Deferred Compensation Planning, the Exclusive Benefit Rule, and the Hughes Aircraft Case: Has the Employer Benefit Restriction Been Altered With Respect to Erisa Qualified Pension Plans?

JurisdictionUnited States,Federal
CitationVol. 33
Publication year1998


Creighton Law Review

Vol. 33



The process of planning a deferred compensation program for employees has seemingly become increasingly more difficult as federal government agencies and the judiciary unnecessarily complicate that which should be facilitated. However, with the decision in Hughes Aircraft Co. v. Jacobson,(fn1) it appears that the United States Supreme Court has rendered a very readable, understandable opinion, and in the process done away with precedent that was lacking in its factual basis.(fn2) Although the Court did not likely intend that Hughes Aircraft achieve the importance it has achieved since the date of decision, it is clear that pension planners have a bright line rule with regard to the "employer benefit" rule, and facts that make for the so-called "good case law."

The issue for which Hughes Aircraft will be remembered is whether a surplusage that builds up in a plan due to good investment decisions - and accrued interest on employee contributions of employees who departed the company prior to the pension vesting date - and which in aggregate form exceeds that amount of monies needed to fund all promised benefits, may be used by the plan sponsor to add a benefit that will most assuredly dissipate the aforementioned surplus.(fn3) In Hughes Aircraft, an opinion arising out of the Ninth Circuit,(fn4) approximately ten thousand former employees argued that the actions of the firm in developing an early retirement program, among the creation of other benefits, amounted to a violation of the anti-inurement rule, such that the company was receiving a benefit to which it was not entitled.(fn5) Not too surprisingly, the employees further argued that this was prohibited by ERISA because the early retirement program improperly diverted funds, intended for pensioners, to the pockets of the firm.(fn6)

The Ninth Circuit agreed with the rationale of the respondents and ordered that Hughes Aircraft cease these prohibited transactions.(fn7) After granting certiorari, the United States Supreme Court reversed the Ninth Circuit decision(fn8) in sterling language that left little doubt as to whether a plan sponsor, typically a firm's board of directors, is a fiduciary;(fn9) whether the plan sponsor can make adjustments to plan benefits during the life of the plan without violating ERISA;(fn10) and perhaps most importantly, whether employees have any rights in a plan's surplusage, as previously mentioned and defined, such that the "employee benefit" rule is violated.(fn11) This article is concerned with these issues.


Defendant, Hughes Aircraft Company, has operated since 1951 as an aerospace and electronics manufacturing firm. Since that time, Hughes Aircraft provided a retirement pension plan ("Contributory Plan") for all employees, and it is that pension plan which was at issue in this particular litigation.(fn12) Specifically, five former employees of Hughes Aircraft claimed that surplus assets from the Contributory Plan were part of a defined benefit plan and, therefore, the plan participants have an ongoing interest in that plan's surplus. Consequently, these former employees argued that they have a right to receive a pro rata share of any existing surplus.(fn13)

The company's Contributory Plan was one requiring both the employer and employee to make pension contributions. These contributions were automatically deducted from an employee's pay and treated on a pretax basis.(fn14) In 1986, the Contributory Plan assets had benefited from both employee contributions and good investment growth such that the accrued value of benefits exceeded the actuarial or present value by approximately one billion dollars. This amount was well in excess of that needed to make good on all payment promises to employees included in the Contributory Plan's provisions.(fn15)

In 1987, Hughes Aircraft was acquired in a merger and acquisition by General Motors Corporation and, at that time, Hughes Aircraft ceased making contributions to the Contributory Plan due to the asset surplus previously mentioned.(fn16) Although the company had ceased contributing, the employees were required to continue contributing to the Contributory Plan in order to maintain their plan participant status. There was nothing overtly illegal or unusual as to this action by Hughes Aircraft.(fn17) By 1992 about half of the surplus in the Contributory Plan could be directly traced to the contributions made by employees, while the remaining fifty percent was the result of employer contributions.(fn18)

This law suit concentrated on the manner in which Hughes Aircraft handled the surplus in the pension plan between 1989 and 1992, when its total assets, including surplusage, clearly exceeded that which would be needed for retirement purposes of the total workforce. In 1989, the company properly amended the Contributory Plan in such a way that a portion of the surplus could be used to provide an early retirement program for current employees.(fn19) The plaintiffs contended that by doing so, the company enabled itself to downsize its workforce and decrease payroll costs in such a fashion that the former employees' interest in the surplus was totally ignored.(fn20) The company countered that in a contributory defined benefit plan, participants do not have an interest in any asset surplusage that accrues as a result of investment growth or excess contributions, which may result from workers leaving the firm before their pension vesting date.(fn21)

The plaintiffs also contended that the company terminated the Contributory Plan in January 1991 when it created a new defined benefit plan which was noncontributory. Hughes Aircraft also was alleged to have frozen new enrollment in the Contributory Plan such that the only option which new employees had was enrollment in the noncontributory plan. There was no grandfather provision in the newer pension plan, and by way of comparison, the two plans were dramatically different. The noncontributory plan did not require employees to contribute and new employees were automatically enrolled. It did not provide health coverage, early retirement benefit provisions, or cost of living adjustments. In summary, the new plan provided for a lower monthly retirement benefit payment than the Contributory Plan, and this was primarily due to the fact that different formulas were used in order to compute which benefits should be paid.(fn22)

In contrast, the Contributory Plan was elective by the employees and they had to continue contributing on a monthly basis in order to remain participants in good standing with the program. The Contributory Plan also provided health coverage, the previously mentioned early retirement benefit package, and cost of living adjustments.(fn23) It is important to note that both plans were essentially administered by the same trustees.(fn24)

The plaintiffs further contended that Hughes Aircraft continued to use the plan surplus from the Contributory Plan to fund the newer, noncontributory plan. They alleged that in doing so the company used assets in which the former employees had rights and, therefore, the company was in violation of the private inurement provisions of ER-ISA with regard to its administration of the Contributory Plan.(fn25) Under the private inurement provision, ERISA requires that no plan assets inure to the benefit of the employer. The employees raised an important question as to exactly what the extent of their rights in the plan's surplus funds were - both while they were employees of the company and following the termination of their employment.(fn26) This argument was not necessarily premised on the manner in which the surplusage was accumulated or the federal statutory options open to a firm, such as Hughes Aircraft, when plan assets vastly exceed required actuarial monies necessary to fulfill company promises made within the context of the plan.

Plaintiffs filed a class action lawsuit in the United States District Court for the District of Arizona, claiming that the class of plaintiffs covered over ten thousand individuals who were participants in the Contributory Plan as of December 31, 1991. Hughes Aircraft filed a motion for change of venue, which was granted. Subsequently, the lawsuit was transferred to the United States District Court for the Central District of California, where Hughes Aircraft filed a motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The district court granted the dismissal and denied the plaintiffs' request to amend the complaint, and this was done with no discovery taken at the district court level.(fn27)


Prior to the Supreme Court's 1999 decision in Hughes Aircraft Co. v. Jacobson,(fn28) the most important case on this deferred compensation issue was that of Lockheed Corp. v. Spink.(fn29) In Spink, a combination of issues were presented regarding whether the retirement plan complied with ERISA and whether the actual implementation violated the Age Discrimination and Employment Act(fn30) ("ADEA").(fn31) In a nutshell, the Supreme Court...

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