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ERISA’s Better Mousetrap James P. Baker
A
s the saying goes, “Build a better mousetrap, and the world will beat a path to your door.” It is not every day that a “comprehensive and reticulated” federal law becomes an employment lawyer’s best friend.1 But such is the Employee Retirement Income Security Act (ERISA) when it comes to deferred compensation arrangements. Imagine a world where only federal judges (and not juries) decide disputes.2 A world where federal law does not permit the judge to consider state law claims of any stripe.3 A world where the federal claims that may be advanced and the damages that can be awarded are very limited.4 In the case of top-hat plan litigation, the number of possible claims shrinks to just one.5 Imagine a world where all disputed claims must first be presented to the plan administrator for review and where the plan administrator’s decision is subject to the arbitrary and capricious standard of review in a later lawsuit.6 Imagine a world where the sponsor can choose which state’s law governs James P. Baker is a partner in Winston & Strawn’s San Francisco office whose practice focuses on ERISA litigation and the counseling of employers on the entire spectrum of employee benefit and executive compensation matters. Chambers USA 2010 describes Mr. Baker as “an ERISA legend on the West Coast,” and the National Law Journal has recognized Mr. Baker as one of the 40 best employee benefit attorneys in the United States. He has again been chosen in 2010 as one of the “Best Lawyers in America” for ERISA litigation. The views set forth herein are the personal views of the author and do not necessarily reflect those of the law firm with which he is associated.
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the interpretation of the plan’s noncompete provision and a world where the record evidence presented to a reviewing court is limited to the evidence presented to the plan administrator.7 Imagine a world where the plan sponsor can dictate a reasonable statute of limitations for filing a lawsuit challenging the plan administrator’s denial of a claim.8 Welcome to the world according to ERISA. In the topsy-turvy world of noncompete agreements, ERISA has become a plan sponsor’s best friend. The easiest way for a competitor to obtain another business’s “secret sauce” recipe, manufacturing know-how, customer lists, marketing innovations, or other proprietary information is to hire away a manager or executive who has access to the desired confidential information. To prevent employees from taking confidential information to their next employer, many employers require employees to sign noncompete agreements. In theory, a noncompete agreement prevents a former employee from working for direct competitors for a reasonable period of time. Noncompete agreements, however, are usually regulated by state law, resulting in a hodge-podge of different rules that vary significantly from one state to the next. For example, a technology company in Massachusetts can enforce reasonable noncompete agreements, yet the same company cannot do so in California.
California’s State Law Provision on Noncompete Agreements The biggest fly in the noncompete ointment is California law. In general, noncompete agreements are not enforceable in California.9 Outside of California a standard noncompete agreement provides that an employee may not work for a competitor for a certain period of time within a certain geographic area following the termination of employment. Whether any form of noncompete agreement can be enforced in California was recently resolved in Edwards v. Arthur Andersen.10 The California court’s answer was an emphatic, “No.” Arthur Andersen’s noncompetition agreement prevented Mr. Edwards from: 1. Working for clients that he had worked for at Arthur Andersen for a period of 18 months following the termination of his employment; or 2. Soliciting any former Los Angeles client of Arthur Andersen for 12 months after his termination of employment. A unanimous California Supreme Court ruled that Mr. Edwards’ noncompete agreement was invalid under California Business and Professions Code Section 16600. It states that “every contract by BENEFITS LAW JOURNAL
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which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” Arthur Andersen argued that “only contracts that totally prohibit an employee from engaging in his or her profession, trade or business are illegal” and based on the narrow restraint exception developed in several Ninth Circuit decisions.11 A unanimous California Supreme Court rejected this “narrow restraint” argument, explaining Business and Professions Code Section 16600’s plain words indicated that no restraint on lawful competition would be tolerated. Several other states have climbed onto California’s bandwagon. They have employed state law statutes or doctrines to limit the use of employee noncompetition agreements. Court decisions on noncompete agreements are all over the lot. Some limit the scope of noncompete agreements, often in contradictory and confusing decisions. For multi-state employers, this hodge-podge of state law and judicial rulemaking potentially requires them to keep abreast of changing laws and court decisions in the jurisdictions where their companies do business or risk losing the right to protect the company’s business interests.
