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A Post (f/n/a “Tweet”) to Remind Plan Sponsors of Key Considerations in Designing Severance Plans

The recent Complaint filed for severance benefits against Elon Musk, X Corp.,, serves as a reminder that it is as important to clearly establish the fiduciary governance structure over severance plans subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), as it is for other ERISA-governed plans, and to administer such plans in compliance with ERISA, the plan processes and procedures.  This case highlights some interesting considerations for plan sponsors and administrators of ERISA severance plans. 

The plaintiffs in this case are the former CEO, CFO, CLO, and General Counsel of Twitter. According to the Complaint filed in this case, the plaintiffs were eligible employees for severance benefits under two different ERISA welfare benefit plans-the CEO, CFO and CLO were eligible under the Change of Control and Involuntary Termination Protection Policy (as amended and restated effective August 8, 2014), and the GC was eligible under the Change of Control Severance and Involuntary Termination Protection Policy (as amended and restated effective February 22, 2017) (the “Plans”).  

Musk and X Corp. had initially entered into an agreement to purchase Twitter through an acquisition of Twitter’s outstanding shares.  Musk subsequently sought to back out of the transaction.  The Twitter Board fought to require Musk and X Corp. to complete the transaction and ultimately prevailed.  Each of the plaintiffs planned to resign for “Good Reason” under the Plans immediately following the closing.  Musk however, maneuvered to close the transaction early and immediately terminated their employment for “Cause” under the Plans, alleging the plaintiffs engaged in unspecified acts of “willful misconduct” and “gross negligence” and that they failed to cooperate with an internal investigation.  The plaintiffs claim that these terminations resulted in denials of severance benefits valued in the aggregate at approximately $200 million, giving rise to claims for denial of benefits under ERISA Section 502(a)(1)(B), tortious interference with attainment of rights under the Plans under ERISA Section 510, and failure to timely provide documents under ERISA Section 502(c). 

The plaintiffs pursued the Plans’ two-level administrative appeals, first before a former employee of SpaceX, and after receiving her denial, to a Twitter Severance Administrative Committee, composed of the original administrator in the first level appeal, another SpaceX employee and a long-time Tesla employee. The first level appeal concluded that the plaintiffs had engaged in acts of “willful misconduct” and “grossly negligent” behavior, resulting in a disqualifying “Cause” termination.  The Committee in the second level appeal also denied the plaintiffs’ claims on the grounds that they engaged in willful misconduct and gross negligence, but predicated on different alleged acts than the alleged acts on which the first level denial was based.  The lawsuit followed these denials.

This case reminds employers of the importance of paying close attention to the design of their severance plans, including devising a well thought out administrative apparatus.  This is particularly true when the plan pays benefits or enhanced benefits in connection with a change in control, and particularly in connection with a hostile change in control.  As the plaintiffs point out in their complaint, the promise of substantial severance aligned the plaintiffs’ interests to follow the direction of the Twitter Board prior to acquisition, despite the fact that their actions might engender the disdain of the buyer.  In light of the foregoing, consider the following threshold issues when designing a severance plan:

  1. The circumstances under which a participant is eligible to receive benefits should be clear and unambiguous.  Ideally, the definitions would also match the definitions of Cause and Good Reason in other governing documents (or if the definitions do not match, include a clear statement of which definition of the applicable term controls the determination).  The Plans met this burden and provided clear definitions of both Cause and Good Reason, such that the administrator in most cases would be able to determine reasonably whether the circumstances of a particular termination qualified the terminating employee for benefits under the applicable Plan.

  2. One of the significant benefits of an ERISA governed plan is that the reviewing court will likely give deference to the plan’s administrator if a terminated employee challenges a denial of benefits.  Normally, a court will only overturn an administrator’s decision if the decision is arbitrary or capricious.  That deference can be undermined, however, if the employer is both the payor of the benefit and the administrator of the plan.  That is the risk to X Corp. in this case, as X Corp. is the payor, Musk is quoted as desiring to save the severance cost and the administrators did not have any independence from X Corp. or Musk.  The plaintiffs are seeking a de novo review of the administrators’ denials on that basis.

    It follows that an employer should carefully consider to whom the plan delegates authority to review benefit denials to maximize the likelihood that a court will defer to an administrator’s decision.  ERISA requires a two level claims review.  While the first level is often the employer’s human resources or legal department (or a combination of the two), employers should carefully consider whether second level appeals should be determined by persons who are independent of the employer’s management, such as an independent board committee or even an outside counsel.  The more independent the second level review is, the more likely an employer will be able to avail itself of the arbitrary and capricious standard before a court.

  3. If an administrator denies a benefit claim, the plan’s administrative procedures should require the administrator to compile and review a record and provide a written determination that references both the operative plan language and the record evidence to support the administrator’s decision.  More should be required than the bare statements and shifting rationales offered to the plaintiffs on which the Plans’ administrators relied to deny benefits.

  4. Finally, none of the above prevents the sponsoring employer, particularly in the case of a hostile change in control, from simply asserting that a terminated employee is not entitled to benefits, as happened to the plaintiffs.  To guard against that eventuality, prior to the closing of a change in control, a sponsoring employer should consider hardwiring the appointment of the administrator and the persons or bodies that are responsible for deciding first and second level appeals for a period after the closing of a change in control.  The Plans generally appointed Twitter’s Compensation Committee, its delegate or the company itself as the administrator rather than specific individuals. Accordingly, Musk, as a successor sponsoring employer, was free to appoint administrators, ultimately three individuals who worked for other of Musk’s companies, who would concur that the plaintiffs were not entitled to severance under the Plans, regardless of whether there were grounds for a “Cause” termination.  That forced the plaintiffs to engage in lengthy administrative appeals and now a litigation to obtain benefits. 

As made evident in this case, it is important to carefully design a severance plan and its governance structure. Mintz’s Employment Practice stands ready to assist employers with their ERISA severance plans. 

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Michelle is an accomplished employee benefits and executive compensation lawyer with more than 25 years of experience advising clients on ERISA, benefits, and executive compensation matters, including in connection with corporate transactions.
David R. Lagasse is a Mintz attorney who handles compensation issues in mergers and acquisitions, venture capital investments, private equity financing, and other transactional contexts. He represents buyers, sellers, and management teams in compensation and equity arrangements.