the error. The plan was then amended in an attempt to correct it. In the meantime, all communications with participants and benefit calculations used the transition multiplier only once.

The plaintiff retired before the corrective amendment and received a lump sum cashout of her benefit. Seven years later, she learned about the exact plan language and brought a claim for the additional benefit that would result from the double multiplication. The plan turned her down, so she sued.

A district court magistrate agreed with the plaintiff that disregarding the literal plan language would be “arbitrary and capricious.” He then turned around and agreed with the defendant that the double multiplier was unmistakably a scrivener’s error, whose application would be unreasonable. As a solution, he granted the plan’s counterclaim for equitable reformation of the document to excise the mistake. The 7^th Circuit’s decision affirms that ERISA’s requirement that plans be administered in accordance with their written documents does not bar this remedy.

Not every court has taken the same view. Last year, in Cross v. Bragg (7/24/09), an unpublished opinion that was not discussed in Young, the 4^th Circuit refused to allow a plan to correct a very similar error in the wording of its benefit formula. In that case, as in Young, the erroneous formula had never been included in the summary plan description or other communications, and benefit calculations had consistently used the intended formula. Other cases have been vague or ambiguous regarding the conditions under which reformation might be allowed. However, the case that the court regarded as most nearly on point was Int'l Union v. Murata Erie N. Am., Inc., 980 F.2d 889 (3d Cir. 1992), which allowed an employer to present evidence that the omission from its pension plan of a clause permitting it to recover surplus assets on plan termination was a scrivener's error and thereby allowed equitable reformation of the plan to avoid a "windfall" to the participants.

Assuming that the 7^th Circuit’s view prevails, it must not be read too broadly. An employer that wishes to correct its plan documents must show by “clear and convincing evidence” that different provisions were intended, that the intended provisions have been consistently applied, and that nothing to the contrary has been conveyed to participants. Only bad drafting can be reformed, not bad decisions.

The court’s decision also confirms that corrections can be made without bringing formal legal action, unless and until there is a likelihood of a dispute with a participant over the terms of the plan. In the case at hand, the employer became aware of the error, and amended the plan, in 1998. It was not, however, required to go to court at that time. Seeking reformation when an actual plaintiff brought a lawsuit was sufficient.

As a further complication, the IRS regards adherence to the literal language of plan documents as essential to plan qualification and insists that amendments to correct a plan’s language to conform to its operation may be adopted only with IRS consent through the Employee Plans Compliance Resolution System (EPCRS). It gives consent only grudgingly (though it did approve the amendment in Cross v. Bragg). While there is no basis in the Internal Revenue Code or the regulations for elevating conformity to plan documents to the level of a qualification requirement, it is hardly prudent to invite a quarrel with the IRS. Therefore, the use of EPCRS to make any but the most trivial correction is advisable. IRS approval does not, however, as Cross v. Bragg demonstrates, offer protection against lawsuits by participants.

PBGC proposes new security requirements for cessation of operations. For over 20 years after ERISA’s enactment, the government did not make use of §4062(e), which requires an employer to provide security to the Pension Benefit Guaranty Corporation (PBGC) if the cessation of operations at a facility results in the separation of more than 20 percent of the participants in a defined benefit plan. The rationale for this rule was unclear: A company that closes a plant and lays off a substantial number of employees may be in financial trouble, but often it is merely shifting its investments to more profitable locations or lines of business.

In the mid-1990’s, as part of an agency initiative to monitor insurance risks more closely, PBGC officials began to talk about enforcing §4062(e). In 2006, the agency published regulations on how to calculate the required security (a matter omitted from the statute) and began looking for applicable situations. Since then, it has resolved 37 cases, obtaining bonds or escrows totaling $600 million. Now a new set of proposed regulations, published in the Federal Register on 8/10/10, will put flesh on the statutory bones, including for the first time, a reporting requirement for “§4062(e) events.”

The proposal’s approach to the statute is somewhat literal. Looking separately at each “operation” (“a set of activities that constitutes an organizationally, operationally, or functionally distinct unit of an employer”) at each “facility” (“the place or places where the operation is performed”), one must determine whether the cessation of an operation (discontinuance of “all significant activity at the facility in furtherance of the purpose of the operation”) is the proximate cause of the separation from employment of more than 20 percent of the participants in any of the employer’s defined benefit pension plans. If it is, the employer must file a report with the PBGC, calculate what its liability would be if the plan were to terminate, and place funds in escrow equal to a ratable percentage of that hypothetical liability, based on the percentage of participants who left employment as a result of the cessation. Alternatively, it may post a bond for 150 percent of that amount or may negotiate some other arrangement with the PBGC.

The bond or escrow must remain in place for five years. If the plan terminates during that period and does not have sufficient assets to cover all benefit liabilities, the security goes to the PBGC. Otherwise, it reverts to the employer.

The benefit to the government is that, if the plan sponsor goes bankrupt within a few years after a §4062(e) event, the PBGC’s insurance fund will (subject to the Bankruptcy Code’s restrictions on preferential transfers) get paid up front, without having to wait in line with other creditors. The drawback to the employer is that, whatever its financial condition, it must tie up cash or credit capacity for five years.

In some circumstances, the proposal will yield questionable results. For example –

• Company A moves a major operation from New York to Texas. Workers are laid off in one state and hired in the other, resulting in no net change in employment or plan participation. Nonetheless, if the layoffs affect more than 20 percent of the plan’s participants, a §4062(e) event has occurred.
• Company B does most of its widget-making in California but also has a small plant in Tennessee. It decides to transfer the whole operation to Tennessee. In this case, it arguably has only one “facility” (“the place or places where the operation is performed”). Since it hasn’t ceased an operation at that facility, it escapes §4062(e) entirely – a fine result, but why is Company A more of a risk to the PBGC?
• Company C sells a loss-making operation to another corporation, reinvesting the proceeds in a profitable venture. The operation has its own underfunded pension plan, which the buyer is unwilling to assume. Under the proposed regulations, the sale of an operation is a “cessation”, just like a shutdown. The preamble states that the PBGC will consider waiving §4062(e) security for sales, but only where the buyer takes over the plan.
• The facility at which Company D carries on one of its operations is destroyed by a hurricane, and all of its employees are laid off. The company rebuilds the facility and rehires all of the laid-off workers. According to the proposed regulations, that event is a “cessation” unless the employer “has resumed significant activity at the facility in furtherance of the purpose of the operation” within 30 days after the disaster. Obviously, there will be many cases in which the 30-day time frame will be unrealistic. Moreover, if one takes the words of the proposed regulation at face value, rebuilding anywhere except on the original site would lead to a “cessation.”

Aside from such anomalies, the proposal leaves a good deal of room for disputes about how many participants were affected by a cessation. For a voluntary cessation, the active participant base must be determined as of the date on which the decision to cease operations was made – potentially an issue subject to much dispute – and the departures of employees who leave before the cessation, or who work in other operations or facilities, may, under the proposal’s broad definitions, be attributable to the event.

One cannot fault a government agency for making use of authority granted by law. However, the rigorous application of §4062(e) may result in financial disruption and uncertainty to plan sponsors and their creditors.