A notable trend in ERISA litigation has emerged as in-house attorneys look to mitigate the risks of coming waves of class action litigation. Beginning in late 2023, there have been several challenges to the use of forfeiture dollars in retirement plans. Currently, 10 actions have been filed advancing a novel theory brought forward by the plaintiffs’ bar that plan sponsors misused forfeited matching contributions, including class actions in California district courts against Intuit Inc., Thermo Fisher Scientific Inc., Qualcomm Inc., HP Inc., Honeywell International Inc., Tetra Tech Inc., and Mattel Inc. We believe small changes to your plan documents, processes, and procedures could greatly enhance your ability to avoid or withstand these complaints.
A forfeiture can occur in retirement plans that have a vesting schedule for employer-matching contributions. Although individuals are always vested 100% in their own deferral contributions, this is not necessarily so with employer contributions, which may be subject to a vesting schedule. Where an individual leaves before the time his or her matching dollars are vested, the match will become forfeiture dollars. Forfeiture dollars are considered assets of the plan under Internal Revenue Code section 401(a)(2) and ERISA section 403(c)(1) and must thus be used for the exclusive purpose of providing benefits to participants and beneficiaries and defraying reasonable plan administration costs. According to the Internal Revenue Service, which reaffirmed its position in 2023, 401(k) plan forfeitures can be used for any of three permitted purposes: (1) to pay plan administrative expenses; (2) to reduce employer contributions; or (3) to make an additional allocation to participants. Forfeiture provisions often give the sponsor/fiduciary some discretion as to which permitted use of forfeiture dollars those dollars are applied. For example, a forfeiture provision in a 401(k) plan might look like the following:
Allocation of Forfeitures. Subject to the Employer’s discretion, Forfeitures may be (1) applied to reduce Employer contributions; (2) applied to reduce the Plan’s administrative expenses (see Rev. Ruling 84-156); (3) used for the restoration of participants’ individual accounts previously forfeited; and/or (4) reallocated among participants in the Plan (see Rev. Rul. 81-10).
Most of the plans at issue in the California litigation contain similar forfeiture allocation language. What appears to be an issue resolved by principles of contract construction and plain plan language has been mired in controversy, with differing results among the California federal district courts to date. The plaintiffs allege that ERISA imposes a fiduciary duty on plan sponsors to act solely in the interest of the participants and for the exclusive purpose of providing benefits to plan participants and that the employers breached this duty by choosing to use forfeited funds to reduce their own future contributions to the plan instead of reducing the administrative expenses that are borne by participants. In so doing, the plaintiffs allege, the employers chose to put their own interests ahead of the interests of the plan participants by choosing not to act for the exclusive purpose of benefiting plan participants.
Motions to dismiss have been filed in each case with mixed results. In the Qualcomm action, dismissal was denied outright on the basis that the plaintiff’s claims were plausible. In HP Inc., the Northern District of California, noting that it did not find the Qualcomm decision persuasive, was more skeptical of the plaintiff’s claims. The court reasoned that the plaintiff’s theory that a fiduciary must always use forfeited funds to pay administrative costs would “improperly extend the protection of ERISA beyond its statutory framework.” The court granted HP’s motion to dismiss but allowed the plaintiff to file an amended complaint. In the Intuit action, the Northern District of California granted in part and denied in part Intuit’s motion to dismiss but declined to dismiss the claims for breach of fiduciary duty. To date, none of these actions has been dismissed with prejudice.
How can sponsors protect themselves from being sued for misuse of the forfeiture dollars?
One way would be to remove from the plan document any employer discretion in this regard. For example, the plan document could state that any forfeiture dollars will be used first to restore participants’ individual accounts that were previously forfeited under circumstances where the plan requires such restoration; next, to offset the plan sponsor’s contributions; next, to pay administrative expenses of the plan; and finally, to increase the balances of all other participant accounts.
An ERISA fiduciary has a fiduciary duty to follow a plan document, so long as it is not contrary to ERISA; and, if the plan document gives the fiduciary no discretion, the fiduciary arguably cannot be considered to be in breach of its duty. Nevertheless, it also could be argued that, to the extent that the forfeiture allocation priorities prescribed in the plan document benefit the employer, the fiduciary would have a duty to ignore the plan document and allocate forfeitures in a manner that more directly benefits participants. This argument is undercut to some extent by the fact that any or all of these uses of forfeiture amounts are clearly permitted under federal tax law. In any event, mandatory priorities in the plan document for how such amounts must be allocated will at least be a stumbling block for a plaintiff looking to sue.
Second, another avenue of attack appears to be the lack of communication of the forfeiture provisions. It would be a good step in mitigating potential risks to ensure the use of forfeiture dollars is clearly communicated to participants in the plan. The plan document, summary plan description, and any other plan communications regarding the forfeiture process and how forfeiture dollars are spent should be clear on the way forfeitures work. If you do not currently have a clear communication, it may be time to find a place in your annual participant notices to state the forfeiture procedures.
Third, consider adding an arbitration provision. The suit against Tetra Tech was stayed and referred to arbitration because the plan contained a “broad arbitration provision,” as well as a “broad waiver of class, collective and representative actions” clause.
Finally, it is important to ensure your vesting provisions are being followed. If you have never audited your vesting and forfeiture processes to ensure conformity with your plan documents, it may be time for a self-audit.