Why ERISA Regulation Matters Those of us who practice in the area of ERISA know that what state law forbids, federal law often permits. Such is the case with noncompetition agreements. An ERISA-regulated non-qualified deferred compensation plan may contain noncompetition provisions that will be enforced in federal court and will not be subject to challenge in state court.12 These plans are called “top-hat” plans because they provide benefits to a select group of management or highly compensated employees. Even tax-qualified retirement plans that provide benefits in excess of the statutory minimum (such as earlier vesting) may contain enforceable noncompetition provisions.13 ERISA “top-hat” plans often provide that if participants join a competitor within a specified period after their employment is terminated, the participant will forfeit his or her deferred compensation benefits.14 Courts have consistently stated that ERISA supersedes state law claims filed in connection with noncompetition forfeiture provisions.15 Congress passed ERISA intending to develop a uniform body of federal substantive law regarding the rights and obligations of participants in employee benefit plans.16 The ERISA statute allows an employer to adopt a deferred compensation plan that contains enforceable noncompete provisions: ERISA’s pre-emption provision was prompted by a recognition that employers establishing and maintaining employee benefit plans are faced with a task of coordinating complex administrative BENEFITS LAW JOURNAL
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activities. A patchwork scheme of regulation would introduce considerable inefficiencies in benefit program operation, which might lead those employers with existing plans to reduce benefits, and those without such plans to refrain from adopting them. Pre-emption ensures that administrative practices of a benefit plan will be governed by only a single set of regulations.17
To ensure uniformity in employee benefit plans, Congress declared the ERISA statute “shall supersede any and all state laws insofar as they may now or hereafter relate to any employee benefit plan,” covered by ERISA.18 Accordingly, if a deferred compensation plan’s noncompete provision is covered by ERISA, a court must apply federal law rather than state law to determine if the plan’s noncompete provision is enforceable. ERISA preempts state laws that “relate to” employee benefit plans.19 The Ninth Circuit, like the other circuits, has ruled that state laws governing noncompete clauses contained in employee benefit plans are preempted and are irrelevant to determining the validity of those clauses.20 Principles of contract law, as opposed to trust law or ERISA’s fiduciary standards, are applied to determine the rights and obligations of participants in a top-hat plan.21 One of the consequences of incorporating a noncompete clause into a “top-hat” plan is to make that noncompete clause enforceable under federal law and subject to ERISA’s broad preemption statutes.22 An ERISA-regulated top-hat plan can be either an unfunded or an insured welfare plan (for example, providing severance or disability benefits) or it can be an unfunded or insured nonqualified retirement plan.23 These plans are usually only offered to executives. The term “unfunded” does not mean money cannot be set aside to fund these deferred compensation promises to executives. Rather, “unfunded” in this case means any money put aside must remain part of the company’s general assets and subject to the claims of the company’s general creditors (e.g., in a Rabbi trust).24
The Allure of ERISA Top-Hat Plans Top-hat plans are ERISA-regulated plans “maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”25 These plans are exempt from the fiduciary, funding, participation, and vesting rules applicable to other ERISA-regulated retirement plans.26 This means top-hat plans are simply contractual agreements. Top-hat plans are, however, subject to ERISA’s enforcement provisions.27 The “consideration” for the agreement not to compete would be the economic benefits provided by the top-hat plan. Moreover, we know the federal courts will enforce the forfeiture of top-hat plan benefits for violating a noncompete agreement.28 BENEFITS LAW JOURNAL
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ERISA defines a “top-hat” plan as an unfunded, non-qualified retirement plan “maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”29 Again, it is settled that tophat plans are exempt from the fiduciary, funding, participation, and vesting requirements applicable to other employee benefit plans.30 As a result, top-hat plans are covered only by ERISA’s enforcement provisions.31
ERISA Supersedes State Laws Purporting to Regulate Noncompetition Clauses in Top-Hat Plans ERISA preempts state laws that have a “connection with” or that “reference” employee benefit plans.32 The Ninth Circuit, like other circuits, has ruled that state laws governing noncompete clauses in employee benefit plans are wholly preempted and irrelevant to an analysis of the validity of such clauses.33 State common law claims regarding the enforceability of noncompete provisions of an ERISA-regulated plan are superseded by the ERISA statute.34 ERISA allows a top-hat plan to include enforceable noncompete forfeiture provisions even if those provisions are not enforceable under state law.35 The preemption clause of ERISA Section 514 thus works to supersede state laws governing noncompete clauses.36 Principles of contract law, as opposed to trust law or ERISA’s fiduciary standards, are applied to determine the rights and obligations of participants in a top-hat plan.37 One of the consequences of incorporating a noncompete clause into a “top-hat” plan is to make that noncompete clause enforceable in federal court and subject to ERISA’s broad preemption statutes.38
