DEFERRED COMPENSATION PLANNING,
THE "EXCLUSIVE BENEFIT" RULE,
AND THE HUGHES AIRCRAFT
CASE: HAS THE EMPLOYER
BENEFIT RESTRICTION BEEN ALTERED
WITH RESPECT TO ERISA QUALIFIED
PENSION PLANS?
JACK
I.
E.
KARNSt
INTRODUCTION
The process of planning a deferred compensation program for employees has seemingly become increasingly more difficult as federal
government agencies and the judiciary unnecessarily complicate that
which should be facilitated. However, with the decision in Hughes
Aircraft Co. v. Jacobson,' it appears that the United States Supreme
Court has rendered a very readable, understandable opinion, and in
the process done away with precedent that was lacking in its factual
basis. 2 Although the Court did not likely intend that Hughes Aircraft
achieve the importance it has achieved since the date of decision, it is
clear that pension planners have a bright line rule with regard to the
"employer benefit" rule, and facts that make for the so-called "good
case law."
The issue for which Hughes Aircraft will be remembered is
whether a surplusage that builds up in a plan due to good investment
decisions-and accrued interest on employee contributions of employees who departed the company prior to the pension vesting date-and
which in aggregate form exceeds that amount of monies needed to
fund all promised benefits, may be used by the plan sponsor to add a
benefit that will most assuredly dissipate the aforementioned surplus. 3 In Hughes Aircraft, an opinion arising out of the Ninth Circuit, 4 approximately ten thousand former employees argued that the
t Professor of Business Law, East Carolina University, Greenville, NC. S.J.D.
candidate) (Health Law and Policy), 2000, Loyola University Chicago; LL.M. (Taxation),
1992, Georgetown University; J.D., 1981, Tulane University; M.P.A., M.S., 1974, B.A.,
1973, Syracuse University.
1. 525 U.S. 432 (1999).
2. Lockheed Corp. v. Spink, 517 U.S. 882 (1996).
3. Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 439-42 (1999); Jacobson v.
Hughes Aircraft Co., 105 F.3d 1288, 1289-99 (9th Cir. 1997), rev'd, 525 U.S. 432 (1999).
4. Jacobson, 105 F.3d at 1288.
CREIGHTON LAW REVIEW
[Vol. 33
actions of the firm in developing an early retirement program, among
the creation of other benefits, amounted to a violation of the anti-inurement rule, such that the company was receiving a benefit to which
it was not entitled. 5 Not too surprisingly, the employees further argued that this was prohibited by ERISA because the early retirement
program improperly diverted funds, intended for pensioners, to the
6
pockets of the firm.
The Ninth Circuit agreed with the rationale of the respondents
and ordered that Hughes Aircraft cease these prohibited transactions.7 After granting certiorari, the United States Supreme Court reversed the Ninth Circuit decision 8 in sterling language that left little
5. Id. at 1298-1300.
6. Id. at 1300-01. The Ninth Circuit relied on its interpretation of ERISA § 4404,
29 U.S.C. § 1344, which provides the proper procedure when an employer terminates a
pension plan. This section requires that residual assets "shall be equitably distributed
to the participants who made such contributions." Employee Retirement Income Security Act, 29 U.S.C. § 1344(d)(3)(A) (1994). An employer may only claim excess plan residue where: "(A) all liabilities of the plan to the participants and their beneficiaries have
been satisfied, (B) the distribution does not contravene any provision of law and (C) the
plan provides for such a distribution." 29 U.S.C. § 1344(d)(1).
One key question here is whether the company "terminated" the plan because final
distributions were not made to plan participants. The plan was essentially modified or
altered and the issue of "termination" was not adequately addressed by the former employee respondents. However, the Ninth Circuit was very sensitive to this issue and
quoted the Treasury Regulations regarding this matter. See 26 C.F.R. § 1.401-6(b)
(1999). Specifically, the regulations provide that a termination "may" occur in situations that include:
(1) an employer beginning to discharge employees in connection with winding
down a business; (2) an employer replacing a plan with a non-comparable plan;
(3) an employer amending the plan to exclude a group of employees who were
formerly covered by the plan; or (4) an employer refunding or eliminating its
contributions to the plan.
Id.
The aforementioned regulations require that a court look at "all the facts and circumstances in a particular case" prior to rendering an opinion regarding the rights to
the plan residue. Id. Application of the "facts and circumstances" cases can be analyzed
by looking at the court's handling of the matter of creation of a constructive trust,
thereby reaching the termination question in exactly the manner prescribed by ERISA.
In most cases when a court applies a constructive trust principle, it is looking to hold
the fiduciary, or in this case, the plan administrator or sponsor personally liable for
having wasted trust corpus assets by and through an individual inurement. In Re Gulf
Pension, 764 F. Supp. 1149, 1202 (S.D. Tex. 1991), affd sub nom., Borst v. Chevron
Corp., 36 F.3d 1308 (5th Cir. 1994).
