Many 401(k) and other defined contribution retirement plans permit employers to use employee forfeitures to reduce future employer contributions to the plan. For example, if a 401(k) plan provides for employer matching contributions, the participant’s right to retain the employer’s contribution may vest over a number of years. If an employee terminates employment before their interest in the employer contributions vests, the participant forfeits the unvested portion of that contribution. Many plans grant the plan administrator the discretion to use those forfeitures to reduce future employer contributions or apply them against administrative expenses that would otherwise be charged to participant account balances.
In recent years, several high-profile lawsuits have called this practice into question. Plaintiffs in these suits allege that this practice violates the fiduciary standards of the Employee Retirement Income Security Act of 1974 (ERISA), including its anti-inurement provision, which prohibits fiduciaries from using plan assets to benefit any employer. Plaintiffs also allege that using forfeitures in this manner violates ERISA’s prudence requirement and its duty of loyalty to plan participants and their beneficiaries and that using forfeitures to reduce employer contributions constitutes a prohibited transaction between the plan and the employer.
Two California courts have recently weighed in on this argument and reached different conclusions.
Case 1: Perez-Cruet v. Qualcomm Inc., (S.D. Cal. May 24, 2024)
In May 2024, the Federal District Court for the Southern District of California denied a motion to dismiss a suit brought by a former employee against Qualcomm, Inc., ordering Qualcomm to defend its use of forfeitures to reduce future employer contributions to Qualcomm’s 401(k) plan. The court held that the plaintiffs plausibly alleged that Qualcomm prioritized its financial interests over the interests of its plan participants by using the forfeitures to reduce its plan contributions.
In allowing the suit to proceed, the court noted that, had the defendants used forfeitures to pay the plan’s administrative expenses in 2021, all plan participants would have avoided those charges. Instead, Qualcomm used the forfeitures to reduce its future contributions, leading to plausible allegations that it breached ERISA’s duty of loyalty by using the plan’s assets to benefit itself. Additionally, even though the plan documents allowed this use of forfeitures, the court found that the plaintiffs had a valid claim for breach of ERISA’s duty of prudence, as the administrative expense charge was placed on participants rather than the employer. Following this line of reasoning, the court similarly concluded that the plaintiffs sufficiently alleged violations of ERISA’s anti-inurement and prohibited transaction provisions.
Case 2: Hutchins v. HP Inc., (N.D. Cal. June 17, 2024)
More recently, the Federal District Court for the Northern District of California granted a motion to dismiss without prejudice in a similar suit filed against HP Inc., which also used forfeited employer contributions to fund future employer contributions to its 401(k) plan.
The court noted that HP, as plan administrator, has discretionary authority to apply forfeitures to reduce employer contributions, restore previously forfeited benefits, pay plan expenses, or utilize forfeitures for any other allowed purpose. The court described the plaintiff’s position as a “swing for the fences” by asserting that ERISA requires a plan administrator to always apply forfeitures to pay administrative expenses regardless of the circumstances. The court determined that the plaintiff’s theory was too broad and therefore implausible. Accordingly, the court dismissed the complaint but allowed the plaintiff leave to file an amended complaint in accordance with the court’s opinion.
Implications and Future Considerations
There are currently several cases pending that pose the same issues as Qualcomm and HP, mostly in the federal district courts in California. It remains to be seen whether the Southern District of California or other courts will be influenced by the Northern District’s ruling. Until then, employers should check their plan documents to determine whether the plan imposes a vesting schedule and, if so, how forfeitures are to be applied. Employers with fixed plan provisions mandating the use of forfeitures to reduce employer contributions should be aware of the associated risks.
If the plan grants discretion to the plan administrator to apply benefits in different ways, the plan sponsor could prevent the issue by removing that discretion (i.e., by mandating that forfeitures must be used to reduce future employer contributions). However, this approach has its risks. While setting the rules of the plan (a “settlor” function) is within the employer’s control, the actual implementation of those rules is a fiduciary duty. The Department of Labor or courts may rule that if the mandated use of forfeitures contradicts the law, fiduciaries could be breaching their duties by following these mandates.
Employers that wish to retain the administrator’s discretion over the use of forfeitures should wait to see how other similar cases pan out. Conversely, more conservative employers may choose to exercise discretion in favor of plan participants, for example, by using forfeitures to cover legitimate plan expenses that the employer would otherwise pay. Differing interpretations of ERISA leave room for challenges that could force employers to reconsider their current practices or change them to conform to the evolving legal landscape. Employers should consult with legal counsel to determine the best approach for handling forfeitures and ensuring compliance with evolving laws.
If you have any questions regarding the content of this alert, please contact Art Marrapese, Employee Benefits Practice Area chair, at amarrapese@barclaydamon.com; Ray McCabe partner, at rmccabe@barclaydamon.com; Shawn Chowdhury, associate, at schowdhury@barclaydamon.com; or another member of the firm’s Employee Benefits Practice Area.