In the world of ERISA litigation, one of the safest bets is usually that, if an employer establishes something that it calls a “plan,” and the plan allows a significant number of its employees to obtain money after retirement, ERISA is going to govern. Sure, there are situations where the employer is exempt from ERISA (it may be a governmental entity or affiliated with a church), but those exceptions are generally easy to spot.
However, Pasternack v. Shrader, 863 F.3d 162 (2d Cir. 2017), is a reminder of the risks of drawing such automatic conclusions, because sometimes a plan is just a plan. Pasternack essentially held that, when the primary purpose of a stock ownership plan was something other than deferring income or providing retirement income, ERISA may not govern. Though the Court asserted that the distinction between a pension plan and one that offered present benefits was “crisp and unambiguous,” one might be forgiven for harboring doubt that the line is as well-defined as the Court believed.
The plaintiffs in Pasternack were former partners in Booz Allen, the consulting company, who claimed that they were wrongfully denied compensation when the company sold one of its divisions. The dispute revolved around Booz Allen’s Stock Rights Plan (SRP).
What is important to note at the outset is that Booz Allen is a corporation that is privately owned by its officers, and that it functions more like a partnership. The SRP, according to the Second Circuit, is a key component of that structure. Under the SRP, each officer is given the right, annually, to purchase a tranche of common stock and a tranche of Class B stock. The common stock is bought at book value, and the Class B stock for a nominal amount. For the next ten years, the officer can exchange some of the Class B stock for common stock at a steep discount (50% of the book value at the time of the initial grant); by the end of the ten years, the initial purchase will typically all be held as common stock. Each year the officer can also buy a new combination of common stock and Class B stock, which then uses the same ten-year conversion schedule. Both common stock and Class B stock carry voting rights, and common stock pays a dividend.
If the officer is terminated for cause or leaves before retirement, all of his or her Class B stock is returned to the company. If the officer stays until retirement, he or she can convert all Class B stock into common stock. Booz Allen then will repurchase the common stock after two years at current book value.
The Court noted that “[t]he SRP is a lucrative arrangement that allows participants to realize handsome profits when they sell their common stock. … Because the book value appreciates at a compounded rate of 10% annually, the current book value in any year will be higher than the purchase price–generally much higher. A participant who received an initial grant of 100 shares in 2001, with a book value of $100 per share, would ultimately pay $5,500 by 2010 to receive 100 shares of common stock, which by then would be worth $23,579–a 329% return on investment with nominal risk.”
The SRP is not a pension plan
ERISA defines “employee pension benefit plan” as:
[A]ny plan, fund, or program . . . to the extent that by its express terms or as a result of surrounding circumstances such plan, fund, or program—
(i) provides retirement income to employees, or
(ii) results in a deferral of income by employees for periods extending to the termination of covered employment or beyond, regardless of the method of calculating the contributions made to the plan, the method of calculating the benefits under the plan or the method of distributing benefits from the plan.
29 U.S.C. § 1002(2)(A).
Pasternack held, in a nutshell, that a plan is not a pension benefit plan unless the primary purpose of the plan is to provide retirement income or income deferral to employees. In this, the Court has the support of several other circuits. Murphy v. Inexco Oil Co., 611 F.2d 570, 575 (5th Cir. 1980) (“The words ‘provides retirement income’ patently refer only to plans designed for the purpose of paying retirement income whether as a result of their express terms or surrounding circumstances.”); Oatway v. Am. Int’l Grp., Inc., 325 F.3d 184, 188-89 (3d Cir. 2003) (holding a plan was not an ERISA plan “because its purpose was to operate as an incentive and bonus program, and not as a means to defer compensation or provide retirement benefits”); Emmenegger v. Bull Moose Tube Co., 197 F.3d 929, 931-34 (8th Cir. 1999) (focusing throughout its analysis on the “purpose” of the defendant company’s stock plan); Rich v. Shrader, 823 F.3d 1205, 1210 (9th Cir. 2016) (“we agree with our sister circuits that have determined that the paramount consideration is whether the primary purpose of the plan is to provide deferred compensation or other retirement benefits”).
Pasternack held that retirement income or income deferral were only incidental or secondary benefits of the SRP.
First, it held that “income” is not really “deferred” under the SRP because the “salient benefit” participants receive “in exchange for a capital injection is an ownership stake in Booz Allen. And because Booz Allen is owned entirely by its officers, that ownership stake entails the right to actively direct the management of the enterprise.” Even though a participant’s stock could only be liquidated upon retirement, “the dominant benefits are the ownership stake in the enterprise and the corresponding rights of management – and these rights were exercised before retirement and ended with the retirement process.”
It summed up its analysis of this element: “We do not think that the statute, which speaks of a ‘deferral of income . . . to the termination of covered employment,’ is meant to include instances in which benefits enjoyed before retirement were converted to cash after retirement. Such benefits were not ‘deferred.’”
Turning to the first part of the definition, the Court held “[t]he statutory phrase ‘provides retirement income’ does not cover every instance in which a person cashes out an investment after retirement, even though a participant will have anticipated this income when planning for retirement. The very fact that the provision is an alternative to § 1002(2)(A)(ii), which explicitly asks whether a plan ‘results’ in deferred income, suggests that the phrase ‘provides retirement income’ considers the plan’s primary purpose rather than its result.”
The Court explained that, in its view, the “primary purposes of the SRP are to provide working capital for [Booz Allen] and to maintain management’s control of it.”
Finally, the Court noted that the Ninth Circuit had previously held that the Booz Allen SRP was not an employee pension benefit plan. Rich v. Shrader, 823 F.3d 1205 (9th Cir. 2016).
It is a hallmark of ERISA jurisprudence that courts almost always conclude that Congress meant exactly what it said in enacting the statute, nothing more and nothing less. In Pasternack, the Second Circuit adopted the rationale that sometimes the statute should not be construed literally, and it read “primary purpose” into the definition of employee pension benefit plan. To be sure, even the Supreme Court has occasionally determined that Congress might not have meant exactly what it said, as evidenced by its recent decision regarding the church-plan exemption. Advocate Health Care Network v. Stapleton, 137 S. Ct. 1652, 1654 (2017). The decision in Stapleton, however, avoided a situation where hundreds of plans, in which tens of thousands of employees participated, were suddenly subjected to ERISA requirements that the plan sponsors did not believe would govern. The Booz Allen SRP, in contrast, is a single plan in which a few hundred people participated.
Even assuming that it is appropriate to graft the “primary purpose” language onto the definition of employee pension benefit plan, one must question how that purpose is determined, and by whom. For example, it is likely that the true principal purpose behind any employer’s decision to establish a retirement plan is to make itself competitive in the employment marketplace; the fact that it does so by providing a retirement benefit or income deferral may be secondary. Pasternack suggests that the goal the employer is trying to accomplish is paramount. Perhaps Pasternack deals with a unique plan for a unique company, and won’t have any larger impact. Or perhaps the rationale of these cases will provide a road map for employers to design a benefit plan with a primary purpose other than income deferral or retirement income, and to argue that ERISA does not govern.