Extracted from Law360
When a string of lawsuits was filed at the end of 2023 alleging that the use of forfeited employer contributions was a per se violation of the Employee Retirement Income Security Act, most were puzzled by the theory and wondered whether any court would buy it.
Within weeks of each other, two district courts in California issued competing decisions on whether such allegations are sufficient to state a plausible claim for relief. On May 24, the U.S. District Court for the Southern District of California in Perez-Cruet v. Qualcomm Inc. denied Qualcomm's motion to dismiss,[1] while on June 17, the U.S. District Court for the Northern District of California in Hutchins v. HP Inc. dismissed the plaintiff's complaint but with leave to amend.[2]
These cases were brought by the same counsel, defended by the same defense firm and assert the same legal theory — so why the different results, and what can employers take away from these decisions?
In a defined contribution plan, employees immediately vest in their own contributions and earnings on them. Employees may not, however, automatically vest in employer contributions made to a defined contribution plan. In general, employers can choose a vesting schedule for these contributions, such as graduated or graded vesting where an employee is vested in employer contributions 20% after two years, 40% after three years, 60% after four years, 80% after five years and 100% after six years.[3] These employer contributions may be forfeited if an employee leaves the company before the employer contributions vest.
Consistent with long-standing guidance from the U.S. Department of the Treasury and Congress, defined contribution plan documents often include a provision that forfeited employer contributions may be used to offset future employer contributions under the plan or used to offset administrative expenses of the plan.[4] In 2023, the Treasury Department also proposed regulations that seek to clarify that forfeited employer contributions may be used to "(1) to pay plan administrative expenses, (2) to reduce employer contributions under the plan, or (3) to increase benefits in other participants' accounts in accordance with plan terms."[5]
The plaintiffs in Qualcomm and HP allege that although the Qualcomm and HP plans expressly permit forfeitures to be used to cover plan expenses or offset employer contributions, Qualcomm's and HP's decisions to not defray plan expenses via these forfeited employer contributions are breaches of their fiduciary duties, prohibited transactions and violations of ERISA's anti-inurement provision.
The Qualcomm and HP courts agreed on two issues. The courts agreed that the current and proposed Treasury regulations didn't foreclose the plaintiffs' claims as a matter of law.[6] In Qualcomm, the court focused on the proposed Treasury regulations but determined they weren't persuasive because they were proposed by the Treasury Department rather than the U.S. Department of Labor, and they haven't been adopted.[7]
The plan at issue in HP is a stock bonus plan, and the court determined that the current Treasury regulations don't apply to such plans.[8] But the HP court found the Treasury regulations persuasive, noting that if the HP plaintiff's theory is correct, the proposed Treasury regulations are contrary to ERISA and a nullity, which the court doubted.[9]
Second, the HP plan and the Qualcomm plan gave discretion in how to allocate forfeited contributions, and both courts agreed that the decision of how to use forfeited contributions is a fiduciary function.[10]
The decisions differ in just about all other respects.
With respect to the plaintiffs' breach of fiduciary duty claims, the Qualcomm court focused heavily on the plaintiff's allegations that Qualcomm had the discretion to choose how forfeited funds were allocated and accepted as true the plaintiff's allegations that Qualcomm made a choice that put its interests ahead of the plan participants' interest.[11]
In contrast, the HP court found that the plaintiff's breach of fiduciary duty claim was so broad that he effectively argued ERISA's duty of prudence and loyalty create a benefit — that is, the payment of his administrative costs — that the HP plan document doesn't provide, or that ERISA creates an unqualified duty to pay administrative costs, which is not mandated by ERISA.[12]
The HP court was also critical of the plaintiff's breach of fiduciary duty theory because it is contrary to "the settled understanding of Congress and the Treasury Department regarding defined contribution plans," which have "long understood that forfeitures in defined contributions plans 'could be reallocated to the remaining participants under a nondiscriminatory formula, used to reduce future employer contributions, or used to offset administrative expenses of the plan.'"[13]
Ultimately, the HP court dismissed the breach of fiduciary duty claims because "at [their] current breadth," they were implausible. But the court permitted the plaintiff leave to amend if it could plausibly allege disloyalty or imprudence based on a more particularized set of facts.[14]
The courts also differed in their interpretations of the plaintiffs' anti-inurement claims.
