A review of the following three areas may be helpful for those seeking to put together a severance package:

* ERISA rules governing severance benefits;

* Severance benefits in the merger and acquisition arena; and

* The legal standard applied by a court to an ERISA case.

Most Severance Plans Are Subject to ERISA. Some employers are not aware that most severance plans are subject to the Employee Retirement Income Security Act of 1974 (ERISA). As a welfare plan, severance benefits are not subject to ERISA's benefit accrual, vesting or funding requirements. However, they are subject to the reporting and disclosure, fiduciary responsibility and administration and enforcement provisions. These areas may cause problems for some employers.

Severance benefits, particularly informal severance pay practices, raise some of the more difficult ERISA plan issues. Clearly, that any plan regularly providing severance benefits is an ERISA welfare plan. This is true whether or not the plan has been formalized, i.e., reduced to writing. What is less clear is whether occasional ad hoc severance benefits paid to selected employees constitute a severance plan. Recognizing that the price for an aggressive position may be a high civil penalty, conservative practice may be appropriate.

Many courts have found employer policies regarding severance pay to be ERISA welfare plans. For example, one court ruled that an unpublished internal-policy statement fell within ERISA's definition of welfare plans. Another court ruled that even an unwritten policy constitutes an ERISA welfare plan where the employer pursuant to the policy consistently paid severance benefits to terminated employees.

The severance issue is clouded by the fact that in some cases what is called or appears to be severance pay may actually be a salary continuation plan, exempt from ERISA. If an employer continues providing an employee with a salary and with all other prerequisites of employment for a period of time during which it does not require the employee to report to work, the continued salary payments arguably are not severance benefits that constitute an ERISA plan. Because resolution of this issue may turn on whether the employment relationship has ended (probably determined under local law), the employer's labor counsel should be consulted.

There is also a long-standing issue of whether a program that provides for severance benefits for more than two years is a welfare or a pension plan under ERISA. Because the DOL standards are not the sole determinant on the issue, an employer may still take the position that a long-term severance program that does not meet the DOL's welfare benefit guidelines is still a welfare benefit plan. If the severance arrangement is a pension plan, it would be subject to ERISA's funding, vesting, and participation requirements. If the severance plan is viewed as a pension plan, employers face the many compliance and regulatory issues of such plans.

As noted earlier, if the severance arrangement constitutes a welfare benefit plan ERISA's reporting and disclosure requirements, fiduciary responsibility provisions, and administration and enforcement provisions apply.

The reporting and disclosure requirements include providing each participant with a summary plan description and a summary of any material modifications in the terms of the plan. Certain other disclosures must be made upon the request of any participant or beneficiary. Also, a summary plan description, a statement of any material modifications in the terms of the plan and an annual report (Form 5500), must be filed with the Department of Labor.

There are exemptions for some of the reporting and disclosure requirements for certain categories of welfare benefit plans. For example, certain exemptions apply to unfunded or fully insured welfare benefit plans with fewer than 100 participants at the beginning of the plan year. In determining the number of participants for purposes of the reporting and disclosure requirements, all participants who are eligible to receive severance benefits under the terms of the plan are counted (i.e., not only those participants who received a distribution during the plan year).

The fiduciary responsibility provisions of ERISA require, among other things, that every employee benefit plan shall "describe any procedure under the plan for the allocation of responsibilities for the operation and administration of the plan and...provide a procedure for amending such plan, and for identifying the persons who have authority to amend the plan." A plan document containing these provisions is required by ERISA.

The administration and enforcement provisions, among other things, require every employee benefit plan to provide for a reasonable claims procedure. For a claims procedure to be deemed reasonable under ERISA, DOL regulations provide that it must be described in the summary plan description.

Merger and Acquisitions. Companies--especially sellers in a merger/acquisition situation--are facing an increasing number of lawsuits. Surprisingly, lawsuits have upheld a former employee's claim to severance benefits, forcing the seller to pay--even when the employee has continued in the same job and often with the same or comparable pay and benefits.

When the employees in a division or facility that is sold accept or are offered employment with the new owner, a determination of whether they are entitled to severance pay depends entirely on the terms of the seller's severance plan. If the employees' claims are denied and a lawsuit ensues, the court will review the plan administrator's decision by interpreting the seller's plan. Furthermore, the court's decision may be influenced by a seller's failure to follow ERISA's procedural requirements (such as filing and distributing a summary plan description), even though such procedural violations carry little or no penalty and generally create no substantive rights for the former employees.

There are nearly as many factual settings for severance claims following the sale of a business as cases. While this makes conclusions on entitlement in any given case difficult to draw, all employers are well advised to--

* Review their severance plans and policies in a sale-of-business context before the transaction occurs,

* Decide on the treatment most appropriate if sale were to take place, if different from the existing policy (i.e., deny severance upon employment with the successor), and

* Communicate clearly to employees the terms of the plan or policy.

Following these simple guidelines will help an employer avoid claims by employees seeking a windfall after the sale of a business unit. If an action begins, these guidelines will enhance the employer's likelihood of prevailing.

Legal Standards. Several years ago, the Supreme Court created new standards for judicial review of decisions by fiduciaries under ERISA. This case was Firestone Tire & Rubber Co. v. Bruch, 109 S.CT948 (1989). Courts are now required to defer to ERISA only to the extent that the plan documents expressly provide for deference. In all other cases, review of fiduciaries' decisions will be de novo. Under a de novo review, a court independently construes the terms of the plan document in light of such evidence as it deems relevant to determine whether the fiduciary decision was proper, without giving weight to the position of the fiduciary. Deference is only appropriate said the Supreme Court, if the plan documents confer discretion upon the plan fiduciaries.

The Supreme Court indicated that "abuse of discretion," a trust law concept, is the appropriate standard of review where discretion has been granted to the plan's fiduciaries. The "abuse of discretion" standard appears to be similar to the "arbitrary and capricious" standard, traditionally used for review of trusts, prior to the Firestone case.

Before condemning a decision as arbitrary and capricious, a court has to be very confident that the decision maker overlooked something important or seriously erred in appreciating the significance of the evidence. Under this standard, the plan's interpretation was sustained as long as it was reasonable. For example, when the trustee's interpretation of a plan was in direct conflict with express plan language, this action was a very strong indication of arbitrary and capricious behavior.

However, the U.S. Supreme Court ruled in Firestone that this standard of deference no longer automatically controls in benefit denial cases.

Therefore, all severance plans that do not contain language giving the fiduciaries discretion to interpret and construe the plan should consider adopting such language to trigger a deferential legal standard.

William A. Bader, JD, CPA, William M. Mercer, Inc.