In Foster v. Sedgwick Claims Mgmt. Servs., Inc., the US Court of Appeals for the DC Circuit held that an employer's short-term disability plan was exempt from ERISA because it fell within a regulatory exception for payroll practices (842 F.3d 721 (D.C. Cir. 2016)).

The employee in this case, a mortgage loan closer, was a participant in her employer's short-term and long-term disability plans, both of which were administered by a claims administrator on the employer's behalf. After missing work due to illness, the employee sought benefits under the short-term disability plan.

The short-term disability plan paid benefits from the employer's general assets to employees who were unable to work due to an approved disability. A disability under the short-term plan generally consisted of an inability to perform the "material duties" of an individual's occupation, as determined by the claims administrator. In contrast, the long-term disability plan, which was funded through a trust and was part of the employer's larger benefit plan, provided benefits for employees who were totally disabled, also as determined by the claims administrator.

The claims administrator denied the employee's short-term disability claim, citing insufficient medical documentation, and the employer later terminated the employee due to her absences. The claims administrator also denied the employee's appeal of its short-term disability decision and rejected both the employee's subsequent claim for long-term disability benefits and an appeal of the long-term disability benefits denial (see Practice Note, Claims Procedure Requirements for Disability Claims).

The employee sued the claims administrator and the short-term and long-term disability plans in federal district court to enforce her rights under ERISA (see Practice Note, ERISA Litigation: Causes of Action Under ERISA Section 502). At the summary judgment stage, the employee conceded that the employer's short-term disability plan was a "payroll practice" and therefore exempt from ERISA. This meant the employee could not seek review of that claim under ERISA. The district court independently concluded that the short-term disability plan was an exempt payroll practice, reasoning that:

The district court therefore granted the claims administrator's motion for summary judgment.

The court also ruled against the employee on her long-term disability claim, concluding that:

Using the deferential standard, the court concluded that the claims administrator had not abused its discretion in denying the employee's long-term disability claim.

Despite her initial concession on the payroll practices question, the employee sought a motion for reconsideration of the district court's finding that the short-term plan was exempt from ERISA. The district court denied this request and the employee appealed to the DC Circuit.

Affirming the district court, the DC Circuit ruled that the short-term disability plan was an ERISA-exempt payroll practice under DOL regulations. These regulations provide that an exempt payroll practice includes "[p]ayment of an employee's normal compensation, out of the employer's general assets, on account of periods of time during which the employee is physically or mentally unable to perform his or her duties, or is otherwise absent for medical reasons" (29 C.F.R. § 2510.3-1(b)(2)). An arrangement that falls within the payroll practices exemption is not an "employee welfare benefit plan" subject to ERISA (see Practice Note, Title I of the Employee Retirement Income Security Act (ERISA): Exceptions to ERISA Coverage). According to the DC Circuit, the parties agreed that without the DOL's regulatory exemption there was no question that the employer's short-term disability plan was an ERISA plan.

The DC Circuit concluded that the employer's short-term disability plan clearly fell within the regulatory definition of a payroll practice. Specifically, the court reasoned that:

The court noted that the employer had apparently drafted its short-term disability plan to comply with the elements of the DOL's regulatory exemption. Citing a "tri-fold match" between the employer's short-term disability plan and the exemption's requirements (that is, payment of normal wages, from general assets, on account of work due to medical reasons), the court concluded that the plan fell "squarely" within the exemption.

The court rejected the employee's argument that the plan was subject to ERISA because it was administered in a way that established an ongoing administrative scheme. The employee made this argument by analogy to the Supreme Court's Fort Halifax standard for determining whether a severance arrangement is subject to ERISA (482 U.S. 1 (1987) (holding that a one-time severance payment to employees upon a plant closing was not ERISA-preempted); see also Practice Notes, Severance Benefits, Plans, and Arrangements: Severance Arrangements Subject to ERISA and ERISA Litigation: Preemption of State Laws: Severance Pay Programs). The DC Circuit distinguished Fort Halifax, noting that whereas that case involved whether a benefit should be construed as an ERISA plan, this case addressed whether an arrangement that clearly fell within ERISA's reach should nonetheless be exempt under a regulatory exemption.

Analyzing the terms of the employer's long-term disability plan, and principles of both ERISA and trust law, the DC Circuit concluded that the district court also properly applied a deferential standard of review. The DC Circuit noted that the plan clearly vested the claims administrator with discretion both to interpret disputed terms and determine benefits eligibility.

We don't often see circuit court of appeals decisions addressing the regulatory exemption from ERISA coverage for payroll practices, so this one caught our eye. The payroll practices exemption is narrow and it is relatively easy for an arrangement to fall outside the exemption. This could occur, for example, if an employer paid benefits through insurance or funded the program, as opposed to paying benefits exclusively from the employer's general assets. In this respect, the exemption is similar to the DOL's safe harbor for voluntary arrangements—which also includes a defined set of requirements, all of which must be satisfied (see Practice Note, Voluntary Benefits). For a discussion of why it matters whether ERISA applies to an arrangement, see Practice Note, Voluntary Benefits: Why It Is Important Whether ERISA Applies.