Are Forfeiture Lawsuits the Next Trend for ERISA Litigation in 2024?

Oakland, CAOn December 13, Clorox Co. asked the Northern District of California to dismiss a class action ERISA breach of fiduciary duty lawsuit that targets the company’s longstanding practice of using forfeited employer contributions to participants’ accounts to reduce its required contributions to the plan. Plan participants argue that forfeited amounts should instead be used to defray the plan’s administrative expenses.

The difference is important. In the first situation, the company benefits. In the second, the participants benefit through increased retirement savings. Over time, the difference can be substantial.

The court is scheduled to hear the case on January 23. If the Northern District dismisses McManus v. Clorox, that may spell the end of the line for four similar lawsuits that target HP Inc., Intuit Inc., Qualcomm Inc. and Thermo Fisher Scientific Inc. On the other hand, if the court declines to do so, ERISA forfeiture lawsuits may emerge as a new way for plan participants to protect their retirement money from runaway administrative costs and fiduciary negligence.

Administrative fees reduce individual retirement savings

Participants in the Clorox Company 401(k) Plan allege that fiduciaries breached their legal obligations under ERISA by:

• failing to preserve plan assets for the benefit of participants and beneficiaries;
• violating ERISA’s anti-inurement provision; and
• engaging in self-dealing and transactions prohibited by the law.

The lawsuit focuses, as many recent breach of fiduciary duty lawsuits have, on the way that administrative expenses are paid. The plan incurs expenses for legal, accounting and recordkeeping services. These expenses are paid from an annual fee charged to each participant and deducted from their individual accounts. The deduction of this fee reduces the amount of money available to each participant on retirement.

Forfeited contributions

The Clorox 401k plan is an individual account plan into which participants may make contributions in lieu of taking that money as salary. Participants are always entitled (or vested) in their own contributions, plus investment earnings and less an allocated share of administrative costs. In addition, according to the plan documents, Clorox makes matching contributions of 100 percent of the value of employee contributions up to a maximum of 4 percent of covered compensation. Participants also vest immediately in this 4 percent matching contribution.

Participants also receive an additional employer contribution of up to 6 percent of covered compensation. The 6 percent contribution vests according to a variety of schedules over a period of five years.  An employee who leaves the company before that five-year period elapses will be entitled to only a portion of the 6 percent contribution. The dispute is about what happens to the portion of that 6-percent contribution that a departing employee forfeits.

It has been a sizeable amount of money. From 2017 to 2022, the company’s 6 percent contribution to the plan was allegedly reduced by a total of $5.7 million as a result of Clorox’s reallocation of forfeited funds. It follows then that participant accounts were reduced by the $5.7 million that participants paid for administrative fees.

Clashing legal rules

ERISA Section 404 requires plan fiduciaries to act prudently and for the exclusive benefit of participants and beneficiaries and to pay reasonable expenses of the plan. For decades IRS rules have permitted employers to use forfeitures to reduce employer contributions. That guidance was more explicitly re-stated in proposed IRS regulations that permit defined contribution plans to re-purpose forfeitures to:

• pay plan administrative expenses;
• reduce employer contributions under the plan; or
• increase benefits in other participants’ accounts according to plan terms.

That guidance became effective for plan years beginning on or after January 1, 2024.

The prognosis

Much depends on the outcome of the January 23 proceeding in the Northern District of California. If the proposed regulations are adopted in their current form, participants will likely find it more difficult to challenge the use of forfeitures to reduce required contributions in the future. Courts may choose not to apply this guidance retroactively, however.

This still would not address what some see as an irreconcilable conflict between the flexibility afforded employers by the proposed regulations and ERISA Section 404’s mandate that retirement plan fiduciaries act to protect plan assets for the benefit of participants and beneficiaries.

The central problem is that only plan fiduciaries have the ability to monitor and control plan expenses. If those expenses are paid from participant accounts rather than employer funds, however, they have no financial incentive to do so. Were the IRS to modify its guidance to prevent forfeitures from being used to pay plan expenses, the incentive to act would be re-aligned with the power to act to control the costs and reflect the original intent of the law, which was to protect the security of employee retirement income.