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As a recent “donning and doffing” lawsuit against Perdue Farms shows, derivative doesn’t mean unimportant when it comes to Employee Retirement Income Security Act (ERISA) claims.
Smock, hairnet, earplugs, bump cap, steel-toed boots, safety glasses and cut-resistant gloves. Each day poultry processing employees across the nation arrive early—well before their shifts begin—to sanitize and don this protective gear. When their shifts end, those employees, covered in the offal of slaughtered chickens, head back into the locker room to reverse the process.
In 1997, the U.S. Department of Labor (DOL) ruled that employers must pay employees for time spent donning and doffing (removing) protective equipment. At the time, this wasn’t the practice of most poultry industry employers. As a result, while they adjusted to the new rule, their employees began suing for back pay.
One poultry processor, Perdue Farms, faced a donning and doffing class-action lawsuit under the Fair Labor Standards Act (FLSA)—with a new twist. Rather than put all their eggs into the wage and hour basket, the 16,000 employees also scrambled up a side dish of derivative claims under the Employee Retirement Income Security Act (ERISA). The employees squawked that, because they were underpaid for donning and doffing time, they received smaller contributions in their employer-sponsored retirement accounts than what the plan required.
Perdue Farms eventually settled that lawsuit for $10 million, of which $3 million went to the plaintiffs’ lawyers. The remaining $7 million was split three ways, with 11 percent distributed to employees who asserted only wage and hour claims, 13 percent given to employees who asserted only ERISA claims, and the remaining 76 percent dispersed to employees who asserted both types of claims.
The DOL then pursued an additional $10 million for the same violations.
Eager plaintiffs’ lawyers soon realized that derivative ERISA claims were not limited to donning and doffing lawsuits but could complement any wage and hour claim, including lawsuits for unpaid overtime and improper employee classification. At the same time, employers discovered how expensive it could be to defend derivative ERISA claims, which routinely settled in the tens of millions of dollars, not counting fines or excise taxes.
Lure of Derivative Claims
Derivative ERISA claims are popular because they can result in substantial monetary judgments, often larger than the underlying FLSA claim. More important, adding such a claim automatically increases the size of the class, which also raises the potential jackpot. This is because derivative ERISA claims are opt-out class actions requiring no action on the part of employees, while the underlying FLSA claim is an opt-in class action, requiring employees to affirmatively elect to join in the class action.
How the Claims Work
In a typical derivative ERISA claim, employees first bring an FLSA claim alleging that they were not properly compensated under wage and hour laws. They then allege that, as a result of the wage and hour violation, their retirement plan benefits have been harmed in violation of ERISA.
For example, a group of employees might claim that they were improperly classified as exempt for purposes of the FLSA and were not paid overtime. If the employees participate in a 401(k) plan, they also might claim that their deferral contributions and employer matches failed to account for their overtime compensation. Alternatively, if the employees participate in a traditional pension, they might claim that their employer failed to take into account overtime when calculating the employees’ accrued benefits.
Derivative ERISA claims usually fall under one of two legal theories: breach of ERISA’s fiduciary requirements or failure to maintain plan records.
Fiduciary requirements. In administering its retirement plan, an employer must satisfy its fiduciary duties under ERISA, including the duties of loyalty and prudence and the duty to follow plan terms to the extent they are consistent with ERISA. A fiduciary breach lawsuit alleges that the employer breached its duties when it used the wrong compensation to calculate an employee’s plan benefits.
Record-keeping requirements. Under ERISA, a plan administrator must maintain sufficient records to determine benefits that are due or that may become due under the plan. A record-keeping lawsuit claims that the company’s payroll records were inaccurate (e.g., missing overtime) and that, consequently, the plan administrator’s records that rely on that payroll data were also incorrect and insufficient to determine benefits under the plan.
Definition of Compensation
In the world of derivative ERISA claims, an ounce of prevention is worth a pound of cure. Before wage and hour claims arise, an employer should review its retirement plan documents to ensure that they are drafted to define compensation as wages paid rather than wages earned. If the plan defines compensation as wages earned, the employer should consult with its ERISA counsel regarding how to amend the plan to change the definition. The amendment must be crafted carefully to avoid violating ERISA’s anti-cutback rules.
If the plan employs a third-party administrator, the employer should communicate with the administrator to ensure that it is aware of the change and that it administers the plan using the new definition of compensation.
To avoid complications, the definition of compensation used to determine benefit calculations could be based on the amount reportable on an employee’s IRS Form W-2. For example, compensation could be defined as "the employee’s compensation as reportable on Box 1 of Form W-2." Form W-2 compensation is undeniably compensation paid.
