Same facts, different results – two courts come to different conclusions in forfeiture litigation

On May 24, 2024, the United States District Court for the Southern District of California denied defendants motion to dismiss in Perez-Cruet v. Qualcomm Incorporated, finding that the sponsor’s exercise of discretion to use forfeitures to reduce employer contributions, rather than to reduce participant-paid administrative costs, presented a colorable violation of ERISA’s fiduciary rules. On June 17, 2024, the United States District Court for the Northern District of California granted defendants’ motion to dismiss in Hutchins v. HP Inc., a case involving nearly identical facts/claims.

In what follows we summarize the facts and legal arguments and then the decisions of the two courts on the key legal issues.

Background – forfeiture litigation generally

Qualcomm and HP (and several other cases, to date all brought in California), all involve a similar set of facts:

1. A plan document that gives someone – the plan’s administrator, or the sponsor, or a plan committee – discretion to decide whether to allocate forfeitures for the benefit of the sponsor (generally by using forfeitures to reduce company contributions) or for the benefit of participants (in Qualcomm and HP, by using forfeitures to pay administrative expenses that would otherwise be paid out of participant accounts).

2. A decision by that person (administrator/sponsor/plan committee) to use forfeitures to reduce employer contributions.

In these circumstances, plaintiffs claim, the person making that decision ((administrator/sponsor/plan committee) (1) was acting as an ERISA fiduciary and not as a “settlor” (see the sidebar below) and (2) violated ERISA’s fiduciary duties of loyalty and prudence, its anti-inurement provision, and its prohibited transaction provisions. (In this article we focus on the duty of loyalty claim, as the most intuitive, least technical of plaintiffs’ claims).

Sidebar: Settlor vs. fiduciary functions. It has long been understood that ERISA recognizes certain decisions as belonging to the sponsor as “settlor” of the plan’s trust. Examples of settlor functions include: the sponsor’s decision to establish a plan, the design of a plan (e.g., its benefit formula or matching contribution rate), the decision to terminate a plan, and the decision to pay administrative expenses out of plan assets or, alternatively, out of the sponsor’s pocket.

These settlor functions are non-fiduciary and are distinguished from fiduciary functions such as discretion over the investment of plan assets and the retention of investment managers.

What the courts said

Both the Qualcomm and HP courts do seem to agree on issue (1) (fiduciary vs. settlor act), holding that with the sort of language used in these plans, the decision to use forfeitures to reduce employer contributions rather than reduce administrative costs is a fiduciary act.

With respect to issue (2), however, they come to opposite conclusions.

The Qualcomm court finds that the discretionary use of forfeitures to reduce employer contributions does present a colorable violation of ERISA fiduciary rules. Without going into the more detailed and complicated arguments with respect to fiduciary prudence, non-inurement, and prohibited transactions, the court’s analysis of ERISA’s fiduciary duty of loyalty is both intuitive and straightforward (if somewhat simplistic): “Plaintiff plausibly claims that the Defendants breached their fiduciary duty [of loyalty] to Plan participants by making a choice that put the employer’s interests above the interests of the Plan participants.”

In a somewhat more complicated analysis of the same issue, the HP court comes to a different conclusion, holding that ERISA’s fiduciary rules cannot be used to create an additional participant benefit not provided for in the plan:

First, Plaintiff’s theory of liability would improperly extend the protection of ERISA beyond its statutory framework. ERISA does not mandate what benefits an employer must provide under a plan and does no more than protect the benefits which are due to an employee under a plan. … Plaintiff is effectively arguing that the fiduciary duties of loyalty and prudence create a benefit: the payment of his administrative costs. … [T]hose provisions [however] “create[] no exclusive duty of maximizing [participant] pecuniary benefits.”

Second, Plaintiff’s theory of liability is contrary to the settled understanding of Congress and the Treasury Department regarding defined contribution plans [citing the Conference Report of the Tax Reform Act of 1986, subsequently quoted in the preamble to IRS’s proposed forfeiture regulation].

It remains to seen how these two different analyses of the same issue will be reconciled – we note that defendants have filed a motion to reconsider in Qualcomm, attaching the HP decision as an exhibit.

What can sponsors learn from these decisions?

With respect to this forfeiture litigation, sponsors need to know two things: First, is there a problem with their current plan? As noted, all of these cases involve plan language that gives someone – the plan’s administrator, or the sponsor, or a plan committee – discretion to decide whether to allocate forfeitures for the benefit of the sponsor (generally using them to reduce company contributions) or for the benefit of participants (in Qualcomm and HP, by using forfeitures to pay administrative expenses that would otherwise be paid out of participant accounts). Many (if not most) sponsors will have this sort of language in their defined contribution plan.

Second, if there is a problem, how should their plan be re-written to make that problem go away? Thus far, at least, no one is disputing that a plan could provide explicitly for using forfeitures first (or only) to reduce employer contributions. Sponsors will want to consult with counsel as to whether their plan should be amended to eliminate discretion in the allocation of forfeitures.

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It is still early days in this litigation, and as these two cases illustrate, courts have yet to reach a consensus view of the legal issues.

We will continue to follow this issue.