7. Jacobson, 105 F.3d at 1297. Given the factual pattern in this case, the Ninth
Circuit stated: "We hold that, when an employer amends a plan to use for its own benefit an asset surplus attributable in part to employee contributions, the employer is
wearing both its 'fiduciary' and its 'employer' hats." Id. (citing Varity Corp. v. Howe,
516 U.S. 489, 502-04 (1996)). In Varity Corp., the Supreme Court noted that "reasonable employees, in the circumstances found by the District Court, could have thought
that Varity was communicating with them both in its capacity as employer and in its
capacity as plan administrator." Varity Corp., 516 U.S. at 503.
8. Hughes Aircraft Co., 525 U.S. at 438. The Court provided that: "Our review of
the six claims recognized by the Ninth Circuit requires us to interpret a number of
20001
DEFERRED COMPENSATION PLANNING
doubt as to whether a plan sponsor, typically a firm's board of directors, is a fiduciary; 9 whether the plan sponsor can make adjustments
10
to plan benefits during the life of the plan without violating ERISA;
and perhaps most importantly, whether employees have any rights in
a plan's surplusage, as previously mentioned and defined, such that
1
the "employee benefit" rule is violated. ' This article is concerned
with these issues.
II.
HUGHES AIRCRAFT-FACTUAL BACKGROUND
Defendant, Hughes Aircraft Company, has operated since 1951 as
an aerospace and electronics manufacturing firm. Since that time,
Hughes Aircraft provided a retirement pension plan ("Contributory
Plan") for all employees, and it is that pension plan which was at issue
in this particular litigation. 1 2 Specifically, five former employees of
ERISA's provisions. As in any case of statutory construction, our analysis begins 'with
the language of the statute'. . . . And where the statutory language provides a clear
answer, it ends there as well." Id. (citations omitted). The Court made clear that its
facts and circumstances inquiry would be based on a plain meaning, strict construction
of the applicable ERISA provisions.
9. Hughes Aircraft Co., 525 U.S. at 443-44. The Court held that the fiduciary
provisions of ERISA do not apply to plan amendments, and further, that the decision in
Spink applied with equal force and integrity to "pension benefit plans" and "welfare
benefit plans." This logic was extended to cover all types of plans, be they "contributory,
noncontributory, or any other type of plan." Id. See Spink, 517 U.S. at 889-90.
10. Hughes Aircraft Co., 525 U.S. at 442. In language critical to the importance of
the direct holding in this case, the Court held:
In other words, Hughes did not act impermissibly by using surplus assets from
the contributory structure to add the noncontributory structure to the Plan.
The act of amending a pre-existing plan cannot as a matter of law create two de
facto plans if the obligations (both preamendment and postamendment) continue to draw from the same single, unsegregated pool of fund of assets.
Id.
11. It is this aspect that is, perhaps, the most important, yet unintended, holding
within the case opinion. This particular issue is of paramount importance to pension
planners since its violation results in a disqualification of the plan for income tax purposes. This is nothing short of catastrophic for all concerned: employees, plan sponsors,
and those who assisted in the formulation and establishment of the plan. Assuming the
latter are accounting and legal professionals, malpractice claims are always a lurking
possibility.
To assuage those concerned with the "employee benefit" rule, the Hughes Aircraft
Court stated that:
ERISA provides an employer with broad authority to amend a plan . . .and
nowhere suggests that an amendment creating a new benefit structure also
creates a second plan. Because only one plan exists and respondents do not
allege that Hughes used any of the assets for a purpose other than to pay its
obligations to the Plan's beneficiaries, Hughes could not have violated the antiinurement provision under ERISA § 403(c)(1).
Hughes Aircraft Co., 525 U.S. at 442-43 (citation omitted) (footnote omitted).
12. Jacobson v. Hughes Aircraft Co., 105 F.3d 1288, 1291 (9th Cir. 1997), rev'd, 525
U.S. 432 (1999); Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 435-36 (1999). The plan
provided in section 3.1 that the sponsor's funding obligation was: "The cost of Benefits
under the Plan, to the extent not provided by contributions of Participants ...shall be
CREIGHTON LAW REVIEW
[Vol. 33
Hughes Aircraft claimed that surplus assets from the Contributory
Plan were part of a defined benefit plan and, therefore, the plan participants have an ongoing interest in that plan's surplus. Consequently, these former employees argued that they have a right to
receive a pro rata share of any existing surplus. 13
The company's Contributory Plan was one requiring both the employer and employee to make pension contributions. These contributions were automatically deducted from an employee's pay and treated
on a pretax basis. 14 In 1986, the Contributory Plan assets had benefited from both employee contributions and good investment growth
such that the accrued value of benefits exceeded the actuarial or present value by approximately one billion dollars. This amount was well
in excess of that needed to make good on all payment promises to employees included in the Contributory Plan's provisions. 15
In 1987, Hughes Aircraft was acquired in a merger and acquisition by General Motors Corporation and, at that time, Hughes Aircraft
ceased making contributions to the Contributory Plan due to the asset
surplus previously mentioned. 16 Although the company had ceased
contributing, the employees were required to continue contributing to
the Contributory Plan in order to maintain their plan participant status. There was nothing overtly illegal or -unusual as to this action by
Hughes Aircraft. 17 By 1992 about half of the surplus in the Contributory Plan could be directly traced to the contributions made by employees, while the remaining fifty percent was the result of employer
contributions. 18
This law suit concentrated on the manner in which Hughes Aircraft handled the surplus in the pension plan between 1989 and 1992,
when its total assets, including surplusage, clearly exceeded that
which would be needed for retirement purposes of the total workforce.
