A new federal court case involves an all-too-familiar scenario. An employer acquired a new business and had to terminate the old workforce. The employer, however, needed to keep some workers around for a few months, so it offered them a severance deal. But when the employer later tried to change the severance terms, it found itself in court facing a breach-of-contract suit. We’ll explain what happened and suggest measures you can take to avoid breach-of-contract lawsuits over severance packages and other employee benefits.
Severance Package Accepted
After acquiring a new company, American General Corp. proceeded to shut down one of the subsidiaries. A group of commissioned sales employees of the subsidiary were offered a lump-sum severance payment to remain on the job until a later termination date. The severance offer letter stated the lump-sum payment amount but didn’t mention how it was calculated.
The sales employees accepted the severance offer. Soon after, however, the company recalculated the severance amounts based on a six-month average of sales commissions, not the 10-month average the company used in its initial offer. This resulted in a substantially lower severance payment for each sales employee than the original severance offer letter stated.
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Employees Claim Breach of Contract
The employees sued American General for breach of contract. Amer- ican General asked the court to dismiss the lawsuit, arguing the severance package was regulated by the federal Employee Retirement Income Security Act, which supersedes state law claims regarding benefits. The company contended the severance benefits were offered to the sales employees under a preexisting ERISA severance plan that originally applied only to salaried employees, and that the company had merely amended that plan to cover the commissioned sales employees. A trial court agreed and threw out the employees’ lawsuit.
Contract or ERISA Plan?
But the U.S. Ninth Circuit Court of Appeal reinstated the employees’ breach-of-contract lawsuit. ERISA requires that benefits plans set forth and follow definite procedures for how they can be amended. In this case, the preexisting ERISA severance plan contained specific procedures for making amendments, but there was no evidence they were followed when the plan was altered to include the commissioned employees. The court said the severance package offered to these employees was a separate contract and not part of the preexisting plan.
The court also rejected American General’s argument that the severance offer was a new ERISA plan. ERISA requires that the benefits be offered as part of an organized scheme, and that the terms of the offer set out the basic elements of the benefits scheme. But the severance offer here didn’t meet these requirements because the letters didn’t even mention how the benefits were to be calculated.
Creating an ERISA Plan
The reason why this ruling is significant is that if your severance plan doesn’t qualify as an ERISA plan and you don’t follow the terms of your plan, employees can sue for breach of contract. And you face potentially larger damage awards in a breach-of-contract lawsuit than you would under an ERISA suit.
For a benefits plan to qualify as an ERISA plan, there must be an ongoing administrative program that enables reasonable people to understand the intended beneficiaries, source of financing, and procedures for receiving benefits and processing benefits claims. Once an ERISA plan is in place, additional compliance requirements kick in, including reporting and disclosure obligations.
Note that even if a severance plan otherwise complies with the rules for an ERISA plan, it still might not qualify under ERISA; one court ruled that a lump-sum payout was too unsophisticated to meet the requirements of an ERISA benefits scheme. Thus, if you’re considering adopting an ERISA severance plan, it’s best to consult a benefits expert.