Severance pay excluded from retirement plan

An employer was justified in subtracting an executive’s $5 million lump-sum severance payment from his wages for purposes of calculating his retirement benefits, a U.S. District Court judge has ruled.

The plaintiff executive argued that the lump-sum payment qualified as earnings as defined in the retirement plan.

But Judge William E. Smith in Rhode Island found that the defendant employer’s decision was not arbitrary and capricious.

“[T]he payment was plainly not intended to compensate [the plaintiff] for labor or services performed on ‘an hourly, daily, or piecework basis,’” Smith wrote. “Instead, it was entirely within reason for [the defendant] to conclude that the lump-sum payment was tendered in consideration for [the plaintiff]’s resignation, release of claims against the company, promised confidentiality, and consulting, rather than for ‘personal services tendered during employment.’”

The 24-page decision is Chapman v. Supple-mental Benefit Retirement Plan of Lin Television Corporation and Subsidiary Companies, et al.

Providence attorney Joseph V. Cavanagh III represented the plaintiff. Thomas C. Angelone, also of Providence, defended the employer.

Qualified plan

Plaintiff Gary Chapman resigned from defendant LIN Television Corp., effective July 10, 2006, after more than 17 years of employment. He held the positions of president, chairman and chief executive officer.

The plaintiff was a vested member of two of LIN’s retirement plans — the Supplemental Benefit Retirement Plan of LIN Television and Subsidiary Companies, and the LIN Television Corporation Retirement Plan, known as the “qualified plan.”

Under the qualified plan, the plaintiff’s monthly benefit, upon him reaching age 65, was to be equal to one-twelfth of 1.5 percent of his “average annual earnings” multiplied by his years of “credited service.”

The qualified plan expressly excluded from the definition of earnings “fringe benefits, including health and welfare contributions, stock option gains, moving expense reimbursements, qualified transportation fringe benefits described in Section 132(f)(4) of the [Internal Revenue] Code, any other reimbursements or expense allowance payments, and payments of any previously deferred compensation.”

Prior to his departure from the defendant, the plaintiff negotiated and executed an employment transition agreement and a general release. The transition agreement provided that the plaintiff would receive a lump-sum payment of $5,378,739 approximately six months after his July 10, 2006, effective retirement date.

In July 2006, the parties butted heads over whether the defendant was required to withhold Rhode Island state income tax from the lump-sum payment. The defendant took the position that it was required to withhold the tax from the payment because the payment was compensation for past services rendered. The plaintiff countered that the payment was made pursuant to the transition agreement and was not payment for past services.

In a letter to the plaintiff dated Sept. 21, 2006, Justin Holden, then-counsel for LIN, stated that the payment was “in settlement of rights [Chapman] accrued over his years of service in Rhode Island and that nothing is properly attributable to future services.”

The defendant adopted that position and remitted the lump-sum payment to Chapman, less a 7 percent withholding of Rhode Island income tax.

‘Practical reality’

The judge found a basis for upholding the defendant’s conclusion that the lump-sum payment did not constitute salary or wages.

“By definition, the lump-sum payment was not paid ‘regularly,’ and thus, it is clear that LIN did not behave arbitrarily or capriciously in deciding that the payment was not a ‘salary,’ within the plain meaning of the word,” Smith said.

“The practical reality, in this writer’s view, is that payments of this sort are a hybrid of compensation for past services (considering both length of service and performance) and consideration for the release of claims,” the judge stated. “The dominant factor is the consideration for the release; the former factor simply defines the payment that will be needed to secure the release. LIN’s decision is clearly in line with this reality.”

The plaintiff argued that the qualified plan expressly excluded certain items — but not severance pay — from the definition of earnings.

The judge, however, found that it was “not an abuse of discretion for the plan administrator to conclude that the list is not exhaustive, but rather that it serves to resolve questions surrounding items about which there is frequent inquiry.”

The plaintiff also strenuously argued that, because the defendant took the position in 2006 that the lump-sum payment was made in exchange for personal services rendered, “it should not be allowed to flip flop now.”

The defendant, meanwhile, maintained that the letter from Holden, the attorney, “was related to whether or not the Severance Payment was subject to taxation in Rhode Island and has no relevance to the Plans.”

Smith found the defendant’s interpretation of the letter’s significance to be a reasonable one.

“Tax treatment of a severance payment decidedly is not binding on the employer,” the judge said. “In the instant case, it is undisputed that the lump-sum payment constituted ‘wages’ for purposes of [Internal Revenue Code] §3121, but again, this is not binding on LIN’s interpretation of the Plans’ language.”