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December 2012

ERISA Payroll Practice Exemption Requires Two-Step Analysis

Court Focuses on Benefit at Issue and Whether It Is "Normal Compensation" Paid From General Assets

The U.S. District Court for the Eastern District of California recently found that an action classified by the plaintiff to recover “unpaid wages” did not fall under the ERISA payroll practices exception, where the benefits sought fell squarely within ERISA’s definition of an employee welfare benefit plan.

The plaintiff, in pro per, initially filed the case in small claims court. The defendant removed the case to federal court under federal question jurisdiction asserting that the plaintiff’s claim for “unpaid wages” was really an action to recover short-term disability benefits under the employer’s Welfare Benefits Plan. The plaintiff made a motion to remand to the state court and this ruling resulted. Jerome Clay v. AT&T Communications of California, Inc. (Nov. 16, 2012) 2012 U.S. Dist. LEXIS 165185.

In denying the plaintiff’s request to remand, the U.S. District Court analyzed the payroll practices exemption from ERISA’s coverage. The court found that the inquiry of whether the payroll practices exemption applies is focused on the particular benefit at issue, not the ERISA plan as a whole. The court rationalized that “comprehensive welfare benefit plans often include diverse components such as medical, dental, vision, and life insurance benefits, some of which could never constitute payroll practices.” The court further found that because different components of a comprehensive welfare benefit plan may be funded differently, the appropriate focus of the analysis is the particular benefit at issue.

Focusing on the particular benefit, the court then considered whether the payment of STD benefits is an exempted payroll practice; whether it (1) constitutes “normal compensation” and (2) is paid from the employer’s general assets.  The court found that the STD benefit was “normal compensation” where it was tied to the employee’s regular pay (replaced a percentage of the employee’s pay, depending on the length of the employee’s service with the employer and duration of the disability leave), reduced by other income sources and clearly designed to replace the employee’s regular pay (not payable when wage or salary is payable). Furthermore, STD benefit checks and payroll checks were paid through the employer’s same payroll system and STD benefits were generally paid at the same time as wage or salary and considered taxable income. Finally, STD benefits, such as wages and salary, ended upon termination. Based on these factors, the court found that the STD benefits closely resembled wages or salary and constitute “normal compensation.”

However, the court found that the STD benefit was not paid from the employer’s “general assets,” where although the employer advanced payment of the STD benefits for administrative convenience, the substance of the payment procedure was that of a funded benefit program. In this case, the employer was reimbursed by an irrevocable trust no later than the month following the payment. The trust’s assets were used for the exclusive purpose of providing benefits, including STD benefits; a trust company independent of the employer served as trustee and was responsible for management of the trust assets and other fiduciary duties; and claims were administered, approved or denied by another entity independent of the employer. Additionally, the trust at issue was operated in compliance with the requirements of ERISA -- including an annual audit, preparation and filing of required forms and plan documents -- and it had a criminal insurance policy to protect against theft and misuse of trust assets. 

The court also found a clear relationship between the amount of funds in the trust and the accrued liability benefits program. The risk of nonpayment did not primarily depend on the financial health of the employer as opposed to the trust fund. As such, although STD benefits initially were paid from the employer’s general assets, the true source of payments was the trust. The court found, therefore, that the payroll exception to ERISA benefits did not apply; ERISA pre-empted the plaintiff’s claim for STD benefits, and the court had federal question jurisdiction.

Click here for the opinion. 

This opinion is not final. This decision may be cited now as persuasive nonprecedential authority. The decision may be modified by further proceedings in the district court or on appeal.