Legal Trends: Terminating Employees on Disability

With respect to the interplay between medical insurance and long-term disability insurance, a recent and somewhat shocking legal development under the Employee Retirement Income Security Act (ERISA) should prompt employers to take extra care when developing benefits policies and administering benefit plans, say experts.

While employers are not legally required to provide workers with either health insurance benefits or long-term disability insurance, many have done so. For example, 99 percent of respondents to the Society for Human Resource Management’s 2003 Benefits Survey offer employees some form of health insurance; 88 percent provide long-term disability (LTD) coverage.

Long-term disability insurance plans typically pay a portion of salary for disabled workers until their retirement age. While the practice varies considerably, many employers have maintained health insurance benefits indefinitely for employees on LTD. As health insurance premiums have skyrocketed, however, employers have looked for ways to cut costs.

One consequence is that terminating disabled workers—which can end their medical coverage under the employer’s plan—has become an increasingly common practice in recent years. In fact, a study released last year by Mercer Human Resource Consulting found that about half of U.S. firms terminate employees either as soon as they go on long-term disability status or at a set time thereafter.

Workers on disability leave who lose employer-provided health care coverage are eligible to continue that coverage for 18 months under the federal Consolidated Omnibus Budget Reconciliation Act, or COBRA, and they can purchase Medicare coverage after that time, but for many people the out-of-pocket expense is prohibitive. The result is that this so-called safety net has wide holes—and many people are falling through.

And some of them, like employee Denice Lessard, have decided they’re not going to accept that fate.

Fraying Around the Edges

Lessard was an employee of Applied Risk Management (ARM) out on workers’ compensation leave because of a work-related spinal injury, according to court papers. She continued to be eligible for medical benefits. However, under the terms of the sale of ARM’s assets to Professional Risk Management (PRM), which was agreed to in February 1999, Lessard would be eligible for employment with PRM only if she returned to active duty.

Lessard filed suit. At that time, she had not been cleared to return to work and her prognosis for full-time employment was poor. She alleged a variety of federal and state law violations, but her case ultimately hinged on a claim of wrongful termination of benefits under ERISA section 510. That section prohibits adverse action and discrimination against plan participants for exercising their rights under the plan.

A lower court ruled against Lessard, saying she had failed to offer evidence of the companies’ intent to interfere with her rights under the benefit plan. But the 9th U.S. Circuit Court of Appeals in San Francisco reversed the decision in Lessard v. Applied Risk Management (No. 01-15648, Oct. 3, 2002), saying the agreement on the sale of assets amounted to direct and uncontroverted evidence of discrimination. The case was sent back to the lower court for determination of damages, but was subsequently settled.

If the 9th Circuit’s view gains broader acceptance in the courts, it could plunge sponsors of ERISA-covered benefit plans into legal hot water if they terminate employees who are on long-term disability leave.

The October 2002 decision defied the conventional wisdom that employers are legally free to terminate at-will employees on disability leave, as long as they do so evenhandedly. Instead, the court held that such terminations, and the resulting loss of medical benefits, deprive employees of a federally protected right. And while the ruling has the force of law only in the nine West Coast and Mountain states plus Alaska, Hawaii and the Pacific Islands, it raises a red flag for employers across the country, lawyers and consultants say.

The theory of the Lessard ruling already has emerged in a similar lawsuit filed during the summer in Massachusetts and could be the basis for more litigation.

“If I were an employer, I would take heed,” says Lawrence Padway, an attorney in Alameda, Calif., who represented the plaintiff in the Lessard case. “These are very expensive lawsuits.”

New Case, Similar Issues

Lawyers who represent benefit plan sponsors have described the 9th Circuit’s decision in Lessard as “surprising” at best and “flat out wrong” at worst. That precedent might be tested in the new case, Ferrari v. Polaroid (D. Mass., C.A. No. 03-CV-11275-MLW), which was filed July 7.

