03 Dec Losing by Winning, Case Offers Harsh Reminder Concerning Preventable Expenses

The circumstances behind a recent court decision were typical, and their consequences painfully predictable. Although the plan administrator “won,” that victory does not reflect the huge—and entirely unnecessary—cost to the plan sponsor in terms of overhead and legal fees.

Herring v. Campbell was a fight over who would receive the retirement benefits accrued by John Wayne Hunter, a participant in an ERISA-governed plan. When Mr. Hunter died, he left behind a $300,000 account balance. Although he had properly designated a beneficiary (his wife), she died before he did. And because he had never designated a new beneficiary, it fell to the plan administrator to choose between the two parties who claimed Mr. Hunter’s benefits.

The plan document included a fairly typical list of default beneficiaries. These were, in order of priority, Mr. Hunter’s surviving spouse, his children, his parents, his brothers and sisters, and his estate. Mr. Hunter left no spouse, no natural or adopted children, and no parents. He was, however, survived by two stepsons and six siblings. The plan administrator therefore had to decide which of these two groups was entitled to split Mr. Hunter’s money. If the stepsons were his “children” under the plan, they would be his beneficiaries. If not, then his siblings would receive the benefit.

The plan’s ambiguity as to the definition of this single word (children) caused the administrator and sponsor to be dragged into court. The litigation lasted several years, leading all the way to the United States Court of Appeals for the Fifth Circuit—just one step short of the Supreme Court.

None of this was necessary. Here were the entirely preventable steps in this matter:

• First, the administrator considered and rejected the stepsons’ (weak) claim that they were entitled to the $300,000 under the Texas probate law doctrine of “equitable adoption.” She instead distributed the account, in equal shares, to Mr. Hunter’s siblings.
• The stepsons appealed the decision. The plan administrator reviewed the appeal and again denied their claim.
• The stepsons then moved their claim to federal court, and the trial judge ruled in their favor.
• The plan administrator filed a motion for reconsideration, which the trial-court judge denied.
• The administrator was therefore forced to file her own appeal in the Fifth Circuit, where a three-judge panel reversed the district court’s ruling, bringing the matter full circle.

The fact that the second-highest court in the land vindicated the administrator’s decision is of little comfort to the administrator, who spent years on an entirely pointless legal battle in which she had no real stake. Nor was being right on the law any comfort to the plan sponsor, which had to pay the (presumably massive) legal fees and court costs in both the federal district court and the Fifth Circuit.

In other words, the interesting legal issues in this case (for example, the proper standard for reviewing a plan administrator’s decision when the plan document is silent about something) are beside the point. Rather, the lesson is that the entire conflict could have been avoided by simply stating, in the plan document, that stepchildren either are or are not “children” for purposes of determining a beneficiary when a participant dies without designating one.

Plan sponsors should review their plans’ default beneficiary provisions and see what— entirely preventable—dangers might lurk there.

Lawrence Jenab, Partner Spencer Fane Britt & Browne LLP