The definition of compensation is important because, many times, the choice of "paid" or "earned" is the deciding factor in whether a derivative ERISA claim has merit.
An ERISA fiduciary must act in accordance with the documents and instruments governing the plan. Thus, when administering its retirement plan, an employer has a fiduciary duty to calculate a participant’s benefit using the definition of compensation in the plan.
If the plan defines compensation for benefit calculations or contributions to include "wages earned" or equivalent terminology, the plan administrator is legally required to make all calculations using wages earned. This is a problem if the amount of the wages earned by an employee for a given year is disputed and then resolved favorably for the employee in a later year, because plan contributions or benefit calculations for the earlier year must take into account those additional wages.
However, if the calculation of benefits or contributions is based on wages paid, the fiduciary must calculate benefits on all wages that are actually paid, not on those that should have been paid—regardless of whether the wages paid improperly omitted pay that the participant was entitled to under the FLSA. The fiduciary must disregard those earned but unpaid amounts when making its calculations.
Basing compensation on wages paid rather than wages earned is also a good idea in the context of record-keeping. ERISA requires the plan administrator to keep sufficient records to accurately determine the benefits to which participants are entitled under the plan.
If an employer records payroll hours incorrectly, but the participant’s benefit or employer contributions under the plan are derived from wages paid (and the benefit formula does not require an accounting of hours worked), then there is no record-keeping failure because hours worked are not required to determine a benefit. Although faulty payroll records may have resulted in underpayment, for purposes of accurately calculating plan benefits, the only relevant amounts are the wages actually paid—which are accurately reflected in the plan’s records.
In contrast, where the plan language explicitly links an accrued benefit or contributions to earned compensation, the employer must correctly record payroll hours—and thus all compensation earned—or the plan administrator will have insufficient records.
Despite an employer’s best efforts to ensure that its systems of employee classification, time and attendance reporting, wage calculation, and payroll processing are accurate, errors can occur—especially when it is not immediately clear whether employee time is compensable.
All claims. If you are faced with a derivative ERISA claim, the first step is to check relevant plan documents. If the retirement plan defines compensation based on wages paid, the employer should have a solid defense that it was required to follow the plan’s terms. But what if the retirement plan defines compensation as being based on wages earned? Depending on how the derivative ERISA claim is structured, an employer may still be able to defend against all or part of the claim.
Next, the employer should check to see if the derivative ERISA claim was filed in a timely manner. ERISA has a six-year statute of limitations for fiduciary claims. The limitations period for other ERISA claims may depend on the analogous state law statute of limitations or a shorter limitations period as set out in the plan document.
Fiduciary claims. Sometimes employees claim that the employer’s misclassification of jobs or failure to pay the proper wages is the underlying ERISA fiduciary breach. The employer could defend this claim on the basis that it was acting in its capacity as an employer, not in its capacity as an ERISA fiduciary, when making the decision—even if the decision had a collateral effect on employee benefits. Decisions about how to classify employees for payroll and FLSA purposes, as well as decisions about how much to pay those employees, are nonfiduciary.
Alternatively, employees might claim that the plan administrator, acting in its fiduciary capacity, failed to ensure that the payroll decisions of the employer were correct before using those amounts to determine plan benefits. The employer could defend that claim on the basis that a plan fiduciary has no duty to double-check the employer’s payroll decisions. When enacting ERISA, Congress did not intend for plan administrators to regulate purely corporate behavior.
An ERISA fiduciary must act in accordance with the documents and instruments governing the plan.
Record-keeping claims. The record-keeping provision in ERISA Section 209 does not provide a private right or cause of action for an employee to sue an employer for a record-keeping failure. Rather, Congress provided for a civil penalty payable upon the finding of a violation. As a result, record-keeping claims are generally brought under ERISA Section 502(a)(3), the "catch-all" provision. But federal district courts disagree on whether this is permissible. Consequently, an employer could argue that a private record-keeping claim is not viable under ERISA.
Even if the court determines that an ERISA record-keeping claim is viable, the claim still would be appropriate only when the failure to maintain records prejudices the plan fiduciary’s ability to accurately determine benefits. In cases where an employer accurately records the hours that a participant works but fails to pay the correct amount of overtime, the error is considered to be one of payment rather than record-keeping.
Strong Employer Position
Derivative ERISA claims are costly but avoidable. As with other ERISA claims, they can be thwarted by inoculating the retirement plan with language that bases compensation on wages paid instead of wages earned. A plan’s definition of compensation should be carefully reviewed and, if necessary, amended to place the employer in a stronger position to defend against potential derivative ERISA claims.
Brian Giovannini, PHR, is an attorney in the Employee Benefits/Executive Compensation practice group at Haynes and Boone LLP in Houston.
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