Polaroid Corp., based in Waltham, Mass., fell into bankruptcy before selling most of its assets to an affiliate of Bank One Corp. Among the disabled employees who were terminated and lost medical benefits were lead plaintiff Sally Ferrari, who suffers from Alzheimer’s disease, according to court papers; a senior human resources administrator, who has a painful form of lupus; and three other workers battling cancer or other debilitating ailments.

Like the Lessard case, the Ferrari case involves workers not being offered employment by the purchasing company. Attorneys for the plaintiffs say they hope that the federal court in Massachusetts will follow the logic of the Lessard ruling. Attorneys familiar with both cases say they involve similar issues.

According to court documents, Polaroid Corp., which was under bankruptcy court protection, sold most of its assets in June 2002 to OEP Imaging Operating Corp., an affiliate of One Equity Partners, which is affiliated with Bank One Corp. Polaroid then changed its name to Primary PDC, and OEP Imaging Operating Corp. changed its name to Polaroid Corp.

The original Polaroid had paid the full cost of medical, dental and life insurance premiums for its employees once they qualified for long-term disability payments. But the new Polaroid sent letters to disabled workers in July 2002 informing them they would not be employees of the new company and that medical, dental and life insurance premiums would not be paid by the firm, according to the suit. Other employees of the original Polaroid were hired by the new Polaroid, the suit alleges.

The suit claims breach of fiduciary duty under ERISA, discrimination under that law and conspiracy to violate the act. Spokesmen for Polaroid and Bank One declined to comment on the suit.

While the 9th Circuit’s ruling is not binding on the Massachusetts court, which is in the 1st Circuit, attorney Laurie Frankl, with Rodgers, Powers & Schwartz in Boston, which filed the Ferrari suit, says, “We’d argue absolutely that the 1st Circuit and the other circuits should apply” the Lessard ruling in similar circumstances.

“The conspiracy count may be pushing the envelope,” concedes Frankl. But the heart of the case is ERISA section 510, on which the Lessard ruling was based. “It’s there to prevent employers from discriminating because these employees are receiving benefits,” says Frankl.

Many attorneys and HR consultants will be watching the Massachusetts case closely.

Carolyn A. Knox, a partner in the San Francisco office of the Seyfarth Shaw law firm who represented ARM in the Lessard case, is among those puzzled by the 9th Circuit decision finding that termination of health benefits is illegal discrimination.

Knox says ARM terminated all its employees on the effective date of the asset sale; it and its welfare benefit plan ceased to exist. “No one was selected out; everyone was treated the same,” she says.

PRM was seeking to hire employees who would be actively employed, and its medical plan required employees to be actively at work to participate, Knox explains. “Common sense dictates that no violation of section 510 occurred here,” she says. The 9th Circuit ignored Supreme Court precedent holding that employers have the right to terminate their welfare benefit plans and ignored the fact that employers can make fundamental business decisions, states Knox.

In holding that the language of the sales agreement was direct, as opposed to circumstantial, evidence of discrimination, the appellate court cut short the analysis and made irrelevant any showing of business justification by the two companies. Had the court considered such evidence, no violation would have been found, Knox contends. “I think [the decision] is flat-out wrong. If [Senior Circuit Judge] Betty Fletcher is going to be looking at every employment decision as a violation of section 510, the 9th Circuit is going to be flooded.”

‘You Have to Deal with It’

Richard L. Strouse, an attorney in the Philadelphia office of Ballard Spahr Andrews & Ingersoll who had no involvement in the Lessard case, agrees with Knox that the decision is incorrect. “But,” he cautions, “if you are an employer in the 9th Circuit, you have to deal with it.”

His impression, however, is that the Supreme Court reverses the 9th Circuit more than any other circuit in ERISA cases.

Notably, Strouse says, the 9th Circuit did not distinguish between the buyer and the seller and made both liable. There is “pretty clear case law” holding that Section 510 does not apply to hiring decisions, he says. The buyer in an asset sale is making hiring decisions. “There is no difference logically and, I don’t think, legally” between that and hiring off the street. “You don’t have to hire people who are not available to work. This provision is very common in these deals.”

Strouse questions the court’s unsupported assumption that if there had been no asset sale involved ARM could not legally have maintained its benefits plan and terminated six employees on leave for illness or injury. “Why not?” Strouse asks.

