As if ERISA fee litigation isn’t enough to keep plan fiduciaries up at night, plaintiffs have concocted new claims brought against fiduciaries in a spate of recent lawsuits. Specifically, five recent suits all brought in Northern California have alleged claims against plan fiduciaries related to the use of plan forfeitures. We discuss the background of the cases, the allegations and potential implications below.
Background
As a refresher, a plan forfeiture occurs when a participant’s plan balance is forfeited due to events spelled out in the plan document. Most commonly, plan forfeitures occur where participants separate from employment before becoming fully vested in employer contributions. Plan forfeitures may also occur on employer matching contributions where the employee doesn’t contribute or meet other conditions to receiving the match as described in the plan document.
In the cases brought by the plaintiffs, the plan documents permit the use of forfeitures for both the paying administrative expenses and reducing future employer matching contributions. The plan documents generally provide that the fiduciary has the authority to use plan forfeitures to either pay reasonable expenses of the plan or to reduce discretionary contributions, special contributions, and/or matching contributions.
These types of provisions are customary in that they allow plan forfeitures be used in accordance with the Internal Revenue Code. In this regard, the legislative history for the Tax Reform Act of 1986 provided that forfeitures arising in any defined contribution plan “can be either (1) reallocated to the accounts of other participants in a nondiscriminatory fashion, or (2) used to reduce future employer contributions or administrative costs.” Moreover, IRS/Treasury recently issued proposed rules that would further codify the existing practice. There, IRS/Treasury proposed that plan forfeitures could be used to 1) to pay plan administrative expenses; (2) to reduce employer contributions under the plan; or (3) to increase benefits in other participants’ accounts in accordance with plan terms. Use of Forfeitures in Qualified Retirement Plans, 88 Fed. Reg. 12282 (proposed February 27, 2023)
Allegations
In essence, the lawsuits claim that despite the fact that fiduciaries are authorized to use forfeitures to pay down plan expenses within the plan document that the fiduciaries consistently use forfeiture amounts to reduce employer contributions.
The claims have surprised the retirement community given that the use of forfeitures to offset employer contributions is so well established and widespread.
Thus, plaintiffs argue, the plan fiduciaries did not serve the plans with an eye single to providing benefits but instead used forfeiture amounts to reduce contributions that the employer would have otherwise owed to the plan. As a result, the plaintiffs allege that the fiduciaries breached their fiduciary duties to the plan under ERISA section 404 when using plan forfeitures to offset employer contributions rather than pay plan expenses. The lawsuits also alleged violations of ERISA’s anti-inurement provision under ERISA section 403, and self-dealing prohibitions under ERISA section 406.
The claims have surprised the retirement community given that the use of forfeitures to offset employer contributions is so well established and widespread. As noted above, the longstanding practice is explicitly described in legislative history and new proposed regulations. We expect defendants to lean on this legal backdrop and argue that the practice of using forfeitures to offset employer contributions is explicitly permitted by the Internal Revenue Code when seeking to dismiss the claims from court.
Potential Implications
These cases raise interesting issues for plan fiduciaries and sponsors and plan sponsors and fiduciaries will be reviewing these cases closely. If the cases are successful and proceed beyond a motion to dismiss, plan sponsors could be left to reevaluate whether plan document language that provides flexibility on the use of forfeiture amounts remains appropriate. The answers to those questions won’t be easy and may involve an analysis of regular and ongoing plan operations. Hopefully decisions in these cases can shed some additional light on these issues. Until then, we will all need to wait.
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George Sepsakos is a principal at Groom Law Group, Chartered, where he represents clients on a broad range of ERISA, federal tax, and securities law matters.
