Labor and Employment

Severance Pay Plans

Employee benefit plans that comply with the Employment Retirement Income Security Act of 1974 (ERISA) secure the advantages of ERISA, which is a federal law that promotes the offering of employee benefit plans by employers. ERISA law preempts, or takes precedence over, state laws governing an employee benefit plan.

The Employment Retirement Income Security Act of 1974 (ERISA) broadly covers severance pay plans, which generally provide benefits in case of termination of employment for reasons such as the closing of a business. Severance benefits may include items such as:

  • A lump sum payment
  • Payments over a period of years
  • Transfer options, job training expense reimbursement
  • Continuation of medical care coverage

The severance pay plan need not have assets placed in a separate ''severance pay'' fund. Instead, the benefits may be paid by the employer, or employee organization, out of its general assets.

Requirements for Plan to be ERISA-Covered

The determination of whether or not a severance pay plan is ERISA-covered became an issue as a result of the United States Supreme Court decision in Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987). The opinion addressed a Maine law which required employers, upon closing plants, to pay lump sum severance benefits to certain employees who were not covered by a severance contract. The employer, which had no severance pay plan, refused to comply with the state law, claiming that ERISA preempted the state law, that is, ERISA took precedence over it. The Supreme Court held that the state law was not ERISA-preempted, reasoning that ERISA covered only ''plans'' and not merely ''benefits.'' The Supreme Court found that the Maine law did not require the establishment of an ERISA severance pay plan, but instead simply required the employer to make a one-time payment of cash benefits.

Some federal courts have found that employer-established severance pay plans are ERISA-covered even if they simply provide lump sum payments on termination of employment in a manner similar to the requirement of the Maine law. Other courts have applied the Supreme Court's decision strictly and have found no ERISA coverage when the severance program provided nothing more than a lump sum payment.

Due to uncertainty caused by the Supreme Court decision, to ensure ERISA coverage, employers should adopt written severance pay plans providing for:

  • A specific class of potential beneficiaries to be covered by the severance plan
  • Specific conditions for payment of benefits (for example, a layoff of employees in a situation where no other company promptly hires them)
  • Discretionary authority on the part of the plan administrator, which is a person designated to administer the plan or the sponsor of the plan, to determine (1) whether a particular employee is ''eligible'' to receive benefits under the severance plan, (2) whether a lay-off was ''without cause,'' and (3) whether an employee resigned ''for good reason''
  • Specific benefits consisting of more than a lump sum payment (for example, payment of one-quarter of the severance benefits upon termination, and the balance over a two year period)

If the employer provides other severance benefits, such as transfer options, job training expense reimbursement, or health care continuation benefits, they should be fully explained in the plan. In addition, the employer should make certain that all of ERISA's reporting and disclosure requirements are met.

Planning Note for Employers

Employers and their lawyers should review and amend their severance pay plans to state their intentions:

  • If the employer intends, the severance pay plan should state that severance benefits be payable only upon the involuntary termination of employment, such as in a layoff or shutdown of a plant, but not in case the employee is rehired within 30 days by the same employer or by another employer in the same or a substantially similar position and with the same or substantially similar compensation.
  • Severance benefits should be payable partly in lump sum and partly over a stated period of time, and the employer should consider providing that the benefits will terminate if the employee is rehired within 60 days.
  • The plan should also expressly give the plan administrator and ERISA claims review fiduciary, which is someone who manages the award of claims, discretionary authority to interpret the plan and determine eligibility for benefits.
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