The Qualcomm and HP plaintiffs allege that using forfeited contributions to reduce future employer contributions is a violation of ERISA's anti-inurement provision,[15] which provides that the "the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan."
In Qualcomm, the court assumed without deciding that nonvested forfeited contributions are plan assets and focused on whether the use of such assets falls within an exception to the anti-inurement provision when contributions are made by mistake.[16] The court refused to dismiss the anti-inurement claim because "no court has concluded that an employer's matching contribution intentionally made at the time an employee was employed and participating in a plan qualifies as a 'mistake'" subject to this exception.[17]
The Qualcomm court distinguished the U.S. Supreme Court's 1999 decision in Hughes Aircraft Co. v. Jacobson because the plan at issue in that case was a defined benefit plan, and Qualcomm's defined contribution plan gives members a right to contributions.[18]
The HP court didn't analogize forfeited employer contributions to so-called mistaken contributions, and instead found instructive cases addressing the disposition of surplus plan assets.[19] The court focused on the Supreme Court's decision in Hughes Aircraft, which found that a plan sponsor didn't violate the anti-inurement provision when it used surplus plan assets for the sole purpose of paying pension benefits under the terms of the plan.[20]
The HP court acknowledged that the Qualcomm court found Hughes Aircraft distinguishable but stated that simply because defined contribution plan participants have a right to contributions does not entitle participants to forfeited contributions.[21]
The HP court determined that the use of forfeited contributions to supply HP's matching contributions for other plan beneficiaries didn't violate the anti-inurement provision "because the forfeited amounts are plan assets which do not leave the Plan trust fund and are used to pay pension benefits to Plan participants."[22] Any benefit HP receives from the reduction in future matching contributions is merely incidental to the payment of benefits.[23]
The courts also reached different conclusions on whether the use of forfeited employer contributions to offset future employer contributions constituted a prohibited transaction.
The HP and Qualcomm plaintiffs alleged that HP and Qualcomm violated ERISA's prohibited transactions provision because nonvested contributions subject to forfeiture are property of the plan or assets of the plan before they are used as future employer contributions, which plaintiffs contend constitute a prohibited transaction.[24]
The HP court determined that the use of forfeited contributions to offset future employer contributions didn't constitute a prohibited transaction because the "forfeited amounts remain plan assets and are merely reallocated to provide pension benefits to other employees through use as matching contributions."[25]
The HP court also explained that "the fact that these reallocated forfeited amounts will reduce the amount HP contributes in the future does not make this a transaction for purposes of § 1106."[26] In essence, the court reasoned, this reallocation of forfeited funds is analogous to the payment of benefits, and the Supreme Court has determined that the payment of benefits isn't a prohibited transaction.[27]
The Qualcomm court assumed that forfeited contributions constitute plan assets and held that the plaintiff alleged plausible prohibited transaction claims.[28] In short, the court determined the plaintiff had plausibly alleged that Qualcomm is a fiduciary, that it dealt with plan assets — i.e., nonvested forfeited contributions — by doing something other than leaving these assets untouched, and that it dealt with such assets in a way that "benefited Qualcomm's own interest or for its own account."[29]
Using a functional approach to define the term "assets," the Qualcomm court found it "easy to come to the conclusion that nonvested employer contributions may not be used to benefit the employer/fiduciary by reducing its own financial burden to make contributions in the future when done at the expense of not defraying the administrative costs borne by participants and beneficiaries."[30]
Takeaways
There are a few takeaways from these decisions.
These courts have held that the decision of how to allocate forfeited contributions is a fiduciary decision. Plan sponsors should keep this in mind when deciding who determines how such funds are allocated and be cognizant that the decision of how such funds are allocated may be scrutinized later.
In both cases, the HP and Qualcomm defendants correctly followed the terms of the plans. If forfeited contributions are used in a manner inconsistent with the terms of the plan, this may expose fiduciaries to additional avenues of liability.
Considering these competing decisions, we expect to see more lawsuits alleging the use of forfeited employer contributions to offset future contributions violates various provisions of ERISA.
[1] Perez-Cruet v. Qualcomm Inc. , No. 23-cv-1890-BEN (MMP), 2024 U.S. Dist. LEXIS 93522 (S.D. Cal. May 24, 2024).