In 1989, the company properly amended the Contributory Plan in
such a way that a portion of the surplus could be used to provide an
provided by contributions of [Hughes] not less than in such amounts, and at such times,
as the Plan Enrolled Actuary shall certify to be necessary, to fund Benefits under the
Plan." Hughes Aircraft Co., 525 U.S. at 435.
The plan sponsor was required to insure that contributions did not fall below that
amount of funds necessary to insure all [ERISA] requirements were followed, but was
permitted to suspend contributions at any time as long as there would be no funding
deficiency as measured by the actuarial requirements, and was required to insure that
all plan participants were appropriately covered by ERISA. Id.
13. Hughes Aircraft Co., 525 U.S. at 435-38; Jacobson, 105 F.3d at 1288, 1291-92.
14. Hughes Aircraft Co., 525 U.S. at 435-38.
15. Id.
16. Jacobson, 105 F.3d at 1291.
17. Id. at 1288, 1291-92; Hughes Aircraft Co., 525 U.S. at 435-38.
18. Jacobson, 105 F.3d at 1291.
2000]
DEFERRED COMPENSATION PLANNING
early retirement program for current employees. 19 The plaintiffs contended that by doing so, the company enabled itself to downsize its
workforce and decrease payroll costs in such a fashion that the former
employees' interest in the surplus was totally ignored. 20 The company
countered that in a contributory defined benefit plan, participants do
not have an interest in any asset surplusage that accrues as a result of
from
investment growth or excess contributions, which may result
21
workers leaving the firm before their pension vesting date.
The plaintiffs also contended that the company terminated the
Contributory Plan in January 1991 when it created a new defined benefit plan which was noncontributory. Hughes Aircraft also was alleged to have frozen new enrollment in the Contributory Plan such
that the only option which new employees had was enrollment in the
noncontributory plan. There was no grandfather provision in the
newer pension plan, and by way of comparison, the two plans were
dramatically different. The noncontributory plan did not require employees to contribute and new employees were automatically enrolled.
It did not provide health coverage, early retirement benefit provisions,
or cost of living adjustments. In summary, the new plan provided for
a lower monthly retirement benefit payment than the Contributory
Plan, and this was primarily due to the fact that different formulas
22
were used in order to compute which benefits should be paid.
In contrast, the Contributory Plan was elective by the employees
and they had to continue contributing on a monthly basis in order to
remain participants in good standing with the program. The Contributory Plan also provided health coverage, the previously mentioned
23
It
early retirement benefit package, and cost of living adjustments.
is important to note that both plans were essentially administered by
24
the same trustees.
The plaintiffs further contended that Hughes Aircraft continued
to use the plan surplus from the Contributory Plan to fund the newer,
noncontributory plan. They alleged that in doing so the company used
assets in which the former employees had rights and, therefore, the
company was in violation of the private inurement provisions of ER19. It is interesting that in one respect the respondents make arguments that are
purely self-directed, while seeing very little need to frequent the plight of current employees. For example, an early retirement program would clearly benefit workers hired
at an older age. Amongst the plans' beneficiaries, perhaps this is an "us versus them"
difference of opinion.
20. Hughes Aircraft Co., 525 U.S. at 442-46.
21. Id. at 437-40.
22. Jacobson, 105 F.3d at 1291.
23. Id.
24. Id. at 1301.
CREIGHTON LAW REVIEW
[Vol. 33
ISA with regard to its administration of the Contributory Plan. 25
Under the private inurement provision, ERISA requires that no plan
assets inure to the benefit of the employer. The employees raised an
important question as to exactly what the extent of their rights in the
plan's surplus funds were-both while they were employees of the
company and following the termination of their employment. 26 This
argument was not necessarily premised on the manner in which the
surplusage was accumulated or the federal statutory options open to a
firm, such as Hughes Aircraft, when plan assets vastly exceed required actuarial monies necessary to fulfill company promises made
within the context of the plan.
Plaintiffs filed a class action lawsuit in the United States District
Court for the District of Arizona, claiming that the class of plaintiffs
covered over ten thousand individuals who were participants in the
Contributory Plan as of December 31, 1991. Hughes Aircraft filed a
motion for change of venue, which was granted. Subsequently, the
lawsuit was transferred to the United States District Court for the
Central District of California, where Hughes Aircraft filed a motion to
dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The district court granted the dismissal and denied the plaintiffs' request to amend the complaint, and this was done with no
discovery taken at the district court level. 27
III.
THE EMPLOYER BENEFIT RULE PRE-HUGHES
AIRCRAFT
Prior to the Supreme Court's 1999 decision in Hughes Aircraft Co.
v. Jacobson,28 the most important case on this deferred compensation
issue was that of Lockheed Corp. v. Spink. 29 In Spink, a combination
of issues were presented regarding whether the retirement plan complied with ERISA and whether the actual implementation violated the
Age Discrimination and Employment Act 3 0 ("ADEA"). 3 1 In a nutshell,
the Supreme Court held that although ERISA does not require an employer to establish a benefit plan, it does require the employer to take
measures insuring that the employees are adequately protected regarding those benefits that they have been promised under the plan. 3 2
More specifically, the Spink case states that when a plan administra25.