Protecting Business Interests Through a Top-Hat Plan Top-hat plan benefits can be completely forfeited if a former employee goes to work for a competitor.39 The bigger question is whether a former employee can be enjoined from working for a competitor due to his or her participation in an ERISA-regulated plan. The key to enforcing an ERISA plan’s noncompetition provision through an injunction is to show that the noncompetition provision is necessary to prevent irreparable harm to the ERISA plan. ERISA does not constrain the plan sponsor’s ability to craft a deferred compensation plan restricting or severely limiting a participant’s ability to work for a competitor. For example, by making the top-hat plan a “profit sharing” arrangement, a violation of the noncompete clause could be shown to cause irreparable harm to the plan’s ability to generate future profits and thus cause immeasurable harm to the other plan BENEFITS LAW JOURNAL
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participants. Each participant can be required to sign a recital on the plan’s enrollment form stating he or she recognizes and agrees that going to work for a key competitor within a reasonable time period (e.g., 12 to 18 months) following the termination of their employment would violate the plan’s terms and harm the company’s future profitability as well as the economic future of the plan’s other participants. Several ERISA cases have issued injunctions to enforce noncompete provisions contained in employee benefit plans.40 An ERISA top-hat plan can protect itself through forfeiture provisions or by injunctive relief if a former participant injures the company’s continued profitability, the profits enjoyed by the plan and the plan’s participants due to wrongful competition.41 The Uniform Trade Secrets Act exception may provide employers with a second contractual means of bolstering an ERISA plan’s noncompete provisions by: 1. Limiting a former employee’s use of confidential or proprietary information; or 2. Soliciting the former employer’s employees or customers.42 While in many cases unfair competition may be independently actionable, there may be several advantages for an employer to prohibit such conduct by embedding the employee’s access to confidential or trade secret activity in an ERISA-regulated plan.
Choice of Law Provision ERISA’s preemptive authority, of course, sweeps broadly to preclude the application of state law authority that would undermine the uniform implementation of the ERISA statute’s text or its attendant case law.43 When private contracting parties formulate a choice of law provision that, with a view to defining liability, incorporates a state legal doctrine, that doctrine is not an emanation of state authority, it is simply a convenient shorthand for what the private contracting parties wish to agree to. The question is whether the principles of liability agreed upon by the parties are inconsistent with the language of ERISA or the policies that inform the statute and animate the ERISA common law. Top-hat plans have virtually no ERISA regulation. There are no ERISA statutory language and no ERISA cases formulating the ERISA common law that suggest that the agreement of parties to a top-hat plan to use Washington state law (or some other state law favorable to noncompete arrangements) would be subversive to any ERISA policy. “Where a choice of law is made by an ERISA contract, it should be followed, if not unreasonable or fundamentally unfair.”44 Washington state law comes to mind because of Google’s 2005 dust up with Microsoft. BENEFITS LAW JOURNAL
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Kai Fu Lee quit Microsoft to take a job at Google. Microsoft sued to prevent Lee from going to work for Google and Microsoft was granted a temporary restraining order in Washington. Google eventually settled.
Forum Selection Clause One important plan design element is to require a top-hat plan participant to voluntarily agree to a forum selection clause in order to receive plan benefits. A series of district courts have ruled (no circuit court has yet issued a decision) that forum selection clauses in ERISA plans are generally enforceable as long as they have some basis in reality. Under federal law, a forum selection clause is presumptively valid.45 The vast majority of district courts have enforced forum selection clauses in ERISA plans. In Laasko v. Xerox Corp.46 the court explained: The forum selection clause contained in the LTD Plan allows one federal court to oversee the administration of the LTD Plan and gain special familiarity with the LTD Plan Document, thereby advancing ERISA’s goal of establishing a uniform administrative scheme.47
Thus, enforcement of the forum selection clause in this case is not inconsistent with the federal policy. ERISA’s own venue provision, 29 U.S.C. Section 1132(e), is helpful. It states that an action can be brought: 1. Where the breach occurred; 2. Where a defendant resides or may be found; or 3. Where the plan is administered. A deferred compensation plan’s choice of law and forum selection provisions are potentially reasonable and would have a basis in reality if the participant has expressly agreed to the provisions and if the governing state law and choice of forum were taken from the state where the plan is administered.
Conclusion Retaining talented employees is the key to a successful business. As shown above, there are several strategies for improving the chances of enforcing noncompete agreements by housing them in ERISAregulated top-hat plans. Using an ERISA-regulated top-hat plan should make the enforcement of noncompete agreements more predictable. Applying one BENEFITS LAW JOURNAL
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standard nationwide to noncompete agreements will also make them a better mousetrap—they will become easier to understand and easier to administer.
Notes 1. Mertens v. Hewitt Assocs., 508 U.S. 248, 251 (1993). 2. Thomas v. Oregon Fruit Prods. Co., 228 F.3d 991, 995 (9th Cir. 2000). 3. Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 54 (1987). 4. Mass. Life Ins. Co. v. Russell, 473 U.S. 134, 147 (1985). 5. Foley v. Am. Electric Power, 425 F. Supp. 2d 863, 868–869 (S.D. Ohio 2005). 6. Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 115 (1989). 7. Wang Labs, Inc. v. Kagan, 990 F.2d 1126, 1128–1129 (9th Cir. 1993). 8. Northlake Reg’l Med. Ctr. v. Waffle House System Employee Benefit Plan, 160 F.3d 1301, 1304 (11th Cir. 1998). 9. See Cal. Bus. & Prof. Code § 16600. 10. 44 Cal. 4th 937 (2008). 11. See, e.g., IBM Corp. v. Bajorek, 191 F.3d 1033 (9th Cir. 1999) (approving a noncompete agreement applicable to only one competitor). 12. Duggan v. Hobbs, 99 F.3d 307, 309 (9th Cir. 1996). 13. Lojek v. Thomas, 716 F.2d 675 (9th Cir. 1983). 14. See, e.g., Fishman v. Zurich Am. Ins. Co., 539 F. Supp. 2d 1036 (N.D. Ill. 2008). 15. Lojek, 716 F.2d at 678. 16. Amato v. Bernard, 618 F.2d 559, 567 (9th Cir. 1980). 17. Fort Halifax Packing Co. v. Coyne, 482 U.S. 1, 11 (1987). 18. 29 U.S.C. § 1144(a). 19. ERISA § 514(a); 29 U.S.C. § 1144(a); Egelhoff v. Egelhoff, 532 U.S. 141, 146 (2001). 20. See, e.g., Lojek v. Thomas, 716 F.2d 675, 678 (9th Cir. 1983) (rejecting argument that Idaho law on noncompetition clauses should govern forfeiture of pension benefits). 21. Eastman Kodak v. Bayer Corp, 369 F. Supp. 473, 478 (S.D.N.Y. 2005). 22. Moore v. Raytheon Corp., 314 F. Supp. 2d 658, 663 (N.D. Tex. 2004). 23. See 29 C.F.R. § 2520.104-24 and § 2520.104-23, setting forth the alternative reporting and disclosure rules for these plans. 24. See DOL Advisory Opinion 9014A and PLR 8727028. 25. 29 U.S.C. § 1051(2). 26. Pane v. RCA, 868 F.2d 631, 637 (3d Cir 1989). 27. Kemmerer v. ICI Americas, Inc., 70 F.3d 281, 286–287 (3d Cir 1995).
