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Many employers have implemented nonqualified plans (1) in conjunction with their 401(k) and pension plans. These plans typically allow highly compensated employees to make up amounts that are cut back by the annual statutory limits on contributions and compensation applicable to their qualified plans. Employers may also use nonqualified plans to supplement a pension plan's benefit formula, or to credit an executive who changes jobs at a later age with additional service credit. Under these circumstances, the provisions of the nonqualified plan and the qualified plan are intended to work together, and the participants receive their monthly retirement benefit (or lump sum payment) from two plans. For this reason, the qualified plan and nonqualified plan may use the same or similar language in determining the participant's benefit, or the nonqualified plan may incorporate by reference some or all of the qualified plan's provisions, such as its benefit formula, vesting provisions, or distribution rules. Unlike the qualified plan, however, the nonqualified plan is exempt from many of the statutory requirements of ERISA, (2) provided that the plan "is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees." A nonqualified plan satisfying this ERISA definition is commonly referred to as a "top hat" plan.
While qualified and non-qualified plans in these situations may be intended to work together and may even be administered by the same administrative committee, a recent case suggests that the interpretation of these same or similar provisions may be subject to different standards of review by the courts. In Goldstein v. Johnson & Johnson, 251 F.3d 433 (3d Cir. 2001), the Third Circuit held that the deferential standard of review made applicable to ERISA plans by Firestone v. Bruch, 489 U.S. 101 (1989), does not apply to a "top hat" plan, even where the top hat plan expressly confers discretionary authority on the employer (or a plan committee) to construe and interpret the plan. Instead, the Third Circuit established a different standard of review analysis for top hat plans, based on theories of contract law, which may present issues for employers. This column examines the standard of review made applicable to "top hat" plans in Goldstein.
Standard of Review
Under ERISA, once an employer decides to establish an employee benefit plan for its employees, the plan and those who administer it are subject to a vast web of statutory and regulatory requirements under ERISA and the Internal Revenue Code. In general, a pension plan (3) subject to ERISA is required to satisfy certain eligibility, vesting, and funding requirements, and those individuals who exercise discretionary authority with respect to the management or administration of the plan or the investment of its assets are subject to ERISA's fiduciary responsibility rules. ERISA contains an exception, however, from these eligibility, vesting, funding, and fiduciary rules for so-called top hat plans. According to ERISA's legislative history, top hat plans are excepted from these provisions on the theory that management and highly compensated employees have a greater degree of sophistication and bargaining power than other employees, and therefore are less in need of ERISA's protections. For this reason, Part 4 of ERISA, including its fiduciary responsibility rules, does not apply to top hat plans. (4) For example, persons with discretionary authority or control over the administration or management of a top hat plan are not required to act solely in the interests of plan participants and beneficiaries, as Part 4 of ERISA would otherwise require.
Like other ERISA plans, however, top hat plans are subject to ERISA's civil enforcement provisions. (5) In general, a participant who seeks to claim a benefit under an ERISA plan is required to exhaust the plan's claims procedure before bringing suit in state or federal court. As part of the claims procedure, an ERISA plan typically specifies the decisionmaker who will decide claims under the plan. This decisionmaker is typically an officer or a committee of employees of the sponsoring employer, or, with respect to welfare benefit plans subject to ERISA, an insurance company. Neither ERISA nor its legislative history specify a standard of review to be applied by a court in reviewing a denial of benefits, and, after ERISA was enacted, the courts struggled to determine the degree of deference that should be accorded to the determinations of such decisionmakers.
In 1989, the Supreme Court held in Firestone that the decisionmaker's determination in a claim for benefits should be reviewed de novo, based on the trust law principles on which ERISA was founded. In Firestone, participants whose employment was transferred to an asset buyer made a claim for benefits under the employer's unfunded severance pay plan, claiming that the transfer constituted a "reduction in force" making them eligible for benefits under the plan. While the severance pay plan did not contain an ERISA claims procedure (as Firestone did not realize at first that the plan was a welfare benefit plan subject to ERISA), Firestone denied the plaintiffs' claim. The participants brought a claim for benefits under ERISA Section 502(a)(1)(B) in federal court. After the district court granted summary judgment for Firestone, the Third Circuit determined on appeal that Firestone's benefit denial was not entitled to any deference, and the court reviewed the claim de novo (that is, decided the claim on its own without giving any deference to Firestone's decision on the claim). According to the Third Circuit, where an employer is both the plan sponsor charged with making benefit payments under the plan and also acts as a plan fiduciary for purposes of deciding claims, deference to its claims denial decisions is unwarranted, "given the lack of assurance of impartiality on the employer's part." In other words, the Third Circuit concluded that, where the employer, as plan fiduciary, gets to decide whether and how much it has to pay under the terms of an ERISA plan, the employer has a conflict of interest that affects the standard of review.
In upholding the Third Circuit's decision, the Supreme Court agreed that Firestone's denial was not entitled to any deference, but its analysis differed greatly from the Third Circuit's. Relying on the common law of trusts which underpins ERISA, the Court determined that Firestone's decision was not owed any deference because Firestone had no discretionary power, either under the terms of the plan or as a matter of law, to interpret its terms. The Supreme Court stated:
Firestone argues that as a matter of trust law the interpretation of the terms of a plan is an inherently discretionary function. But other settled principles of trust law, which point to de novo review of benefit eligibility determinations based on plan interpretations, belie this contention. As they do with contractual provisions, courts construe terms in trust agreements without deferring to either party's interpretation.... Adopting Firestone's reading of ERISA would require us to impose a standard of review that would afford less protection to employees and …