ATLANTA -- Georgia-Pacific Corp. might have to pay millions of dollars to former employees who took lump-sum payments from the company's cash balance pension plan in the early and mid-1990s.
In the first big victory for cash balance plan participants, the 11th U.S. Circuit Court of Appeals in Atlanta has ruled that cash balance plans essentially are defined benefit plans, and must follow the rules laid down for defined benefit plans.
The appellate court's ruling could prompt scrutiny of lump-sum payouts participants receive from cash balance plans. It also could spur lawsuits against other hybrid pension plans if employers have failed to follow government regulations for defined benefit plans.
"Nothing in this decision provides any comfort to those who argue that cash balance pension plans are special beasts that ought to be analyzed differently than defined benefit plans," said Marc I. Machiz, a partner in the law firm of Cohen, Milstein, Hausfeld & Toll in Washington.
In its ruling in Jerry L. Lyons vs. Georgia-Pacific Corp. Salaried Employees Retirement Plan, the appeals court overturned a lower court's decision. That ruling had described as unreasonable Treasury regulations concerning lump-sum calculations. The Treasury regulations, which interpret federal pension law, said sponsors of defined benefit plans cannot make lump-sum payments to employees that are less than the present value of the benefits they would receive at retirement age.
The Treasury Department, in guidance given in 1996, made it clear to employers with cash balance plans that they must calculate lump-sum payouts by converting participants' hypothetical account balances into annuities at retirement age, and then pay out the present value of those annuities.
In order to do that calculation, employers must project participants' hypothetical account balances to normal retirement age, usually 65, by using the interest rate set by the employer, and then discounting back that amount using a stipulated government interest rate to arrive at the present value of the benefits.
The Treasury Department's guidance, however, does not require cash balance plans to perform these tortuous calculations if they simply use interest rates tied to the short-term Treasury rate, the benchmark 30-year Treasury bond, or the Consumer Price Index.
But sponsors of some cash balance plans set up in the late 1980s and early 1990s failed to calculate lump-sum payments in the manner prescribed. Instead, as Georgia-Pacific did, they simply gave departing employees their account balances as a payout.
That would have worked fine, if the company simply had credited to participants' accounts the interest rate the Pension Benefit Guaranty Corp. uses to value annuities. That is the same rate G-P was required to use to discount the annuity back to its present value. Had it done this, the present value of the annuity would have been equal to the hypothetical account balance.
Instead, the company credited employee accounts with a rate that was 0.75% higher than the prevailing PBGC rate of about 4.5%. As a result, Georgia-Pacific would have given participants more than their account balances if it performed the calculation laid down under the Treasury regulation.
Georgia-Pacific converted its traditional pension plan into a cash balance plan in 1989.
Mr. Lyons retired in January 1991. Two years later, he opted to take his retirement benefits as a single payout, and received $36,109.15. Two months later, he learned from the National Center for Retirement Benefits that he should have received $49,341.83.
Call for recalculation
The NCRB, on behalf of Mr. Lyons, asked Georgia-Pacific to recalculate his benefit. But company officials told the NCRB that because the plan was a cash balance plan, it did not have to follow the rules set down for traditional defined benefit plans.
Mr. Lyons sued the company in a class-action lawsuit in April 1997.
In the lawsuit, the company also argued Section 203(e) of federal pension law, the basis for the Treasury Department rules, applied only to involuntary lump-sum distributions of $3,500 or less.
In its Aug. 11 ruling, the appeals court stated that cash balance plans cannot escape the rules set down by the Treasury Department for defined benefit pension plans. And Section 417(e)-1 of the Internal Revenue Code unequivocally states that "the present value of any optional form of benefit cannot be less than the present value of the normal retirement benefit . . ."
Georgia-Pacific also argued in the lower court that until the IRS' 1996 notice, there was no guidance from the Treasury Department suggesting that the regulations would apply to cash balance plans. But the appellate court dismissed that claim, noting the plan's own documents required the company to convert hypothetical account balances into annuities, and then calculate the present value of those annuities to figure lump-sum payouts.
Moreover, the court noted that a Treasury decision, issued in September 1991 -- well before Mr. Lyons was given his payout -- stated that cash balance pension plans must comply with the Treasury Department regulations, even if the resulting lump-sum amount would be greater than the value of the hypothetical account balance.
Because the government clarified its position in 1996, and most new cash balance plans set up since then follow the prescribed regulations, those most at risk are those like Georgia Pacific's that were set up in the late 1980s and early 1990s.
"What is impossible to say is how many plans are exposed. Is it five, is it 10, who knows?" said Robert Rachal, partner in the New Orleans law firm of McCalla, Thompson, Pyburn, Hymowitz & Schapiro.
Ken Haldin, a spokesman for Georgia-Pacific, said: "We are disappointed with this decision, and we are currently evaluating our options. Of course, all along we have believed our plan has been and continues to be administered in compliance with applicable regulations."
More to come
Eva Cantarella, partner at the law firm of Hertz, Schram & Saretsky in Bloomfield Hills, Mich., who represents Mr. Lyons, believes there are several thousand more former Georgia-Pacific employees who could walk away with more money than they received when they left the company.
"We think potential damages are $20 million," she said.
Moreover, the appeals court's decision could directly affect a pending decision by the 2nd U.S. Circuit Court of Appeals in New York in the case of Lynn Esden vs. Bank of Boston, said Douglas E. Sprong, partner in the Belleville, Ill., law firm of Carr, Korein, Tillery, Kunin, Montroy, Cates & Glass. Mr. Sprong is representing the plaintiff in this case.
"I've read the (Georgia-Pacific) decision with glee," Mr. Sprong said.
In the Esden case, participants received interest on their hypothetical accounts at interest rates ranging between 5.5% and 10%, but the company calculated lump sums using only a 4% interest rate (and discounted back the annuities at a 6% interest rate.) It is that lower interest rate that is at the heart of the dispute.
By using a lower interest rate to convert the hypothetical account balances into annuities, the company produced lower annuity values. Using a higher figure to then discount the annuities back to a present value further reduced the lump sum paid to departing employees.
The company's brief before the appeals court in New York refers several times to the lower court's ruling in the Georgia-Pacific case, where the Treasury regulations had been held invalid.
The defendants "cited Lyons more often than they cited our own district court brief," said Mr. Sprong, who is expecting a decision in that case any day.