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28. Clark v. Loren Young Tire Profit Sharing Trust, 816 F.2d 480, 481 (9th Cir 1987). 29. See 29 U.S.C. §§ 1051(2), 1081(a)(3), 1101(a)(1). 30. See ERISA §§ 201, 301, and 401. See also Pane v. RCA, 868 F.2d 631, 637 (3d Cir. 1989) (top-hat plans exempt from funding, vesting and fiduciary protection provisions of ERISA); Threadgill v. Prudential Sec. Group, Inc., 145 F.3d 286, 291 n.4 (5th Cir. 1998); Northwestern Mut. Life Ins. Co., 848 F. Supp. at 1520–1521. ERISA § 514(a), 29 U.S.C. § 1144(a), which preempts state laws that “relate to” employee benefit plans, applies with equal force to protect top-hat plans from state law regulation. See, e.g., Pane, 868 F.2d at 635, Bruno v. Hershey Food Corp., 964 F. Supp. 159, 163 (D.N.J. 1997) (stating ERISA preempts state law claims brought against a top-hat plan). 31. Kemmerer, 70 F.3d at 286–287. 32. Egelhoff v. Egelhoff, 532 U.S. 141, 146 (2001). 33. See, e.g., Lojek v. Thomas, 716 F.2d 675, 678 (9th Cir. 1983) (rejecting plaintiffs’ argument that Idaho law on anti-competition clauses should govern); Brower v. Comark Merch., Inc., 949 F. Supp. 1183, 1188 (D.N.J. 1996) (“ERISA preempts New Jersey law with respect to non-competition forfeiture clauses.”); Clark v. Lauren Young Tire Ctr. Profit Sharing Trust, 816 F.2d 480, 481 (9th Cir. 1987) (“State law plays no part in assessing the validity of [a non-competition forfeiture clause] in an ERISA plan.”) 34. Clark, 816 F.2d at 481; Noelle v. Am. Design, Inc. Profit Sharing Plan, 764 F.2d 827, 831 (11th Cir. 1985); Hepple v. Roberts & Dybdahl, Inc., 622 F.2d 962, 965 (8th Cir. 1980); Bigda v. Fischbach Corp., 898 F. Supp. 1004, 1014 (S.D.N.Y. 1995). 35. See Bigda, 898 F. Supp. at 1016 (holding New York law may prohibit noncompete forfeiture provisions but ERISA statute allows forfeiture of all deferred compensation benefits under noncompete forfeiture provision in a top-hat plan); see also Lojek, 716 F.2d at 678–679 (holding even though Idaho law does not permit the enforcement of noncompete clauses in employment contracts, ERISA’s statute allows forfeiture of pension benefits in excess of ERISA’s minimum vesting requirements in noncompete clause); Clark, 816 F.2d at 481–482 (holding state law may prohibit noncompete forfeiture provisions, but ERISA preempts state law with regard to those clauses in an ERISA-regulated pension plan). 36. See Brower, 949 F. Supp. at 1188 (D.N.J. 1996) (“[S]tate law plays no part in assessing the validity of [a non-competition forfeiture] clause in an ERISA plan.”); Clark, 816 F.2d at 480–481; Lojek, 716 F.2d at 678 (rejecting the plaintiff’s argument that state law on anti-competition clauses should govern). 37. Eastman Kodak v. Bayer Corp, 369 F. Supp. 473, 478 (S.D.N.Y. 2005). 38. Moore v. Raytheon Corp., 314 F. Supp. 2d 658, 663 (N.D. Tex. 2004). 39. Clark v. Lauren Young Tire Profit Sharing Trust, 816 F.2d 480, 481 (9th Cir. 1987); Lojek v. Thomas, 712 F.2d 675, 678 (9th Cir. 1983). 40. See Bausch & Lomb, Inc. v. Smith, 630 F. Supp. 262, 265 (W.D.N.Y. 1986). 41. See, e.g., Chem-Trol v. Christiansen, 2009 WL 1850316 (S.D.N.Y. 2009). 42. Confidential information, if treated as such by the employer through the adoption of rudimentary precautions, may constitute trade secret information. 43. Egelhoff, 532 U.S. at 146.
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44. Wang Lab., Inc. v. Kagan, 990 F.2d 1126, 1128–1129 (9th Cir 1993); see also Buce v. Allianz Life Ins. Co., 247 F.3d 1133, 1148–1149 (11th Cir. 2001). 45. M/S Bremer v. Zapata Off-Shore Co., 407 U.S. 1, 10 (1972). 46. 566 F. Supp. 2d 1018, 1023 (C.D. Cal. 2008). 47. Klotz, 519 F. Supp. 2d at 436.
Copyright © 2011 CCH Incorporated. All Rights Reserved Reprinted from Benefits Law Journal Spring 2011, Volume 24, Number 1, pages 70-78, with permission from Aspen Publishers, Wolters Kluwer Law & Business, New York, NY, 1-800-638-8437, www.aspenpublishers.com
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