26.
27.
28.
29.
30.
31.
32.
Hughes Aircraft Co., 525 U.S. at 437.
Id. at 439, 443-44.
Jacobson, 105 F.3d at 1290-92.
525 U.S. 432 (1999).
517 U.S. 882 (1996).
Age Discrimination in Employment Act, 29 U.S.C. § 621 (1994).
Lockheed Corp. v. Spink, 517 U.S. 882, 883-86 (1996).
Spink, 517 U.S. at 887-88.
2000]
DEFERRED COMPENSATION PLANNING
tor effects a change to a deferred compensation plan, he or she does
not act as a fiduciary within the meaning of ERISA and can make such
changes so long as any modifications do not terminate welfare benefits
or dissipate them to the point that the employee receives less than he
or she would have received under the original plan. 3 3 This ruling regarding fiduciary status was significant and surfaced as a significant
issue in Hughes Aircraft.
Mr. Spink was sixty-one years of age when he was reemployed by
the Lockheed Corporation in 1979, and, because of his age, he was
prevented from participating in the company's retirement plan
("Plan").3 4 The Plan in effect at that time complied with ERISA, however, section 9203(a)(1) of the Omnibus Budget Reconciliation Act of
198635 ("OBRA") repealed ERISA's provision permitting age exclusion
and discrimination. 3 6 Simply stated, the statutory change meant that
employees could not be discriminated against based upon age, and
this particular factor was reinforced by the adoption of the ADEA in
1967.
In order to meet the requirements of OBRA, Lockheed required
that former employees previously covered by the old plan become
members of the revised Plan, making very clear in the employment
contract that these former employees would not receive credit for their
pre-1988 service years. 37 Later, the company made the Plan more attractive to older employees by permitting early retirement in exchange for their signature waiving any employment claims they may
38
have against Lockheed.
Spink decided not to participate in the early retirement option
and did not sign the waiver. 3 9 Instead, he filed suit alleging that the
company, along with the plan administrators, violated ERISA by
amending the plan to create retirement programs ignoring his pre1988 service years. This contention was premised on the argument
that the plan administrators owed a fiduciary duty to the employees
not to diminish the value of the deferred compensation under any pension plan that the company might have, or may have had in the past
and, therefore, any new plan had to take into consideration prior ser40
vice years.
33.
34.
35.
36.
37.
Id. at 891-93.
Id. at 883-86.
Omnibus Budget Reconciliation Act of 1986, P.L. 99-509, 100 Stat. 1874 (1986).
Spink, 517 U.S. at 885.
Id.
38. Id.
39. Id.
40. Id. at 888-90.
CREIGHTON LAW REVIEW
[Vol. 33
The district court issued summary judgment in favor of the company, but the United States Court of Appeals for the Ninth Circuit
reversed, holding that the new plan amendments were unlawful pursuant to ERISA § 406(a)(1)(D). 4 1 This particular provision does not
permit a plan fiduciary from effecting any change or transaction that
transfers plan assets that are scheduled for the benefit of a particular
party or interest.4 2 Consequently, the court also decided that "there
was no need to address" the issue regarding whether Lockheed had
violated its status as a plan fiduciary. 43 Perhaps more importantly,
the Ninth Circuit found that by refusing to credit Spink with his pre1988 service years, Lockheed violated the OBRA amendments and
44
that these omitted years should have been applied retroactively.
The Supreme Court took the case on a writ of certiorari and reversed
45
the holding of the Ninth Circuit.
The issues presented in Spink are very important to pension planners, vis-a-vis those presented in Hughes Aircraft, given the apparent
contradiction between the two decisions. In fact, the Supreme Court
even noted that there was a "tension" between the Ninth Circuit's
opinion in Hughes Aircraft and its decision in Spink. 4 6 As the
Supreme Court reviewed the Spink factual background, it noted that
ERISA neither requires employers to provide a benefit plan nor specifies what type of plan to provide should the firm decide to implement
one. 47 The primary purpose of ERISA, however, is to seek and ensure
uniformity of the handling of plan assets such that all employees re48
ceive that to which they are entitled.
Perhaps the purpose of ERISA is stated best in Nachman Corp. v.
Pension Benefit Guaranty Corp.,49 in which the Supreme Court stated
that the intention of Congress in enacting the statute was that it
"wanted to . . . mak[e] sure that if a worker has been promised a defined pension benefit upon retirement-and if he has fulfilled
whatever conditions are required to obtain a vested benefit-he actually will receive it."50 Consequently, the thrust of ERISA is to make
certain that the pension fund assets are adequate to meet the expected benefit payments required to cover the former employees during their expected retirement period, but ERISA does not speak
41.
42.
43.
44.
45.
46.
47.
48.
49.
50.
Id. at 885-86.
Id. at 885-88.
Id. at 885-86.
Id. at 885-88.
Id. at 887-88.
Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 437-38 (1999).
