Excluding workers from benefit plans - conflicting guidance from the courts.

Employers maintaining benefit plans intended to exclude a specific category of workers should be reviewing plan documents and administrative procedures in light of recent judicial guidance. The Ninth Circuit's initial decision in Vizcaino v. Microsoft Corp., 97 F3d 1187 (9th Cir. 1996), and other recent cases have raised concerns that some independent contractors, leased employees or freelance workers might be held entitled to employee plan benefits. The Ninth Circuit granted a rare re-hearing in Microsoft, which was argued Mar. 27, 1997. The decision on re-hearing will provide further guidance on this important issue.

In Microsoft, the affected individuals were "freelancers" who had been hired as independent contractors. After these freelancers were reclassified by the IRS for employment tax purposes as employees, they sued for benefits under Microsoft's Sec. 423 employee stock purchase plan and its Sec. 401 (k) plan. Focusing on the plan language defining persons eligible to participate, the Ninth Circuit's decision concluded that, since the reclassified individuals were "employees," they were eligible to participate in the Sec. 423 plan, which by law requires participation by virtually all employees. The court also determined that since the individuals were "employees" within the definition of that term under the Sec. 401 (k) plan, they were eligible for benefits under said plan. With respect to the latter plan, the court did not defer to the plan administrator's interpretation of the definition of "employee," but rather, held Microsoft to a strict interpretation of the plan language.

In Bronk v. Mountain States Telephone & Telegraph, 495 F Supp 1317 (DC Colo. 1996), a district court found that employers were required to include leased employees as covered employees in a retirement plan. In reaching this conclusion, the Bronk court applied the analysis used in a 1992 New York district court decision, Renda v. Adam Meldrum & Andersen Co., 806 F Supp 1071 (DC N.Y 1992). The court in Renda found that Section 1052(a)(1)(a) of the Employee Retirement Income Security Act of 1974 (ERISA) and Sec. 410 require a business to cover leased employees in its tax-qualified retirement plans if the individuals are common-law employees; the court supported its conclusion by citing various requirements for plans set forth in Sec. 410 and the related regulations. In Bronk, the Tenth Circuit has accepted Mountain States Telephone's appeal as to whether the district court's decision conflicts with the Sec. 410(a) regulations.

In effect, the courts in Microsoft, Bronk and Renda have rewritten the employer's employee benefit plans to require inclusion of workers originally intended to be excluded from coverage. However, in other recent cases, employers have been able to exclude classes of employees from participation in qualified retirement plans on the basis of plan language. In Abraham v. Exxon Corp., 85 F3d 1126 (5th Cir. 1996), the court found that leased employees were not eligible for plan benefits. Exxon's plan language specifically excluded participation by leased and "special engagement" employees, and gave the plan administrator authority to determine eligibility. Exxon conceded that the plaintiffs were common-law employees, but maintained they were not entitled to be included in its benefit plans. The court agreed with Exxon, finding the Renda analysis "unpersuasive."

Three additional cases also support the concept that an employer generally may exclude categories of workers from coverage under a tax-qualified plan (to the extent allowed by the tax rules). Trombetta v. Cragin Bank for Savings Employee Stock Ownership Plan, 7th Cir., 1996, Speen v. Crown Clothing Corp., 1st Cir., 1996, and Clark v. Dupont, 4th Cir., 1997, all involved suits for pension benefits brought by individuals who were independent contractors or leased employees. In Speen, the plaintiffs also alleged discrimination under the Federal Age Discrimination in Employment Act (ADEA), which does not apply to independent contractors.

In Trombetta and Clark, the courts analyzed plan language defining individuals eligible for participation, considered facts surrounding each plaintiff's employment relationship with the service-recipient businesses, and supported the plan administrators' denial of benefits, based on a standard of whether the administrators' actions were "arbitrary and capricious." In Speen, the court determined that the facts did not support the claims of the plaintiff (a clothing salesman) that he was an employee rather than an independent contractor, and denied his claims alleging ADEA and ERISA violations, as well as Massachusetts common-law claims. Notably, neither the Trombetta nor Speen court mentioned Renda, Bronk or Exxon, or made any point of whether ERISA requires the inclusion of persons excluded by the plan document. In Clark, the court relied on Exxon for the proposition that "ERISA allows an employer to limit plan coverage to certain employees, so long as said `discrimination' is not based on age or length of service."

Notwithstanding the Bronk and Renda decisions, recent cases appear to find plan language determinative in deciding whether individuals are eligible to participate. If a plan (explicitly or implicitly) includes common-law employees in the definition of "employee" and leased employees or independent contractors are reclassified as common-law employees, the employer may well have exposure for providing benefits to such workers. Employers should review their employee benefit plans to ensure that the plan's language explicitly excludes classes of workers the employer intends to exclude, to the extent consistent with tax-qualified status for the plan. In addition, employers should review carefully administrative procedures under their plans to make sure that administrative actions taken in connection with a denial of a claim for benefits would satisfy any "arbitrary and capricious" standard of judicial review.