Audits/Due Diligence - Page 19 of 24

The Impact of 409A on Severance Payments

The Issue: An employment agreement conditions severance payments to an executive on her signing a release. Can this create a tax problem for the executive under the non-qualified deferred compensation rules of the Internal Revenue Code?

The Solution: Yes, unless the provisions of the employment agreement are properly drafted and the parties comply with the terms of the agreement.

Analysis: Code Section 409A (409A) governs the terms and operation of “non-qualified deferred compensation plans” and imposes restrictions on the reasons for and timing of deferred payments. Neither the employee nor the employer may accelerate or defer the receipt of deferred compensation (with some exceptions not applicable here).

Failure to comply with 409A leads to serious tax consequences for the executive, including acceleration of income and a 20% tax penalty. California imposes its own 5% tax penalty for failure to comply with 409A.

Termination of employment is a permissible payment event. If the employment agreement provides that severance will be paid within 2-1/2 months after termination with no conditions, the payment isn’t subject to 409A. If the agreement provides for a series of payments equal to not more than twice the executive’s pay (or the qualified plan compensation limit, currently $260,000) and they are to be paid within two years after termination, there is no problem.

The concern with conditioning severance pay on an executive signing a release is that if there is no time limit on when the release must be signed, the employee can affect the timing of payment by either signing the release quickly or delaying to a later date. This violates the strict requirements of 409A. It is important to recognize that it is not the employee’s action or inaction that is the problem; it is the provision in the employment agreement.

The remedy is simple. The employment agreement must specify (or be amended to specify) a fixed payment date after termination of employment (either 60 or 90 days) or a specified period no longer than 90 days when the severance payment will be made or commence (with special rules if the payment period can go into another tax
year). If the executive fails to sign and return the release by the commencement date, the severance must be forfeited.

Employers should tread carefully when dealing with the complicated requirements of 409A. If an employment agreement provides for any post-termination payment, it should be reviewed for compliance with 409A.

Forum Selection Clauses and Non-Compete Agreements

The Issue: You are a California employer with out-of-state headquarters, and your executive works and lives in California. Your employment agreement has a one-year post-termination non-compete. Can you enforce it?

The Solution: In general, no, but the answer may depend on whether you have a valid forum selection and choice of law clause that provides for resolution in a state that permits reasonable post-termination non-competes.

Analysis: In general, California employers cannot enforce post-termination non-competes and a party cannot circumvent California restrictions on non-competition with a choice of law provision designating a more non-compete friendly jurisdiction. However, the Supreme Court’s recent decision in Atlantic Marine Construction Co.,
Inc. v. U.S. District Court for the Western District of Texas, 134 S. Ct. 568, 571 U.S. ___ (Dec. 3, 2013) held that contractual forum selection clauses should be enforced in all but the most exceptional cases, and therefore may be helpful to employers who seek to enforce non-competes against employees who work or live in states, like California, that disfavor restrictive covenants.

Indeed, some recent California federal district court cases have focused on whether the employment agreement has an out-of-state forum selection and choice of law clause. In Meras Engineering, Inc. v CH20, Inc., the Washington-based employer was permitted to enforce its Washington forum selection and choice of law clauses against its California sales associates who left for a California competitor. The Washington court concluded it was proper to apply Washington law as provided by the employment agreements. The California court dismissed the California employees’ lawsuit in favor of the Washington forum selection clause.

Similarly, in two other recent California district court cases, Plaintiffs were former California employees who signed employment agreements with restrictive covenants and Pennsylvania forum selection clauses. In both cases, the employees argued the cases should not be transferred because the more restrictive covenant friendly Pennsylvania courts would enforce the non-compete, which contravenes a strong California public policy. Both California courts however, focused on the reasonableness of the forum selection clause, rather than on the clauses’ effect. Both found that the possibility a Pennsylvania court might apply Pennsylvania law to the non-compete clause was not a sufficient basis to invalidate the forum selection clause.

In light of these recent cases, California employers should consider whether they have a reasonable and enforceable basis for selecting an alternative forum and choice of law for their executive agreements, and, in consultation with
counsel, draft carefully tailored restrictive covenants that comply with that state’s law.

Webinar – Church Plan Update: It’s a Changing World -What Church Plan Sponsors Need to Know

On Monday, February 24, 2014, the Drinker Biddle Employee Benefits & Executive Compensation Team will present a free one hour webinar on hot topics that church plan sponsors should be considering for 2014. The webinar will be led by Chicago partners David L. Wolfe and Mark E. Furlane. Some of the topics to be covered during the webinar include:

An update on church plan litigation, including the recent ruling against Dignity Health and what this means for your church plan;
How church plan sponsors can best position themselves to defend against such an attack;
What church plan sponsors need to know about maintaining their church plan status in 2014;
Pros and cons for various employee benefit plans.

