Employers and ERISA fiduciaries should be sitting up in their seats as the newest 401(k) liability theory slowly begins to advance in California federal courts. The newest liability theory goes like this: even though it is lawful (and in fact may be required by the U.S. Treasury Department) for employers and plan fiduciaries to use forfeited employer 401(k) contributions1 to reduce employer contributions to current participants, the employer and plan fiduciaries allegedly violate ERISA if they do not use forfeited contributions to pay down the plan administrative costs that are charged to participants. Plaintiffs asserting this new theory contend that any other use of forfeited contributions breaches the fiduciary duties of loyalty and prudence, violates ERISA’s anti-inurement provision,2 and constitutes an ERISA-prohibited transaction.
There are many legal hurdles facing this theory. Perhaps the most significant is that the Treasury Department (which regulates qualified plans such as 401(k)s) has said for decades that forfeited amounts “must be used as soon as possible to reduce the employer’s contributions under the plan.” 26 C.F.R. § 1.401-7(a). More recently, the Treasury Department proposed a new regulation that authorizes forfeitures to be used for one of three purposes, “as specified in the plan: (1) to pay plan administrative expenses, (2) to reduce employer contributions under the plan, or (3) to increase benefits in other participants’ accounts in accordance with plan terms.” See Use of Forfeitures in Qualified Retirement Plans, 88 Fed Reg. 12282-01 (Feb. 2023), which can be found here. Thus, the 2023 proposed regulation, if adopted, would continue to allow the long-standing practice of reallocating forfeited employer contributions to other employees’ accounts. It merely offers sponsoring employers additional options in handling forfeited amounts without dictating which one of the three options must be selected. It is a certainty that most employers have for decades structured their plans to permit or require forfeited contributions to be used to reduce the employer’s contributions rather than to reduce participants’ administrative expenses.
One would think in light of this regulatory history and long-standing custom (which has never before been challenged by the government) that plaintiffs would not have much hope of prevailing in the nine “forfeiture use” cases they filed in the Northern, Southern, and Central Districts of California over the past ten months. But if you shoot off enough flares in different directions from your leaky legal rowboat, then apparently someone in California will come to your rescue. In May 2024, in Perez-Cruet v. Qualcomm, the Southern District of California court ruled that plaintiff’s class action complaint survived a motion to dismiss. In Perez-Cruet, the plan gave the company the “discretion” to use forfeitures to reduce employer contributions or to pay plan administrative expenses. The court held that plaintiff plausibly alleged that defendants breached their fiduciary duties in exercising their discretion in favor of reducing employer contributions rather than paying expenses. It also determined that plaintiff properly stated claims for breach of ERISA’s anti-inurement and prohibited transactions provisions. Defendants have filed a motion for reconsideration.
A June 2024 decision out of the Northern District of California, Hutchins v. HP, Inc., is somewhat better for employers and fiduciaries, but not the victory they were hoping for: although the court granted the defendants’ motion to dismiss, it left the door open to continued litigation. In Hutchins, the Plan stated that forfeited amounts could be used to “reduce employer contributions, to retore benefits previously forfeited, to pay Plan expenses, or for any other permitted use.” The court rejected the plaintiff’s blanket claim that a fiduciary who is given these options must “always…choose to [use forfeited contributions to] pay administrative costs.” This blanket approach is flawed, the court said, because (1) ERISA does not create “an unqualified duty to pay administrative costs,” (2) it would “abrogate Treasury regulations and settled rules regarding the use of forfeitures in defined contribution plans,” and (3) the court, in evaluating a claim for breach of fiduciary duty, must consider the circumstances prevailing at the time the fiduciary acts. The court thus granted the motion to dismiss but allowed plaintiff to amend his complaint because “[p]laintiff might be able to plausibly allege disloyalty or imprudence based on more particularized facts or special circumstances present in this case.” Presumably plaintiff will have to allege facts that adequately explain why the fiduciaries were compelled to use the forfeited contributions to pay administrative expenses at the time they made their decision. The court thus fashioned a narrow opening for a “forfeiture use” plaintiff to state a claim.
Courts in the seven other cases have not yet decided defendants’ dispositive motions. One of the seven cases, Barragan v. Honeywell International, is nonetheless important now because the parties recently agreed to transfer the case to the federal District Court for the District of New Jersey. Thus, plaintiffs will have their first opportunity to export their theory to other parts of the country.
Takeaways: (1) Although plaintiffs have not yet prevailed on the merits of their claims and face a long road ahead to victory; the Perez-Cruet and Hutchins decisions lay out a path forward for plaintiffs and class action lawyers. These decisions may be a “tipping point” that leads to the filing of more “forfeiture use” cases; (2) There are many more legal arguments against the “forfeiture use” theory than those discussed above; and (3) In the ERISA fiduciary world a reasoned and documented decision-making process often counts more than the outcome. Accordingly, employers and fiduciaries should consult with experienced ERISA counsel to develop litigation and compliance strategies with respect to challenges based on the use of forfeitures.
[1] An employer’s contribution to a participant’s 401(k) account may be forfeited if the employee leaves the company before satisfying the vesting period required by the plan.
[2] The anti-inurement provision states that “the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan.” 29 U.S.C. § 1103(c)(1).
Please contact Reger Rizzo and Darnall, LLP Partner James (Jim) Griffith if you would like more information. Jim can be reached at jgriffith@regerlaw.com or (215) 495-6510.