The most troubling practical effect of the Lessard reasoning in an asset sale situation is that a business entity that has otherwise ceased to exist must maintain a health plan for certain people, he says.

Polaroid will “face problems in Massachusetts,” Knox believes. The federal bench is “not that much different than in California, a slight bit more conservative, but not much.”

The facts as alleged in the Ferrari complaint involve “a very sad story from a human standpoint; it could be any of us,” says Knox. But corporations need to have the flexibility to respond to economic adversity and protect the employment of those available to work, she continues.

That leaves hanging the question of who is responsible for maintaining the health care safety net for persons in these situations. The employer? The government? The individual?

“Stay tuned,” Strouse says. “There will be more cases like this. I think you will see more cases where the courts say, ‘We’re not sure what Lessard means, but we’re going to limit that case.’ ”

Steps to Minimize Risk

It might take a long time for this issue to play out in courts across the country. As a result, attorneys and consultants warn that plan sponsors need to understand—and take the following steps to minimize—the legal risks involved in terminating employees on long-term leave:

Exercise bargaining power. Strouse is encouraging his clients in asset sale situations to get the buyer to take over all the seller’s employees. The buyer, he says, is likely to say, “Okay, indemnify me.” In that case, it comes down to bargaining power.

Review plan documents. Before terminating employees where there is no sale involved, Strouse says, review plan documents and summary plan descriptions. Make sure they grant no vested rights when someone goes on inactive status and that they clearly state that the sponsor can amend or terminate the plan going forward, he advises.

Adopt termination policy. Knox and Strouse agree that employers should adopt an express policy stating that employment and employee benefits will end if an employee remains on inactive status for a stated period of time. But even that might not hold up under Lessard, Strouse cautions. According to the Mercer study, at least 18 percent of employers currently have no such policy.

Coordinate policy with other leave laws. What’s the appropriate length of time to maintain employees on inactive status? A year is good, two years is better, to avoid running afoul of other employment laws, such as the Americans with Disabilities Act, the Family and Medical Leave Act and workers’ compensation laws, the lawyers say.

Be flexible when possible. Give employees terminated under such policies a preference in hiring if they become available to work, Knox suggests.

Emphasize COBRA. Be sure to refer to employees’ COBRA rights in the policy.

Communicate, communicate, communicate. Distribute the policy to all employees, get a signed acknowledgement, hold a workshop—“whatever it takes to ensure that employees can’t claim they didn’t know” the policy existed, Knox advises.

Amend plan documents. After adopting a termination policy for employees on LTD, the plan sponsor should “amend its plan documents, issue a summary of material modifications and incorporate all that information” into the summary plan description, says Knox.

Practical—Or Impractical—Realities​

If you take the steps listed above, you still won’t be guaranteed to avoid a day in court. However, if you do end up before a judge, you should find yourself in a much more defensible position.

“You are still going to get lawsuits—that’s the unfortunate reality,” comments Knox. “But the corporation will have a more complete defense to the allegations.”

Padway, the attorney for Denice Lessard, argues that once a company says it will provide a benefit, it can’t break that pledge, no matter how financially stressed it becomes. “The test is and should be: Have you taken an adverse action against an employee because they’re using their employee benefits?”

Tom Casey, a principal with Buck Consultants in New York, says the companies involved in the two lawsuits would not have terminated employees on disability leave if they had any reasonable alternative. “These are extremely painful decisions” for employers as well as for workers, he says. “It’s the perfect storm. It’s people when they are at their most fragile. It’s the companies facing these issues when they are the most fragile.”

Firms facing the prospect of paying benefits for increasing numbers of disabled workers with increasingly expensive medical bills “are hesitant to put all the burden on people who are healthy and productive,” says Jay R. Schuster, a partner with the Los Angeles consulting firm Schuster-Zingheim and Associates. “Companies need help from the federal government” to repair the safety net.

Margaret M. Clark, J.D., SPHR, is senior legal editor, and Steve Bates is senior writer for HR Magazine.