New Case Law Developments on Payroll Practices May Have Employers Rethinking Old Plan Design

By Nicole Diller, Partner, Morgan Lewis, San Francisco, CA
Andrew Sullivan, Associate, Morgan Lewis, San Francisco, CA

Most employers and benefit practitioners assume that when an employer creates a welfare plan for the benefit of its employees, the Employee Retirement Income Protection Act of 1974, as amended (“ERISA”), will govern the plan’s benefits and obligations.  As a result, the Ninth Circuit’s recent decision in Bassiri v. Xerox Corp., 463 F.3d 927 (9th Cir. 2006), took many off guard.  Bassiri considered whether a long-term disability plan sponsored by Xerox constituted an employee welfare benefit plan within the scope of ERISA or if its payment of a portion of an employee’s wages while out on disability made it a payroll practice specifically exempted from ERISA.  Id. at 929.  Under the plan’s design, benefits lasted only as long as the recipient was a full-time permanent employee of Xerox.  Benefits ended upon termination¹.  Id. at 928. 

ERISA defines an employee welfare benefit plan as:  “any plan, fund, or program . . . established or maintained by an employer . . . for the purpose of providing for its participants or their beneficiaries . . . benefits in the event of sickness, accident, disability, death or unemployment . . . .”  ERISA Section 3(1), 29 U.S.C. § 1102(1).  Department of Labor regulations implementing ERISA, however, exempted “payroll practices” from ERISA’s coverage.  Those regulations define a payroll practice, in part, as:  “[p]ayment of an employee’s normal compensation, out of the employer’s general assets, on account of periods of time during which the employee is physically or mentally unable to perform his or her duties, or is otherwise absent for medical reasons (such as pregnancy, a physical examination or psychiatric treatment).”  29 C.F.R. § 2510.3-1(b)(2).  The Department of Labor explains in the preamble to the regulations that it exempted payroll practices from ERISA coverage because, “although related to benefits described in [ERISA Section 3(1)], [they] are more closely associated with normal wages or salary.”  Bassiri, 463 F.3d at 929, citing 40 Fed. Reg. 34256 (Aug. 15, 1975).

Deferring to the Department of Labor’s long-standing opinion that “normal compensation” includes payments of less than full salary, the Ninth Circuit held that Xerox’s LTD plan may qualify as payment of “an employee’s normal compensation” despite the plan’s payment of only sixty percent of Bassiri’s full salary.  Specifically, the court found that Xerox’s plan more closely resembled salary because:  (1) the payments come in regular paychecks, in an amount tied to the employee’s salary and not to the variable performance of a fund; and (2) like salary, the benefits end upon termination of employment.  Id. at 932.  In reaching its conclusion, the Ninth Circuit noted that the Department of Labor chose to define “normal compensation” broadly, and to focus on the source of the funding rather than its amount.  Id. 

Although Xerox’s plan has a number of distinguishable features, and future litigation may distinguish Bassiri on those grounds, employers may expect renewed scrutiny for employers that pay long-term disability benefits from their general assets.  In addition, where an employer’s plan does qualify as a payroll practice, a plaintiff may plead a simple claim for benefits as part of a broader suit asserting other state law causes of action.  For example, the plaintiff in Bassiri sought alternative relief under state law – if the Xerox LTD plan was exempt from ERISA – for breach of contract, fraud, and negligent misrepresentation.  Given the unavailability of those claims under ERISA, the Ninth Circuit’s analysis in Bassiri should prompt employers with plans similar in structure to that of the Xerox plan to revisit their plan design.