Spink, 517 U.S. at 887-88.
Id.
446 U.S. 359 (1980).
Nachman Corp. v. Pension Benefit Guar. Corp., 446 U.S. 359, 375 (1980).
2000]
DEFERRED COMPENSATION PLANNING
specifically to the issue of the handling of any accrued plan surplus,
regardless of how that surplus may have been garnered. 5 1
It is the handling of the Contributory Plan surplus that was the
critical issue in Hughes Aircraft, and the absence of any coverage of
this particular issue in Spink is very important. The Spink Court
noted that Congress established minimum funding levels, issued guidance relative to tax liens and how they affected plan benefits, and
most importantly in ERISA, section 406 declared the statutory intent
that "prohibits fiduciaries from involving the plan and its assets in
certain kinds of business deals."5 2 It is this latter issue which was the
key point presented and decided in Spink.
In section 406 Congress provided that plan administrators were
prohibited from taking any actions "to bar categorically a transaction
that [is] likely to injure the pension plan." 53 This particular issue is,
of course, salient with regard to Hughes Aircraft, in that Spink's position was that the development or change in the second plan, which
precluded recognition of prior service years, was a change in the plan
such that it should be construed to be a transaction that injured the
plan. 54 In Spink, the key issue revolved around the company's establishment of an early retirement benefit that older, former employees
could not take advantage of simply because they would not be given
credit for their former work years. Of course, the same issue was
presented in Hughes Aircraft because an early retirement plan was
made a part of the new plan.
In Spink, the Supreme Court held that Lockheed Corporation was
not in violation of ERISA when it conditioned "the receipt of early retirement benefits upon the participants' waiver of employment
claims." 5 5 As section 406 of ERISA states: "[A] fiduciary with respect
to a plan shall not cause the plan to engage in a transaction if he
knows or should know that such transaction constitutes a direct or
indirect ... transfer to, or use by or for the benefit of a party in inter56
est, of any assets of the plan."
Section 406(a)(1) is a primary regulatory provision within ERISA
and places certain restrictions on the conduct of pension plan fiduciaries. Specifically, section 406(a)(1) makes it unlawful for the plan fiduciary to engage in certain business transactions which may fall
outside the scope of their lawful authority as it is defined within ERISA. The statute also prescribes statutory punishments given for vio51. Hughes Aircraft Co., 525 U.S. at 439-42.
52. Spink, 517 U.S. at 887-88.
53. Id. (citations omitted).
54. Id. at 885-86.
55. Id. at 887-88.
56. 29 U.S.C. § 1106(a)(1)(D) (1994); Spink, 517 U.S. at 887-88.
CREIGHTON LAW REVIEW
[Vol. 33
lations of section 406 where the fiduciary is rendered personally liable
for any losses to the plan, or improperly received profits that would
inure to the benefit of plan participants. Further, the court may im57
pose any other "equitable and remedial relief deemed appropriate."
However, the most important requirement for a plaintiff in bringing an action at the time of the Spink case was a showing of a fiduciary demonstration that the individual or entity had personally been
responsible for causing the deferred compensation plan to engage in
whatever the plaintiff alleged to be an unlawful transaction. 58 Absent
such a showing, there was no violation of section 406(a)(1) and equitable relief was not available to the plaintiff. In Spink, the Supreme
Court was particularly disturbed that the court of appeals failed to
delve into the question of whether an actual fiduciary status existed
59
between the parties before it found a violation of section 406.
It is important to understand the rationale that the Supreme
Court employed in reaching the Spink decision. This is due primarily
to the fact that prior to Hughes Aircraft, the rationale presented by
Spink was all that a plaintiff or defendant could rely upon regarding
ERISA's restriction on the "employer benefit" rule. Therefore, the failure of the circuit court to address the question of whether a fiduciary
status prevailed prior to finding any other violation of ERISA loomed
large with regard to its holding in both Spink and Hughes Aircraft.
When analyzing pension plans under ERISA, perhaps the most
common position taken by opponents is that the company and its
board of directors have a fiduciary duty to the pension plan. Typically,
this position is premised on the fact that the board of directors established the pension plan and someone within the hierarchy of the company serves as the plan administrator. When actions are taken to
make changes in the provisions and benefits provided by the plan,
such as the allowance for an early retirement program, these actions
are virtually always approved by the company's board of directors.
In Spink, the Supreme Court disagreed with this particular argument and did so by making an interesting analogy. The Court stated
that any employer who undertook to make any changes to a pension
plan, such as the adoption of an early retirement program, acted not
as a fiduciary, but rather in the nature of a trust settlor. 60 The Court
rejected a "per se" rule that any involvement as a member of the board
of directors meant de facto fiduciary status pursuant to ERISA. 6 1
57. Spink, 517 U.S. at 887-88.
58. Id.
59. Id. at 889-90.
60. Id. at 889-92.
61. Id.
2000]
DEFERRED COMPENSATION PLANNING
This is not to say that a board of directors could not take action that
could be construed as a violation of ERISA and tantamount to that of
the plan administrator. However, the Spink Court ruled that the employer and plan sponsors are not necessarily under the constraints of
ERISA when it comes to making any sort of modification to the terms
62
of the program.
