United States: DOL Weighs In On Top Hat Plan Dispute

Last Updated: July 3 2015
Article by Jeffrey R. Capwell

For years courts have struggled with defining what qualifies as a "top hat plan." The stakes in these cases are often high, as top hat plans are exempt from most of ERISA's substantive requirements, including from its funding requirement which is necessary for the plan to be tax efficient, and from its minimum vesting requirements which is frequently necessary for the plan's design objectives to be achieved. For example, non-qualified deferred compensation plans must be unfunded to avoid participants from being currently taxed on their benefits until those benefits are actually paid. In addition, many plans are designed to promote employee retention and to enforce non-competition and other post-termination restrictions by using vesting and forfeiture provisions that generally are not permissible under ERISA.

Part of the difficulty in this area has been the absence of interpretive standards, either in ERISA, its legislative history or in regulations. ERISA defines the exemption as covering a plan that "is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees." There is very little in ERISA's legislative history to help interpret this "select group" requirement, and the U.S Department of Labor (DOL) has never issued regulations. Instead, the DOL has issued a handful of advisory opinions on this topic over the past 41 years. The early advisory opinions, and the courts that drew from those opinions, focused on various objective factors to determine top hat plan status. Factors frequently considered by the courts were the percentage of the employer's workforce covered under the plan, how the average compensation of plan participants compared with that of the rest of the employer's workforce and the compensation levels of participants in absolute terms.

Beginning in 1990, the DOL adopted two additional interpretations narrowing the scope of top hat plan the exemption (see DOL Advis. Op. 90-14A). First, the DOL adopted the position that a select group is limited to persons who "by reason of their position or compensation level, have the ability to affect or substantially influence, through negotiation or otherwise, the design and operation of their deferred compensation plan."  This bargaining power factor has since been accepted by a number of courts as one, but not the exclusive, means of evaluating a plan's status. In addition, the DOL adopted the position that the word "primarily" relates solely to the purpose of the plan and not to the determination whether the plan covers a select group. In the DOL's view, the exemption applies to a plan if the primary purpose of the plan is to provide deferred compensation; not to a plan that "primarily covers" of select group of management or highly compensated employees.

Both of these interpretations recently have been reiterated by the DOL in an amicus brief filed in a top hat plan case on appeal to the Fourth Circuit Court of Appeals. The case, Bond v. Marriott International, Inc., involves a plan that provided deferred stock bonus awards to participants that vested on a pro rata basis between the date the award was granted to the date on which participant attained age 65. A group of former participants who did not vest in their awards under the plan because they left employment before age 65 asserted that the plan did not qualify as a top hat plan because it covered a large number of employees that was not a "select group" within the meaning of the ERISA exemption, and that the plan violated ERISA's minimum vesting requirements. The plan covered up to 2500 participants until it was amended in the late 1980's to limit participation, which resulted in participation dropping to less than 100.

The district court agreed with the employer that the plan was in fact a top hat plan and thus was exempt from ERISA's minimum vesting requirements, and dismissed the former participants' claims. The court reached this conclusion on the basis of objective criteria, noting that only 2% of the employer's workforce and 20% of all of the employer's management employees participated in the plan, and that the employer sufficiently disclosed to plan participants that the plan was a top hat plan. The court refused to apply the DOL's "bargaining power" requirement, referring to it as "a fairly significant expansion upon the perceived scope of the top hat exemption." In addition, the court also did not apply the DOL's view that the statute's use of the word "primarily" refers only to the purpose of the plan. Instead, the district court concluded that the inclusion of certain participants who were not management or highly compensated did not preclude the plan from qualifying as a top hat plan so long as the plan was "principally intended" for the benefit of such persons.

Following appeal, the DOL submitted an amicus brief in support of the plaintiffs. The brief reiterates the DOL's commitment to both its "bargaining power" and "primarily" standards. The brief argues that both standards are supported by ERISA's legislative history and other federal court decisions. In addition, the brief emphasizes that the Fourth Circuit has previously observed that ERISA's substantive requirements were enacted to help persons who "lacked sufficient economic bargaining power to obtain contractual rights to nonforfeitable benefits" (see Darden v. Nationwide Mut. Ins. Co., 796 F.2d 701 (4th Cir. 1986)).

The Bond case is worth watching. While the DOL's "bargaining power" standard has been adopted by some courts as one factor that should be considered along with other objective criteria, it is inherently difficult to apply in cases that involve plans covering a group of participants, as opposed to individually designed and negotiated compensation arrangements. On the other hand, the DOL's narrow view of the "primarily" requirement has not been widely accepted by the courts. In fact, the Second Circuit Court of Appeals in an oft-cited decision rejected the DOL's interpretation and concluded that a plan could still be a top hat plan even if it included only a "very small number" of participants who were not part of a select group of management of or highly compensated employees (see Demery v. Extebank Deferred Compensation Plan (B), 216 F.3d 283 (2d Cir. 2000)). The Fourth Circuit now has an opportunity to further refine the law in this area.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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