Case Draws Difference Between 409A Claims Against Different NQDC Plan Designs

Claims for non-ERISA NQDC plans may be brought under state-contract law, but a federal appeals court found Safelite's plan was an ERISA plan, so state-law claims were preempted.

A federal appellate court has dismissed a lawsuit against Safelite Group regarding Internal Revenue Code Section 409A failures in its nonqualified deferred compensation (NQDC) plan. The claims were brought as state-law claims, which are preempted when a nonqualified plan is an Employee Retirement Income Security Act (ERISA) plan.

In 2005, Safelite’s Board of Directors created the Safelite Group, Inc. 2005 Transaction Incentive Plan (TIP), which provided for substantial bonus payments to its participants—five Safelite executives—if they secured a strategic buyer for the company. By late 2006, Belron SA emerged as a likely buyer. Realizing that Belron’s acquisition of Safelite would trigger significant payments under the TIP that could increase participants’ tax obligations, on December 29, 2006, the Board adopted the Safelite Group, Inc. Nonqualified Deferred Compensation Plan, a plan to allow participants to defer compensation and thereby avoid certain tax consequences.

In February 2007, less than two months later, Belron purchased Safelite for $334 million, generating substantial payments to the TIP participants that could be deferred by operation of the Safelite Plan.

Between 2006 and 2013, Dan H. Wilson elected to defer hundreds of thousands of dollars of compensation each year.  Wilson left Safelite on July 5, 2008.  By 2014, Wilson had deferred compensation totaling $9,111,384. That year, a federal audit revealed that some of Wilson’s elections failed to comply with Internal Revenue Code Section 409A, a tax statute regulating deferred compensation plans. As a result, Wilson owed income taxes and incurred substantial tax penalties.

On September 12, 2016, Wilson sued Safelite in federal court, asserting state-law claims for breach of contract and negligent misrepresentation. Safelite moved for partial summary judgment on Wilson’s state law claims, arguing that they were preempted by ERISA. The district court granted Safelite’s motion, finding that the Safelite Plan met the statutory definition of “employee pension benefit plan” under ERISA Section 3(2)(A)(ii),29 U.S.C. §1002(2), and was not a bonus plan exempted from ERISA coverage under Department of Labor (DOL) regulation.

The district court granted Wilson 28 days to file an amended complaint asserting claims under ERISA’s civil enforcement provision. Wilson chose not to amend his complaint, and the district court entered final judgment on April 19, 2018. Wilson appealed.

In its opinion, the 6th U.S. Circuit Court of Appeals noted that the issue is whether Wilson’s state-law claims are preempted because the Safelite Plan is an employee pension benefit plan covered by ERISA and not exempted as a bonus plan. The court looked at the statutory definition, which says an “employee pension benefit plan” is established where a “plan, fund, or program…by its express terms or as a result of surrounding circumstances…results in a deferral  of  income  by  employees  for  periods  extending  to  the  termination  of  covered employment or beyond.”

In light of the ordinary meaning of the word “results” and Congress’s exclusion of the word “requires,” Section 1002(2)(A)(ii) covers plans containing terms that have as an effect, issue, or outcome—even if not as a requirement—deferral of income by employees to periods extending to the termination of covered employment or beyond, the appellate court pointed out.

It said the question is whether a plan that allows for distributions both before and after termination can be an ERISA employee pension benefit plan. Subsection (ii) does not specify deferral of income “until termination” or “to termination”; rather, it says “for periods extending to the termination.” Thus, deferrals may occur for various “periods,” and those periods may last up to and/or beyond termination.  The court found that Subsection (ii) covers a wide array of plans and does not exclude plans that give participants the option to receive in-service distributions.

The appellate court also found the express terms of the Safelite Plan indicate that the plan means to provide the benefit of deferred compensation and intends to be covered by ERISA. As the district court correctly noted, “[t]he statute does not mandate that ‘all deferrals extend to the termination of employment’ or that payments be ‘systematically deferred’ until termination.” Thus, the Safelite Plan contemplates that deferral occurs “for periods extending to the termination of covered employment or beyond” and fits within the meaning of subsection (ii).

Considering whether the plan was exempt from ERISA as a bonus plan, the 6th Circuit said, by regulation, employee pension benefit plans do not include “payments made by an employer to some or all of its employees as bonuses for work performed, unless such payments are systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.” This regulation envisions bonuses, not pay for regular compensation, such as annual salaries. Citing an 8th U.S. Circuit Court of Appeals decision, the appellate court said, “A ‘classic bonus situation’ involves ‘reward (higher cash value) for superior performance (higher corporate earnings).’”

Generally, a bonus plan’s terms state that the plan’s express purpose is to pay a financial “bonus” or “additional incentive” to employees to encourage performance or retention. Regulations exclude bonus plansproviding for in-service distributions that are not systematically deferred to termination or for retirement income purposesfrom the definition of employee pension benefit plans.

The appellate court found the Safelite Plan does not state an intention to provide financial incentives for employee performance or retention and does not explicitly operate as a bonus plan. The plan also permits deferral of several types of employee income: participants’ base salaries, annual bonuses, and the TIP Amount.  Because the Safelite Plan is not designed as a bonus plan and instead distributes deferred amounts of non-bonus income, it is not a plan providing for payments made “as bonuses for work performed.” The 6th Circuit ruled that the Safelite Plan is not a bonus plan and is not exempted from ERISA coverage.

It affirmed the district court’s dismissal of the complaint.

Mark L. Stember and Carlisle Toppin, attorneys with Kilpatrick Townsend & Stockton LLP, note in a blog post that employees may face additional taxes and decreased benefits resulting from employer failures involving nonqualified deferred compensation (NQDC) plans and may sue employers to recover their losses. But, for ERISA-covered NQDC plans, such claims may be brought under ERISA; whereas claims for non-ERISA NQDC plans may be brought under state-contract law.

“Although in this case the employer defeated action, a different outcome may occur for differently-designed NQDC plans. Therefore, employers sponsoring NQDC plans should review all areas of plan administration (e.g., deferral elections, distributions and FICA withholding) for compliance with the Section 409A rules and to optimize tax savings and plan benefits for the participants,” they suggest.