Although the Court stopped short of endorsing this particular
point, the author believes that any action taken by the plan sponsor or
employer that could be construed as providing a benefit or option to an
employee would not be sufficient to automatically confer a fiduciary
relationship. Otherwise, the "per se" rule mentioned previously would
have a strong judicial hold as to liability issues. For all practical purposes, it would have a firm hold on employers looking to alter a pension plan and still remain in compliance with federal law. What
matters most to the courts is that the plan modification or amendment
is accomplished so workers are not penalized, actually or potentially,
with regard to the availability of plan funds, assuming of course, a
compliance with ERISA. Stated differently, and in a light most
favorable to the employer, the plan alterations need to be made in
good faith with regard to past, present, and future pensioners.
The Supreme Court quoted the Second Circuit in making this particular fiduciary duty distinction, 6 3 stating that company management would be construed as the fiduciary "only when fulfilling certain
defined functions, including the exercise of discretionary authority or
control over plan management or administration." 64 The mere
designation as a settlor means a fiduciary duty is automatically owed
to a trust in all respects. It is well known that a settlor may make
changes to a trust having profound consequences upon the beneficiaries and yet fall within the fiduciary's purview. For example, the
general rule is that the more control the settlor attempts to retain
over the trust corpus, the more likely it is that the trust will not reap
the full benefit of the tax benefits permitted by the Internal Revenue
Code. This same analogy is very much in line with the Court's reasoning in Spink. Finally, the Spink Court noted that ERISA defines a
"plan" as either a "pension" or a "welfare plan," or both. 65 Given this
language, along with the judicial reference that the statute refers only
62. Id. at 889-90.
63. Id. The Court provided that "as the Second Circuit has observed, 'only when
fulfilling certain defined functions, including the exercise of discretionary authority or
control over plan management or administration,' does a person become a fiduciary
under § 3(21)(A) [of ERISA]." Id. (quoting Siskind v. Sperry Retirement Program,
Unisys, 47 F.3d 498, 505 (2d Cir. 1995); See 29 U.S.C. § 1002(21)(A) (1994).
64. Spink, 517 U.S. at 890 (citations omitted).
65. Id. at 891-92.
CREIGHTON LAW REVIEW
[Vol. 33
to "a fiduciary ... with respect to a plan,"6 6 considerable support is
given to the Court's earlier trust analogy.
The second argument put forth by Spink was that the company's
67
board members violated the prohibited transaction clause of ERISA.
This particular provision does not permit fiduciaries to take any action
which would cause a plan to become part of any action whereby there
would be a transfer of benefits or assets of the plan to the "inurement"
of the company. 68 The Court responded to this argument, stating that
the "prohibited transactions" contemplated by the statute were more
in line with those of a commercial bargain made with plan insiders or
with those who would not be at an arms-length bargaining position in
the contractual setting. 69 Since any early retirement program is, in
fact, not a "transaction" within the meaning of section 406(a)(1), it is
really more of a contractual payment between the employer and plan
participants whereby the plan administrator issues benefits according
to appropriate plan and statutory provisions. 7 0 Strictly construed, it
is difficult to embrace the argument that this type of modification is a
"prohibited transaction."
Spink's argument was that the creation of an early retirement
program, in and of itself, is a prohibited transaction. 7 1 This is a clear
reasoning error, since plan sponsors always have the right to make
good faith changes to the plan in light of the ERISA umbrella. Consequently, the Court ruled that it could dispense with this argument
72
just as the previous fiduciary status argument had been handled.
Because the members of the retirement committee were not fiduciaries, it was not necessary for any conduct engaged in by these individ73
uals to be scrutinized pursuant to ERISA § 406(a)(1)(D).
IV.
ERISA AND THE EXCLUSIVE BENEFIT RULE
When Hughes Aircraft Co. v. Jacobson7 4 was appealed to the
Supreme Court, an opportunity to revisit many of the key issues in
Lockheed Corp. v. Spink 7 5 was presented. This fact was not lost on
the Court and it reversed the two-to-one decision of the Ninth Circuit. 76 Hughes Aircraft involved a pension plan sponsor who had
66.
67.
68.
69.
70.
71.
72.
73.
74.
75.
76.
Id. (citing 29 U.S.C. § 1104(a) (1994)).
Id. at 892.
Id. at 891-94.
Id.
Id. at 893-95.
Id. at 893-94.
Id. at 893-95.
Id. at 891-92.
525 U.S. 432 (1999).
517 U.S. 882 (1996).
Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 437 (1999).
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DEFERRED COMPENSATION PLANNING
taken actions similar to those of other employers in a number of situations. Specifically, Hughes Aircraft took the surplusage from the ex77
isting Contributory Plan and used it to fund new pension benefits.
Stated another way, from the position of the plaintiffs, the plan sponsor used existing pension benefits, which purportedly were partly
theirs, in order to provide pension benefits that would ultimately benefit present employees. 78 It is the conflict between these two points of
view that created the dilemma in the Hughes Aircraft case.
