This ERISA dispute arose from an employer's denial of severance benefits to a former employee who was terminated after experiencing a stroke and other serious medical problems that left her unable to work (Soto v. Disney Severance Pay Plan, (2d Cir. Feb. 16, 2022)). A three-judge panel of the Second Circuit (with one judge vigorously dissenting) held that the former employee did not show that the plan administrator's decision to deny severance benefits was arbitrary and capricious. The court concluded that the plan correctly interpreted the term "layoff" as excluding terminations based on disability, and that this interpretation was consistent with regulations under Section 409A (which were incorporated in the plan's definition of layoff).

After experiencing a severe stroke and other medical issues, the former employee in this case was placed on a leave of absence during which she received sick pay, short-term illness, and long-term disability (LTD) benefits. The employer terminated the employee a year later, citing her inability to return to work due to disabling illness. The employee was later denied benefits under the employer's ERISA-governed severance plan on the grounds that the termination was not a layoff as defined under the plan. After the plan upheld its decision on administrative appeal, the employee sued the employer, plan, and plan administrator in federal district court under ERISA (see Practice Note, ERISA Litigation: Causes of Action and Remedies Under ERISA Section 502 for Benefit and Fiduciary Breach Claims). The employee argued that the plan incorrectly concluded that the severance plan's definition of "layoff" excluded terminations due to disability and, as a result, she was owed more than $44,000 in severance under the plan. The district court dismissed the employee's claims and the employee appealed.

Applying a deferential (arbitrary and capricious) standard of review, the Second Circuit affirmed the district court on appeal (see Practice Note, ERISA Litigation: Standard of Review). The severance plan at issue defined the term layoff as an involuntary termination of employment, except for poor performance or misconduct, as determined by the plan administrator in its discretion. The plan also provided that an involuntary termination would not be considered a layoff if it did not qualify as a separation from service under Code Section 409A and Treasury Regulation Section 1.409A-1(h)—both of which were expressly incorporated in the plan's definition of layoff (26 U.S.C. § 409A; 26 C.F.R. § 1.409A-1(h); see Practice Note, Applying Section 409A to Severance Benefits: Separation from Service).

According to the majority, the meaning of involuntary termination of employment under the plan's definition of layoff was ambiguous because it could refer to either:

(Given that the term layoff was ambiguous, the plan administrator was authorized—under the plan's Firestone language—to use its discretion in determining whether the term applied to the employee's circumstances (see Standard Clause, Plan Language, Firestone Plan Interpretation).)

The Second Circuit concluded that the narrower interpretation should govern, relying on a plan provision that required plan administrators to interpret the plan consistent with Section 409A. Specifically, the court cited a Section 409A regulation that generally defines involuntary separations from service as terminations resulting from an employer's unilateral authority to terminate an employee's services where the employee was willing and able to continue performing services (26 C.F.R. § 1.409A-1(n)(1)). This reading, the majority concluded, supported the interpretation that terminations based on disability were excluded from the meaning of layoff under the plan. The Second Circuit also discussed other plan provisions tending to support its conclusion that the term layoff was ambiguous.

From here, the Second Circuit concluded (based in part on pleadings from the employee's own complaint) that the plan administrator's interpretation of layoff was reasonable. For example, after emphasizing a plan provision requiring compliance with Section 409A, the court stated that the Section 409A regulations define involuntary terminations of employment to exclude terminations based on disability. This adherence to Section 409A, the court observed, was intended to ensure that severance benefits under the plan would not be taxable deferred compensation under Section 409A.

Having determined that the plan administrator had reasonable bases for its interpretation of the term layoff (and its resulting decision to deny severance benefits), the Second Circuit held that the employee's claims challenging the plan's denial were not viable.

In a dissenting opinion, one judge stated that the plan's definition of layoff was unambiguous and included terminations due to disability. The judge would have ruled that the plan's decision was therefore arbitrary and capricious.

Although the plan's interpretation of its own definition and resulting severance benefit denial were ultimately upheld, this outcome came at the price of litigation reaching up to the Second Circuit (and back). Moreover, the dissenting opinion in this case underscores that federal judges can—and often do—disagree in reviewing plan benefit determinations. As a result, plan documents should be clear regarding the interaction of severance and disability benefits, including the effect of offset provisions.

For more information on these issues, see: