A Third Circuit decision, Sikora v. UPMC, 876 F.3d 110 (3d Cir. 2017), deepens a circuit split over whether a participant’s bargaining power is relevant to determining whether a plan qualifies for “top hat” status under ERISA.

Plans that qualify for “top hat” status are exempt from ERISA’s eligibility, vesting, funding, and fiduciary requirements. To qualify, a plan must be unfunded and must limit coverage to a “select group of management or highly compensated employees.”  In Sikora, a former employee sued to recover a pension benefit that he forfeited upon termination of his employment on the ground that the forfeiture violated ERISA’s vesting requirements.  To make his case, he argued that the plan did not qualify for “top hat” status — and therefore was not exempt from ERISA’s vesting requirements — because the participants in the plan did not have bargaining power with respect to the plan.  The Third Circuit held that bargaining power over plan design and operation is not relevant to determining whether a plan is limited to a “select group” of employees.  Instead, the Court ruled that the inquiry should focus on the number of participants who are eligible (it should be a small portion of the employee population) and participants’ compensation levels (to satisfy the “highly compensated” requirement). 

In this case, the Third Circuit evaluated the demographics and found that the plan qualified as a “top hat” plan. As a result, ERISA’s vesting requirements did not apply.

The Third Circuit’s test aligns with the First Circuit. In contrast, the Second, Sixth, and Ninth Circuits have interpreted a Department of Labor Opinion Letter from 1990 to mean that courts should inquire as to a plan participant’s bargaining power to determine whether s/he is a member of a “select group of management or highly compensated employees.” The Third Circuit disagreed with that interpretation, stating that the Opinion Letter merely “observ[ed] that participants in top-hat plans were deemed by Congress to possess bargaining power ‘by virtue of their position or compensation level.’”  According to the Third Circuit, “engraft[ing] a bargaining power requirement onto the elements of a top-hat plan” would be contrary to the plain text of the statute and the Opinion Letter.

The Sikora decision serves as a fresh reminder that there is no single test for determining top hat status.  The stakes are high: if an unfunded plan fails to qualify as “top hat,” the sponsor can be forced to pay benefits far in excess of what was anticipated; the sponsor can become subject to funding and fiduciary obligations; and plan participants can be exposed to significant (and unexpected) adverse tax consequences.  As such, it is worthwhile to review eligibility for unfunded plans and balance the desire to provide generous benefits against the risk of becoming subject to ERISA’s eligibility, funding, vesting, and fiduciary rules.