Understanding the need to take notice of ERISA's imprimatur of
fiduciary responsibility and misappropriation regarding the rights of
plan participants, the Ninth Circuit was very careful to analyze the
methods by which the plan sponsor had decided what would be funded
by the surplusage. 79 There was no debate or question by the Ninth
Circuit, or by the Supreme Court, that at least part of the surplusage
was impliedly attributable to employee contributions. 80 The position
taken by the company was that any surplusage was the result of plan
monies that had not yet vested, as well as the interest that had accumulated on these funds.8 1 The question was whether former employees had any rights to surplusage containing interest on their own
funds, as well as interest on invested funds that would ultimately be
dealt with in accordance with plan provisions, unless the unvested
employee returned to employment and worked enough years to qualify
for benefits.
The Supreme Court initiated its analysis of the claims analyzed
in the Ninth Circuit opinion by focusing on the argument of the former
employees. The employees argued that there was a prohibited benefit
to the company as a result of Hughes Aircraft using the surplus funds
for its exclusive benefit.8 2 Respondents rejected the argument that
they had no vested interest in these funds and that they were subject
to blind acceptance of the company's disposition of the same.8 3 The
Supreme Court's opinion was brief and to the point, stating that
"these claims fail because the 1991 amendment did not affect the
rights of pre-existing Plan participants and Hughes did not use the
surplus for its own benefit."8 4 Simply stated, there was no employer
77. Hughes Aircraft Co., 525 U.S. at 442.
78. Id.
79. Jacobson v. Hughes Aircraft Co., 105 F.3d 1288, 1297-98 (9th Cir. 1997), rev'd,
525 U.S. 432 (1999).
80. Jacobson, 105 F.3d at 1291; See Hughes Aircraft Co., 525 U.S. at 435-36.
81. Hughes Aircraft Co., 525 U.S. at 440-41.
82. Id. at 438.
83. Id. at 437-40.
84. Id. at 439.
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[Vol. 33
benefit and, therefore, no violation of ERISA's "exclusive benefit"
85
rule.
The Court then began an exhaustive review of the different types
of pension plans, a review it believed necessary to better explain the
reasoning that would support its rationale. First, the Court addressed
the elementary differences between a defined contribution and a defined benefit plan-Hughes Aircraft maintained the latter type of
plan.8 6 The Court explained that a defined contribution plan places
the burden to contribute on both the employee and the employer, with
the employer's contribution being fixed.8 7 The primary problem with
the defined contribution plan is that the possibility arises that there
will be insufficient funds to cover the benefits promised by the employer within the plan's provisions. This problem is typically referred
to as an underfunding by the employer, and is an obvious violation of
ERISA. However, this problem was not at issue in Hughes Aircraft.8 8
A defined benefit plan, as existed within the Hughes Aircraft company, utilizes a pool of assets instead of individualized employee accounts.8 9 As the name of the plan indicates, after retirement the
employee is entitled to receive a fixed payment on a periodic basis,
usually monthly. 90 The key question, or problem, is how the pool of
assets will be funded, since either the employer or the employee or a
combination of both may do this. However, if the employer faces a
situation where the amount of money in the plan falls short of that
needed to cover required payments, there are serious consequences for
the employer relative to violations of ERISA. 91
Similarly, where the defined benefit plan is overfunded to the
point that there is a surplusage, the employer has several options.
First, the employer may reduce total contributions to the plan or it
may create alternatives for the employees, which would have a direct
impact on the surplusage. The problem with the latter approach is
that when additional alternatives are added using the surplusage as
the basis for doing so, the employer takes an added risk with regard to
the ultimate funding of those benefits. In Hughes Aircraft, former employees argued that the company, or plan sponsor, had no right to create alternatives which could take away from the surplusage available
92
to pay the defined benefits promised by the plan.
85.
86.
87.
88.
89.
90.
91.
92.
Id.
Id.
Id.
Id. at 439-42, 447.
Id. at 439.
Id.
Id.
Id. at 439-42.
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DEFERRED COMPENSATION PLANNING
Another way to look at this situation is to assume that not long
after making these changes to the plan, Hughes Aircraft had a poor
period of economic performance such that it was unable to make as
much of a contribution to the plan as had been customary in the past.
The former employees made the argument that had Hughes Aircraft
not changed plan benefits, the surplusage would have been available
in this particular situation to fund established plan obligations for a
longer period of time. 93 This argument was tendered with full knowledge that the surplusage had not accrued completely from the investment, or interest on the investment, of the former employees'
contributions or the matching contributions by the firm.
One of the most important contentions made by the respondents
in this case was that the creation of the new contribution alternatives
using the available surplusage represented Hughes Aircraft taking
money "for its sole and exclusive benefit, in violation of ERISA's antiinurement provision." 94 Section 403, ERISA's anti-inurement provision, was looked at very carefully by the Supreme Court and found to
focus clearly and almost exclusively on the ability of the firm " to pay
pension benefits to plan participants, without distinguishing either
between benefits for new and old employees under one or more benefit
structures of the same plan, or between assets that make up a plan's
95
surplus as opposed to those needed to fund the plan's benefits." Interestingly, the former employees bringing this action did not make
any assertion that Hughes Aircraft failed to pay the surplusage pension benefits to anybody other than plan participants. Certainly, the
respondents did not make the argument that the company had blatantly taken the money and put the funds into its own operating account. This would have been totally without substantiation. Instead,
the arguments asserted by the respondents were that there had been
an "inurement" to the benefit of the company simply by virtue of the
manner in which the company had handled the creation of plan alternative benefits and the manner in which those alternatives were
funded. 96 The Supreme Court refused to accept this argument as be97
ing in violation of the "exclusive benefit" rule previously mentioned.
