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Informal, unwritten policies or “individual severance arrangements” are sometimes thought to be the most flexible and discretionary severance benefit structures. However, adopting a formal ERISA severance plan often provides an employer the most advantages—including maximum discretion and greater flexibility. Employers without formal ERISA plans introduce unnecessary risk and may end up forgoing beneficial flexibility.

Severance arrangements that do not qualify as ERISA plans are subject to state law, which can leave an employer at both a substantive and a procedural disadvantage. State law requirements can vary from state to state, which makes compliance difficult. This includes such issues as the standards for determining whether severance payments are subject to precedent and statute of limitations differences. In addition, many of these state laws, such as state wage payment and collection laws, include provisions that expose an employer to substantial risk in a lawsuit for nonpayment, including in some states punitive damages, jury trials, and potential personal liability for company officers.

Employers also frequently create “accidental” ERISA plans. Generally, employer severance payment arrangements are covered by ERISA if they are a “plan, fund, or program . . .  established or maintained by an employer” to provide severance benefits to employees. Thus, even if an ERISA plan isn’t intended, an employer could create one by having a regular practice of paying severance, particularly where such payments are subject to internal policies or procedures designed to maintain consistency or to limit the discretion of human resources personnel. Without the benefit of a formal ERISA plan document, this leaves the employer open to the discretion of the court in determining what benefit payments may be due to a particular former employee or group of employees. In this situation, prior practices can be determinative of what future payments should be. Adopting a formal ERISA plan would make the benefit structures clear. Further, employers with “accidental” ERISA plans will fail to meet the ERISA reporting and disclosure requirements, which includes providing eligible employees with summary plan descriptions and filing annual IRS Forms 5500. There can be steep financial penalties for failure to file an IRS Form 5500, including an IRS penalty of $25/day up to a maximum of $15,000 and a DOL penalty of up to $1,100 per day with no cap. And failing to comply with ERISA’s procedural requirements may make it more difficult to defend a claim for severance benefits.

In addition to the reasons outlined above, creating an ERISA covered severance plan is beneficial in many ways, as follows:

  • ERISA preempts state law, which allows an employer to have one set of laws to comply with, and under federal law, claims and potential damages are more limited.
  • ERISA litigation is generally decided by a judge and not a jury.
  • ERISA plans are required to include claims and appeals procedures and participants are generally required to exhaust these procedures before filing a lawsuit. Additionally, if the claims and appeals procedures are followed by the employer, courts generally tend to defer to the decision of the employer regarding whether benefits are payable under the plan.
  • The plan document can indicate which state law applies in the event that any portion of a claim is not preempted by ERISA (instead of potentially being subject to multiple state laws).
  • A reasonable statute of limitations provision may be added to the plan to limit the time period in which a participant may file a lawsuit after a claim denial. Additionally, the plan can specify the venue (place) where litigation may be brought.
  • The plan document can provide maximum discretion to pay severance payments in different amounts to different participants.

In short, employers that pay severance to departing employees on a recurring basis, particularly those who do so in accordance with internal policies or practices, should consider and evaluate the benefits of implementing a formal ERISA severance plan.