ERISA does not require employers to establish retirement plans for its employees, and it does not require employers to pay particular benefits if they choose to establish a plan. ERISA does, however, impose some restrictions on employers who choose to provide a retirement benefit. One of those requirements concerns backloading, which is a concept only an actuary could love. Backloading rules, and remedies for violating them, combined to give rise to a wildly complicated class-action dispute called Kifafi v. Hilton Hotels Retirement Plan, — F.3d –, 2012 WL 6216631 (D.C. Cir. Dec. 14, 2012).
“Backloading” occurs when an employer awards a significantly higher percentage of an employee’s total benefits in the employee’s later years of service. 29 U.S.C § 1054. Because not all employees will work for an employer throughout their entire career, backloading would allow an employer to design a plan that ostensibly provided for a certain amount of benefits to accrue over an employee’s working life, but that, in reality, required less contributions due to normal employee attrition. ERISA provides three “anti-backloading” rules, and every retirement plan must satisfy one of them. The rule that was most at issue in this case was the “133-1/3% rule,” which requires that the benefit accrual rate for any given year of service cannot be more than 133-1/3% of the rate in any other year of service. In other words, if the benefit that accrues in year one is $100, the maximum benefit that can accrue in any subsequent year is $133.33.
With that background, we turn to the Kifafi case, which took approximately fifteen years to litigate, and generated twelve district court opinions before the DC Circuit weighed in. Hilton ultimately conceded a violation before the litigation ended, but the litigating complexity arose primarily in connection with determining the significance of a finite period of time during which the rules were violated, and deciding which employees could benefit. (There was also a separate issue regarding vesting of benefits, which we will not discuss here).
In a nutshell, Kifafi brought a class-action lawsuit alleging that Hilton’s pension plan violated ERISA’s anti-backloading rules. Hilton asserted that its plan intended to comply with the 133-1/3% rule, and initially claimed that it had complied, though ultimately admitted that it had not. In 1999, while the lawsuit was pending, Hilton amended the plan “to eliminate any controversy regarding the propriety of the rate of benefit accruals” under the plan, and provided that participants would get the greater of the benefits provided by the old plan or the amended plan. The IRS ruled that the amended plan satisfied the anti-backloading rules. Apparently, the amended plan did so by decreasing benefits that would accrue in later years of service (so that the benefits accruing in earlier years would not be insufficient).
The district court certified Kifafi’s class, ruled that Hilton had violated the anti-backdating rule; and reformed the pre-amendment plan to remedy the default. Both parties were unhappy, and appealed
Hilton first argued that its 1999 amendment to the plan, which complied with the anti-backloading rules, made Kifafi’s claims moot. The Circuit Court framed the issue as whether a party can deprive a court of jurisdiction by apologizing for misconduct and promising that it will not happen again. Though the court recognized that Hilton’s current plan complied with the rules, it held that there was a possibility that Hilton could violate the rules again, especially because Hilton had represented that it was complying with the anti-backloading rule even when it was out of compliance. As the court stated: “This is a complicated area of law in which even the best-intentioned actors may yet do wrong.” Thus, the court determined that Hilton could not establish that the violation would not reoccur in the future, and the case was not moot.
Next, Hilton argued that the 1999 amendment retroactively cured the pre-1999 backloading violation, apparently by reducing the benefits that would accrue in the future. In essence, Hilton appears to have argued that, even though the pre-1999 plan did not comply with the 133-1/3% rule, the 1999 amendment caused the plan to retroactively comply with a different anti-backloading rule. Hilton argued that, because it needed only to comply with one of three anti-backloading rules, the district court did not have the authority to require it to provide employees with the benefits they would have received if the plan had complied with the 133-1/3% rule prior to 1999.
The circuit court rejected this argument in an interesting bit of ERISA equitable logic. The court began by agreeing that a plan could comply with any of the three rules, and that it cannot be in violation even if it turns out that it complied with a rule that was different than the one with which it intended to comply. However, as the court then stated: “Once the [district] court determined the Plan violated ERISA, it entered the world of equity.” In that world, the standard for prospective compliance did not necessarily circumscribe the remedies for a prior violation. In essence, the court held that an employer could not remedy a prior failure to comply with the anti-backloading rules by decreasing benefits payable in future years. The court likened Hilton’s approach to an employer remedying a failure to pay overtime by retroactively decreasing the base pay rate so that the wages paid complied with overtime rules.
But, the district court did not simply increase the benefits accruing for each pre-1999 year, as Kifafi argued. Instead, the district court noted that a plan participant can “outgrow” a violation of the anti-backloading rules if he stays employed for long enough. For example, if an employee is to receive a total benefit of $100 over a 40-year period of service, backloading results in more of that $100 being credited in later years (assuming he is still employed). But if he stays the full 40 years, he will receive the full $100. The remedy Kifafi advocated would have given participants a greater total benefit at the end of their service than if the plan had complied with the rule from the beginning. Because of this, the circuit court held that fixing a backloading problem “might entail increased benefits, but it need not.” It held that the district court acted within its discretion to limit the remedy to those employees whose total benefits actually were reduced by the backloading.
The parties also argued over the application of the statute of limitations. They agreed that a three-year limitation period was appropriate, and that it should begin to run when a participant discovered or should have discovered the violation. The court rejected the notion that a participant who received backloaded benefits should have discovered a violation, holding that, “to catch the backloading, Plan participants would have needed to apply complex law to complex facts.” Thus, participants who received benefits more than three years before Kifafi sued could recover.