By: Sherrie Boutwell and Deborah Fabricant (2010)
What happens when the drafter of an ERISA plan makes an innocent error (a “scrivener’s error”) that unintentionally increases benefits to plan participants by more than $1.6 billion? Should the employer be stuck paying benefits that were never intended and never expected? Is the plan’s tax-qualified status at risk if the plan document is not followed as written?
Two recent federal court decisions highlight the tension between the need to protect plan participants and the potential unfairness of allowing participants to receive a windfall just because of an innocent mistake, as well as the difference between correction by retroactive plan amendment under EPCRS and reformation of a plan document by a court under ERISA.
The Verizon Case: can a “typo” be corrected by a court under ERISA?
Last month, the 7th Circuit Court of Appeals upheld a decision of a Chicago federal district court that had used ERISA’s equitable relief provision to reform the language of a cash balance plan to correct a so-called “scrivener’s error,” Young v. Verizon’s Bell Atlantic Cash Balance Plan, 2010 U.S. App. LEXIS 16483 (7th Cir. Aug. 10, 2010). The Seventh Circuit, while preserving Verizon’s specific $1.6 billion victory in the lower court, made it unmistakably clear that the Verizon situation was exceptional laying out a tough test that an employer must prove by “clear and convincing evidence” that a plan contains a scrivener’s error that does not “reflect participants’ reasonable expectations of benefits.” The district court, just a year before, had slammed Verizon’s attempt to reform its plan on its own, rather than applying to a court to reform the document. Young v. Verizon’s Bell Atlantic Cash Balance Plan, 575 F Supp.2d 892 (N.D. Ill. 2008).
The Verizon case arose when a participant claimed that Verizon had miscalculated her cash balance plan account benefit, by applying a transition factor only once, instead of twice, as called for by the plan document. Verizon agreed that the Plan Document, read literally, provided her the higher benefit, but the plan administrator denied her claim and the plan committee affirmed the denial, reasoning that it was the plan sponsor’s intent “to apply the factor just once” and that the second reference in the plan language was “a mistake.” In short, the committee decided to reform the plan itself by interpreting the document to mean what was intended rather than what the document literally said. When the participant sued, the federal district court initially ruled that the plan had abused its discretion in attempting to reform the plan without a court ruling. The judge said the committee could not disregard the plan’s unambiguous double reference to the transition factor and that it should have “sought to reform the plan document in court…subject to de novo judicial review.” Following that decision, the committee did exactly what the court had suggested, or as the Seventh Circuit, in its August decision put it, took the court’s “cue” – it sought an order from the same court, asking the same judge to reform the document.
After a full evidentiary trial earlier this year, Verizon ultimately convinced the district court to reform the plan language and the Seventh Circuit agreed with the district court that the evidence presented was objective and clear and convincing. The Seventh Circuit inventoried and ruled on the evidence noting:
the drafting history “left little doubt”, without needing to even rely on the drafter’s “arguably self-serving testimony” that the factor was to be applied only once and that there had been a drafting error;
the “communications” between Verizon and participants before the plan conversion clearly explained that the transition factor would be applied only once;
the “course of dealing” between Verizon and participants showed that in fact, the factor had been applied only once to many account balance calculations for years; and
no participant had ever relied on the language in the plan.
Because the evidence of the intended meaning of the Plan clearly supported Verizon’s position, Verizon got the relief it requested in the district court and the Seventh Circuit court, after the plaintiffs appealed, affirmed the district court decision.
Is this case good precedent for other plans facing scrivener error issues? Time will tell but it may not be - it is rare for the facts showing a scrivener’s error to be as “clear and convincing” as those in the Verizon case. In addition, the amount of money at stake (over 1.6 billion dollars), which both the district court and the 7th Circuit pointedly noted would give a windfall to participants, clearly justified the high cost of protracted litigation for all parties.
More importantly, both the district court and the Seventh Circuit expressly acknowledged that the decision to reform the plan is at odds with the long established and respected ERISA “plan document rule” which requires that participants’ benefits be determined pursuant to a written plan document. In this case, an otherwise “unreformable” ERISA plan was reformed but the Seventh Circuit closed the door explicitly to most reformation claims holding that “only those who can marshall ‘clear and convincing evidence’ that plan language is contrary to the parties expectations will have a viable claim.” This standard of proof is “rigorous”; the evidence must be “objective” and not dependent on the credibility of testimony of interested parties. This high standard, the Court said “should deter an employer from seeking to reform plan language simply because it has proved unfavorable.”
Interestingly, the Seventh Circuit suggested that several earlier decisions by other courts (including the 9th Circuit which governs plans in California) that refused to deviate from the plan document rule to reform a scrivener’s error did not present facts required to meet its tough evidentiary standard. See Cinelli v. Security Pacific Corporation, 61 F.2d 1437 (9th Cir. 1995). It will be interesting to see whether the 9th Circuit’s support for “ERISA’s strong preference for the written terms of the plan” will be affected by the standard set out by the Seventh Circuit in Verizon.
The Verizon case did not address or discuss the tax implications of reformation, but another recent case discussed below addressed and rejected the effect of approval by the IRS of a retroactive amendment under EPCRS and in that case, the participants won.
The Cross Case: can a “typo” be corrected by retroactive amendment under EPCRS?
In another recent unpublished scrivener’s error case, Cross v. Bragg, No. 07-1699 (4th Cir. July 24, 2009) (unpublished), a plan actuary mistakenly changed a formula for calculating benefits to a richer formula but the plan continued calculating and paying benefits under the old formula until the plan discovered the error six years later. The plan sponsor then applied under EPCRS for a compliance statement approving correction by retroactive amendment, which the Service granted. When the plan sponsor tried to “revise” the documents retroactively, the participants, who admittedly had not relied on the error, brought suit, and the Fourth Circuit rejected the attempted reformation and made short shrift of giving any deference to the IRS determination. The Court correctly noted that the IRS’s decision about taxability had nothing to do with the “contractual rights of a plan beneficiary” and ruled that ERISA prohibited the attempted reduction in benefits.
So what do plans need to know now about scrivener’s errors?
The Verizon case, while a big win for the plan sponsor, is not as helpful as it seems. The clear and convincing evidence standard is tough and Verizon will likely be limited by other courts to its specific, plan favorable facts.
The facts of the case (and the ability to prove them) are critical. Whether to seek judicial reformation depends on the facts and the court where the case will be litigated. Self-reformation may not be an option in certain circuits no matter how good the facts are.
Seeking reformation could result in liability. If a plan brings an action to seek reformation and it is denied, the plan could be potentially liable for the participants’ attorneys’ fees. Participants might also be able bring a counterclaim asserting a breach of fiduciary duties (especially in cases where the facts or the law of that circuit are not favorable to the plan).
EPCRS only protects the sponsor from tax liability. Following the Verizon case, plans should use EPCRS only to protect against adverse tax consequences and consider seeking a court ruling to correct for ERISA purposes.
Maintain insurance. Plan fiduciaries and service providers should maintain errors and omission insurance that would cover a scrivener’s error. And be aware that most such policies require notice to the insurer promptly upon discovery of facts that could lead to a claim, as well as a requirement that the insured not admit to liability (which can be an issue in an EPCRS filing).
Consider adding a “scrivener’s error” provision to the plan. Discuss with counsel safeguards that might be able to be built into the drafting process and into the plan document itself.