To register click the RSVP button:

Date: Monday, February 24, 2014
Time: 1:30 – 2:30 pm central

David L. Wolfe
David is a partner and member of the Employee Benefits & Executive Compensation Practice Group. He represents clients in a full spectrum of industries with an emphasis on tax-exempt organizations. He is a co-founder and member of the Steering Committee for the development and continuing sponsorship of the HR/Hospital Advisory Board (co-sponsored by Deloitte) for senior HR executives in tax-exempt health care systems.

Mark E. Furlane
Mark is a partner in the Labor & Employment Practice Group. Before joining the firm in 1979, Mark spent nearly five years as a lawyer for the U.S. Marine Corps where he gained extensive trial experience. In Mark’s 30 years of private practice, he has represented employers in nearly all labor and employment issues confronting today’s employer. He focuses his practice on employment law, with an emphasis on employment, benefits and fiduciary litigation and employment counseling.

See LaborSphere’s prior coverage of recent church plan litigation here.

Special Rules Apply To Documents With Employee Protected Health Information

Editor’s Note: The following post by Heather Abrigo, Counsel in the Los Angeles office, appears in the latest issue of the California HR Newsletter.

Special Rules Apply To Documents With Employee Protected Health Information

The Issue: Must an employer safeguard documents containing employee protected health information (PHI) in any special way?

The Solution: Yes. An employer must adopt privacy policies or procedures related to employee PHI. These policies should include controls over who has access to the documents (physically and electronically).

Analysis: Under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), employers must prevent the unauthorized disclosure of protected health information (PHI). This will primarily affect those employers that sponsor self-insured health plans, cafeteria plans with a flexible health spending account component, offer on-site health clinics, and/or that offer significant hands-on help to employees in connection with their group health plans (e.g., handling benefit claims).

Employers subject to the HIPAA privacy rules should have written privacy procedures in effect that safeguard all documents with PHI. This includes the administration of the PHI (e.g., who needs access to such information to administer the health plan, entering into business associate agreements with any third-parties who might handle, and training employees who may handle, PHI as part of their duties). The written privacy procedures should also address other safeguards of PHI (whether in paper or electronic form) including physical safeguards (e.g., workstation use/security) as well as technical safeguards (e.g., person authentication and transmission security).

If you are unsure whether these rules apply and you sponsor any of the aforementioned plans, please contact your benefits lawyer.

The Scoop on Revenue Sharing

Editor’s Note: The following post by Los Angeles Of Counsel Joe Faucher appears in the latest issue of the California HR Newsletter.

The Scoop on Revenue Sharing

The Issue: What do plan fiduciaries need to know about revenue sharing?

The Solution: Fiduciaries need to understand that revenue sharing is a common practice in the investment industry. They must be aware if revenue sharing payments are being made and the amount of those payments, determine how those payments are used, and evaluate whether the overall compensation of the party that receives them is reasonable.

Analysis: “Revenue sharing” occurs when an investment company, like a mutual fund company, issues compensation to another service provider – a recordkeeper or a third party administrator. The payments are typically made in exchange for services that the mutual fund company might otherwise have to provide itself. Service providers who expect to receive them are obligated to disclose the anticipated payments and how they are calculated to the responsible plan fiduciary. Fiduciaries need to understand what the service providers who receive revenue sharing do with the money they receive. In some cases, service providers “offset” or reduce their fees by these payments, or credit the payments back to the accounts of the participants. Others simply retain the payments. Since fiduciaries are obligated to know how much compensation their service providers receive, and to determine whether that compensation is reasonable, it is imperative that they understand who is paying revenue sharing, who is receiving it, how much it is being paid and how it is being used.

Cheryl Orr Quoted on Illinois Medical Marijuana Law Story in Chicago Tribune

San Francisco Partner Cheryl Orr was quoted in a recent story in the Chicago Tribune on Illinois medical marijuana law and the legal implications for Illinois employers whose policies are at odds with the law. Some of the issues Illinois employers will need to confront include reconciling their drug-free work place policies with patients’ rights, what they can ask job applicants, how to deal with an impaired employee and whether or not an employer can punish an employee for engaging in what is now deemed to be a legal activity.

Cheryl submitted that the Illinois statute may offer civil employment protections for workers. One provision of the Illinois law appears to narrowly tie the ability to discipline a medical marijuana patient for failing a drug test to those employers who are specifically connected to federal work or funding. This framework, Cheryl wrote, “creates a plausible argument that the statute does provide protections” for medical marijuana users in the private sector.

LaborSphere previously looked at employer liability under the Illinois law, and other states who have laws providing for some form of legalized medical marijuana, and will continue to follow this ever evolving area of law.