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February 2014

Sick Leave Plan Deemed Payroll Practice Outside ERISA Pre-emption and Subject to California Kin Care Law

The California Court of Appeal, First Appellate District, recently held that United Airlines Inc.’s sick leave plan was subject to an ERISA exception subjecting United to California’s Kin Care Law.

According to the Jan. 31 opinion in Airline Pilots Association International, et al. v. United Airlines Inc., United created and maintained a sick leave plan and sick leave trust for most of its employee groups, including pilots.  The plan stated that “it is intended to constitute an employee welfare benefit plan within the meaning of ERISA.”  Under the terms of the plan, pilot employees were not permitted to use accrued sick leave to tend to ill children, parents, spouses, or domestic partners. 

There were two iterations of the trust – the original trust and the trust as revised in 2009.  The original trust used a funding policy that forecasted anticipated sick leave payments based on historical trends in sick leave usage.  Under the revised 2009 trust, funding was based on an actuarial formula and a funding policy approved by the plan administrator. 

In November 2007, three United pilots and their union, the Airline Pilots Association International, sued United claiming that by prohibiting employees from utilizing accrued sick leave to tend to ill family members, United violated California’s Kin Care Law. 

The Kin Care Law, codified as Labor Code § 233, requires employers that pay sick leave to employees to allow employees to use up to a certain, limited amount of accrued sick leave to tend to ill family members.  Section 233 specifically excludes sick leave benefits provided under an employee welfare plan qualifying as an ERISA plan.

The primary issue on appeal was whether the plan qualified as ERISA plan, pre-empting the plaintiffs’ claims under the Kin Care Law.  The court concluded the plan fell within ERISA’s definition of an employee welfare benefit plan.  However, a question existed whether the plan was merely a “payroll practice” falling under the “payroll practice” exemption from ERISA.  Finding that sick leave benefits were paid as part of the employees’ normal compensation and out of United’s main operating account, the court reasoned the plan was within the plain meaning of a “payroll practice.”

United argued the plan nonetheless qualified as an employee welfare benefit plan under ERISA because it was funded by a separate trust.  Relying on Alaska Airlines v. Oregon Bureau of Labor (9th Cir. 1997) 122 F.3d 812, the court rejected United’s argument and stated that an employer may not simply create a separate fund to qualify for ERISA pre-emption – “the separate fund must be actually liable for the benefits.”  In other words, the nature of the separate trust funding the plan was critical to determining whether the plan was subject to ERISA pre-emption. 

The court determined the plan, as funded by the original trust, did not fall within the scope of ERISA because the “funding was not actuarially determined or otherwise commensurate with the Plan’s accruing liability.”  Rather, the court reasoned that United’s funding method produced arbitrary results and offered no real protection for the employees’ benefits, with the degree of risk dependent on the financial health of United instead of the trust.  The original trust was therefore not actually liable for the benefits.  

Moreover, the court affirmed the district court’s conclusion that that neither the original trust nor the revised trust were bona fide separate trusts.  Rather, the trusts were grantor trusts under the Internal Revenue Code – providing that the trust assets are considered part of the employer’s general assets, and remain reachable to the employer’s creditors in the event of insolvency – and constitute “payroll practices” exempt from ERISA. 

Though United conceded the trusts were grantor trusts, it argued the assets were not subject to United’s creditors and, regardless, the Internal Revenue Code’s grantor trust rules had no bearing in the case because the plan and trusts did not involve deferred income, as with a pension plan.  Rejecting United’s argument, the court stated that the critical issue is not the type of benefit funded but the ownership of the trusts.  If the risk that the employees would not be paid benefits depends on the financial health of the employer rather than the fund, the benefit plan is not a bona fide separate trust and is thus beyond the scope of ERISA.

It was undisputed that United owned the trusts at issue, included the trusts’ income on its tax returns, and paid taxes on such income; further, employees were not taxed on the income until it was distributed.  According to the court, “United’s position that the trusts’ assets are not subject to United’s creditors is fundamentally inconsistent with the tax treatment of United as the owner of the trusts.”  Favorable tax treatment hinges on the trust remaining liable to the employer’s creditors. 

Finding the trusts’ assets remained reachable by United’s creditors, and that the risk that United’s employees would not be paid depended on the financial health of United, the court held the plan beyond the scope of ERISA and not pre-empted. The plan was thus subject to the Kin Care Law.

Lastly, the court addressed United’s argument that the union lacked standing to sue under the Kin Care Law.  The court determined that the Union satisfied the criteria for associational standing, because it sought equitable relief on behalf of its members, private party employees of United for Labor Code violations; it acted in its representative capacity; and doing so is a “ ‘union’s fundamental purpose.’ ”

Click here for the opinion. 

This opinion in Airline Pilots Association International, et al. v. United Airlines, Inc.; 2014 Cal. App. LEXIS 100 (1st App. Dist. 2014), is not final.  It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court.  These events would render the opinion unavailable for use as legal authority in California state courts.


Shannon L. Ernster