Finally, the Supreme Court dealt with several other arguments
put forth by the respondents, all of which were rejected as being insufficient to support the case presented. First of all, and not unexpectedly, the Court found that ERISA's fiduciary provisions do not apply to
any changes or alternatives subsequently added to a pension plan by
93. Id. at 441-45.
94. Id. at 441.
95. Id.
96. Id. at 439-40.
97. Id.
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the sponsor. 98 The Court cited its decision in Spink, in which it articulated the reasons for this argument in great detail. 99 Perhaps
most importantly, the Court noted that the Spink rationale applied to
"pension benefit plans" as well as "welfare benefit plans." After this
differentiation, the Court stated that there is no distinction between
persons exercising fiduciary duties over different types of deferred
plans, either those aforementioned or contributory or noncontributory
10 0
plans, as the case may be.
The respondents went on to argue that the transaction promulgated by Hughes Aircraft was a sham transaction based upon the
manner in which it was handled, and the manner in which the assets
were transferred. They argued that any amendment required a court
order according to ERISA and that the 1991 amendment to the company plan effectively was a violation of the common law theory of a
"wasting trust."1 1 The Supreme Court denied each of these arguments in summary fashion because they were not nearly as important
as the initial arguments regarding inurement, fiduciary duty, or the
employer "exclusive benefit" rule. These arguments merely represented a final, desperate attempt to invalidate the actions taken by
Hughes Aircraft in dealing with the surplusage issue.
V.
CONCLUSION
Although the primary import of Hughes Aircraft Co. v. Jacobson 102 is the resolution of the issue that pension plan participants in
an ongoing, contributory, defined benefit plan do not have a definable
interest in the plan's surplusage, the case is far more likely to be
remembered amongst pension planners for a variety of reasons. In
espousing the above proposition, the Supreme Court's opinion transcended the immediate issue to the point of making the case opinion
one of the most important pension planning cases in the last quarter
century. The Hughes Aircraft case also will be remembered and cited
for what it elucidates regarding the company "exclusive benefit" rule.
Specifically, according to the Court, that standard does not preclude
the conferral of benefits by the plan sponsor on others, and that plan
sponsors are not prohibited from promoting business interests that
are unrelated to the pension plan benefits or to enhance existing plan
benefits for current employees. 10 3 These goals are permissible and
may be achieved through the judicious use of surplus funds, and will
98.
99.
100.
101.
102.
103.
Id. at 443-46.
Id.
Id. at 443-44.
Id. at 445-48.
525 U.S. 432 (1999).
Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 439-43 (1999).
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DEFERRED COMPENSATION PLANNING
not violate ERISA's inurement provisions. The previous statement is
caveated only to the extent that the plan sponsor demonstrates that
the plan is adequately funded to an actuarially accepted level, so as to
cover all benefits as promised to former and current pensioners.
The foregoing may not have been the primary reasons this case
came before the United States Supreme Court, but pension planners
will reap much more from the unintended clarifications provided by
the overall opinion rather than the narrow point of law for which 0it4
was appealed. This case also replaces Lockheed Corp. v. Spink, 1
which was, by nearly all accounts, a case with bad facts intended to
address some of the issues set forth in Hughes Aircraft. In Spink, the
employer used its pension plan as a device to rid the company of unwanted and overaged employees.1 0 5 The company had previously precluded these same employees from plan coverage, and only a change in
the law permitted them to claim an interest in the firm's deferred compensation program.' 0 6 This readily apparent lack of company largesse was followed by a scheme to delete the extra benefits, but only if
the employee signed an age discrimination claim waiver.107
The Hughes Aircraft case, on the other hand, presented a much
different set of facts as a foundation for dealing with many of the same
issues presented in Spink. There were no bad faith efforts on the part
of the plan sponsor to diminish the number or the value of existing
plan benefits, and in fact, exactly the opposite was true. Hughes Aircraft took steps to expand the number of options available to employees and did so with the clear and explicit knowledge that more than
l0
adequate monies resided in the plan to accomplish these goals.'
This is the guiding principle emanating from the Hughes Aircraft
case. Once adequate monies exist to make good on promises made to
plan participants, a plan sponsor may take leave of ERISA's statutory
strictures to promote its self-image through the creation of additional
deferred compensation enhancements without risking plan disqualification under the "employer benefit" and "private inurement" provisions. 10 9 For pension planners, this is truly the beginning of a new
millennium.
104.
105.
106.
107.
108.
109.
517 U.S. 882 (1996).
Lockheed Corp. v. Spink, 517 U.S. 882, 893-95 (1996).
Spink, 517 U.S. at 885-86.
Id.
Id. at 895-98.
Hughes Aircraft Co., 525 U.S. at 439-45.
524
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