[2] Hutchins v. HP Inc. , No. 23-cv-05875-BLF, 2024 U.S. Dist. LEXIS 107306 (N.D. Cal. June 17, 2024).
[3] See Internal Revenue Service, Retirement Topics – Vesting https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-vesting (last visited July 10, 2024).
[4] See 26 C.F.R. § 1.401-7(a); HP Inc., 2024 U.S. Dist. LEXIS 107306, at *20 (citing H.R. Rep. 99-841, at II-442 (1986)).
[5] Use of Forfeitures in Qualified Retirement Plans, 88 Fed. Reg. 12282-01, 12283 (proposed Feb. 27, 2023).
[6] Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *20-22; HP Inc., 2024 U.S. Dist. LEXIS 107306, at *8-10.
[7] Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *22.
[8] HP Inc., 2024 U.S. Dist. LEXIS 107306, at *9-10 (citing Rev. Rul. 71-313, 1971-2 C.B. 203 (1971)).
[9] Id. at *20-22.
[10] See Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *5-9; HP Inc., 2024 U.S. Dist. LEXIS 107306, at *13-14.
[11] See Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *5-9.
[12] See HP Inc., 2024 U.S. Dist. LEXIS 107306, at *18-19.
[13] Id. at *18, *20 (quoting Use of Forfeitures in Qualified Retirement Plans, 88 Fed. Reg. at 12283).
[14] Id. at *21-22. The HP plaintiff filed an amended complaint on July 17, 2024. HP's deadline to respond to the amended complaint is currently August 23, 2024.
[15] See 29 U.S.C. § 1103(c)(1).
[16] See Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *10-15; 29 U.S.C. § 1103(c)(2)(A) ("In the case of a contribution ... [(ii)] made by an employer to a multiemployer plan by a mistake of fact or law (other than a mistake relating to whether the plan is described in section 401(a) of the Internal Revenue Code of 1986 [26 U.S.C § 401(a)] or the trust which is part of such plan is exempt from taxation under section 501(a) of such Code [26 U.S.C. § 501(a)]), paragraph (1) shall not prohibit the return of such contribution or payment to the employer within 6 months after the plan administrator determines that the contribution was made by such a mistake.")).
[17] Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *14-15.
[18] Id. at *13-14 (citing Hughes Aircraft Co. v. Jacobson , 525 U.S. 432 (1999)).
[19] HP Inc., 2024 U.S. Dist. LEXIS 107306, at *23-30.
[20] Id. at *24 (citing Hughes Aircraft, 525 U.S. at 442).
[21] Id. at *25-26.
[22] Id. at *27 (citing Hughes Aircraft, 525 U.S. at 442; Maez v. Mountain States Tel. & Tel. , 54 F.3d 1488, 1506 (10th Cir. 1995)).
[23] Id. at *27 (citing Holliday v. Xerox Corp. , 732 F.2d 548, 551 (6th Cir. 1984); Flanigan v. GE , 242 F.3d 78, 88 (2d Cir. 2001)).
[24] See 29 U.S.C. §§ 1106(a)(1), (b)(1); Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *15-19; HP Inc., 2024 U.S. Dist. LEXIS 107306, at *31-34.
[25] HP Inc., 2024 U.S. Dist. LEXIS 107306, at *33 (citing Chao v. Hagemeyer N. Am. Inc. , No. 2:06-01173-PMD, 2006 U.S. Dist. LEXIS 107219, at *18 (D.S.C. Oct. 20, 2006)).
[26] Id. (citing Black v. Greater Bay Bancorp Exec. Supplemental Comp. Benefits Plan, No. 16-CV-00486-EDL, 2017 WL 8948732, at *8-9 (N.D. Cal. Jan. 18, 2017)).
[27] Id. at *32 (citing Lockheed Corp. v. Spink , 517 U.S. 882, 892 (1996)).
[28] Qualcomm Inc., 2024 U.S. Dist. LEXIS 93522, at *17-18.
[29] Id.
[30] Id. at *18-20 (S.D. Cal. May 24, 2024) (citing Acosta v. Pac. Enters. , 950 F.2d 611 (9th Cir. 1991)).