• Exclusion of Common Law Employees From Tax Qualified Plans is Permissible
  • December 22, 2003
  • Law Firm: Winston & Strawn LLP - Chicago Office
  • It is generally accepted that, while a tax-qualified plan must cover only employees of an employer, in order to avoid violating the Internal Revenue Code's exclusive benefit rule, it is not required to cover all of an employer's common law employees. Rather, the minimum number of common law employees that must be covered is determined under the nondiscrimination rules for tax-qualified plans. Why, therefore, would an individual bother to litigate this issue At least two thoughts come to mind. First, despite the weight of authority to the contrary, there is at least one federal district court that reached a contrary conclusion: the western district of New York in Renda v Adam Meldrin & Anderson Co., in 1992. Second, even though an employer can exclude some common law employees without running afoul of tax-qualification requirements, the plan must so provide. Where the plan is ambiguous in this regard, litigation may follow, as occurred in two recent cases.

    In Kolling v American Power Conversion Corporation, the plan administrator had denied benefits to Kolling on the basis that he was a consultant. The plan defined eligible employee as "employees of the employer," a classic circular definition, and including leased employees, but did not further define the term. Consistent with the company's business practice, the plan administrator applied a W-2 definition to the term employee. Under this definition only individuals receiving a Form W-2 were eligible to participate in the plan. Since Kolling did not receive a Form W-2 from the plan sponsor, he was not treated as an employee.

    According to the court, while Kolling may have had a plausible argument that he was a common law employee rather than an independent contractor, it is the language of the plan that controls. Where, as in this case, the plan adopts a circular definition of employee, the plan administrator has the discretion (if the plan so provides) reasonably to determine the meaning of that phrase. In this instance, according to the administrator, the plan sponsor intended that only individuals who received W-2 forms and leased employees could participate in the plan. The court found that it was reasonable for the plan administrator to adopt a definition of employee that carried out the plan's objectives.

    In Boin v. Verizon South, Inc., the court explained that plaintiff, a contracted worker had to satisfy a two prong test to be a participant in an ERISA plan. First, as a matter of law, he or she has to be a common law employee. Second, the plaintiff must be eligible to receive benefits under the plan according to the language of the plan. Unlike the first part of the test, if the plan provides that the plan administrator has discretion, an independent review by a court is not required. In this case, the dispute concerned a provision in an earlier version of the plan, which stated that "no employee shall fail to qualify as an Employee if he completes at least 1,000 hours of service as an employee of the Company in any calendar year." This language did not reflect the intention of the plan sponsor, as evidenced by the most recent iteration of the plan: what is intended was that an individual who did not receive regular and stated compensation, but who otherwise satisfied the requirements to be an employee would not fail to be treated as an employee if he or she completed 1,000 hours of service within the applicable computation period. However, applying the plan as drafted, the defendants were not entitled to win on a motion for summary judgment finding that its interpretation of the plan, excluding contracted employees was not arbitrary and capricious, because the court concludes that, even though inadvertent, the plan language might make the interpretation of the plan unreasonable.

    In conclusion, two observations flow from these cases. First, had these plans contained the "Microsoft" language we include in all benefit plans, the likelihood of litigation on these issues would have been substantially reduced. Second, a plan must accurately reflect the intention of the plan sponsor: neither the "Firestone" language that we include in benefit plans to obtain the benefit of review under an arbitrary and capricious standard, nor a "scrivener's error" doctrine, will necessarily suffice to overcome inartful or inaccurate drafting. It is also important to keep in mind that different standards of review apply to other types of plans, such as top-hat plans or equity compensation plans.