Forfeitures Lawsuits—The New Kid on the Block
May 27, 2025
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Reprinted with permission from the March 27, 2025 edition of The Legal Intelligencer © 2025 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
Most 401(k) retirement plan breach of fiduciary duty cases filed by plan participants tend to follow trends. In the past few years, we have seen a plethora of cases premised on alleged breaches of fiduciary duty because of the investment performance of the investment options offered by the plan, the fees associated with the investment options offered by the plan, and the fees charged by recordkeepers. However, now there is a new kid on the block. The new wave of lawsuits is the “forfeiture lawsuit.” This flurry of lawsuits alleges that employers are violating the Employee Retirement Income Security Act of 1974 (ERISA) by breaching their fiduciary duties, receiving an improper inurement, or violating the prohibited transaction restrictions—specifically in how they are using the forfeitures in the plans, specifically when forfeitures are used to offset employer contributions.
As employers, plan administrators, and benefit professionals well know, forfeitures frequently occur in retirement plans. Forfeitures occur most commonly when a plan participant terminates employment and is not fully vested in the employer’s contributions. The second most common instance when forfeitures occur would be when a plan is not operated in compliance with the Code or the plan document, and part of the correction procedure is to forfeit employer contributions that should not have been made. For example:
- The employer’s contributions associated with deferrals that exceeded the annual limit or deferrals from an employee who was allowed to participate in the plan prior to being eligible would be subject to forfeiture.
- Employer contributions, both match and nonelective, would also be forfeited in situations where the employer used an incorrect definition of compensation and provided a match or other contribution in excess of what should have been made had the employer used the correct definition of compensation.
- With the advent of the new plan’s automatic deferral features, forfeitures would occur when a match is made on an automatic deferral, and the plan participant subsequently withdraws the deferral.
When employer contributions are forfeited, they are not returned to the employer but placed in a “forfeiture account” within the plan. Employee deferrals are never forfeitures.
In the past, plan administrators would look to the plan document when determining how to use forfeitures. Plan documents should outline permissible uses of and, in some instances, the sequence of forfeitures. The plan document would, in all likelihood, have a determination letter (or an opinion/advisory letter) indicating that it had been approved by the Internal Revenue Service (IRS) as complying with Section 401 of the Internal Revenue Code. However, do not forget: this approval letter may not mean that the provisions in the plan would not cause the plan sponsor to breach a fiduciary duty. Therefore, relying upon a plan document simply because it has a determination letter, to ensure that a plan administrator is not breaching a fiduciary duty with respect to plan forfeitures, does not guarantee that a breach of fiduciary duty is not occurring.
Typically, attorneys and plan administrators would also look to Department of Labor (DOL) and IRS guidance for confirmation on how to use forfeitures. The DOL has not issued any regulations on the use of forfeitures, and official guidance is sparse. Practitioners glean the DOL’s position from cases that it has filed and settlements that have been reached. Typically, the cases brought by the DOL only focus on the plan fiduciaries’ failure to follow the plan’s provisions with respect to forfeitures. The cases do not allege that the plan may not use forfeitures to offset employer contributions in general.
In 2023, the IRS proposed regulations that clarified that forfeitures may be used to pay plan administrative expenses, reduce employer contributions under the plan, or increase benefits in other participants’ accounts in accordance with the terms of the plan. However, the proposed regulations have not been formally adopted as final regulations, although they can generally be relied upon for matters with the IRS.
In the past, if the plan was administered in accordance with the plan documents and DOL and IRS guidance, practitioners thought plans were generally safe from potential litigation. However, that has changed since the Supreme Court, in Loper Bright Enterprises v. Raimondo, overruled years of precedent and held that courts should not give regulatory agencies deference in their interpretation of the law. With this, practitioners have lost the security blanket previously provided by the regulators.
Within the last year and a half, there has been an overabundance of cases filed with respect to forfeitures, asking the courts to approve this new theory of breach of fiduciary duty, inurement and prohibited transactions. Amazon, HP, JP Morgan, Clorox, and Qualcomm are some of the companies that have had to defend against the “forfeiture lawsuit.”
Looking to the courts for guidance now becomes tricky, as the courts are not consistent with their rulings on forfeiture cases. The salient facts of a typical forfeiture case are the participants were responsible for paying plan expenses, the plan document gave the employer the discretion to apply forfeitures to plan expenses or employer contributions, and the employer applied the forfeitures to future employer contributions. The plan participants then argue that the employer and/or plan administrator breached its fiduciary duty, breached the anti-inurement provisions of ERISA, and engaged in prohibited transactions contrary to ERISA by applying the forfeitures to reduce employer contributions instead of plan expenses.
Because the “forfeiture lawsuit” is a new theory, most cases have not proceeded far past the motion to dismiss stage. The courts, however, do not agree on whether the allegations in a standard “forfeiture lawsuit” should proceed past this stage. Some courts hold that the decision on how to use forfeitures is a settlor function and not a fiduciary one, there is no inurement when the forfeiture amounts never leave the plan, the benefits under the plan are contractual rights and unless it is specifically in the plan, there is no contractual right to have forfeitures offset plan expenses before employer contributions, and there is no prohibited transaction in using forfeitures to provide benefits for employees even when it is in the form of reducing employer contributions.
Conversely, some courts take the opposite position that using discretion to determine how forfeitures are used is a fiduciary act, using forfeitures to offset employer contributions is an inurement to the employer as the cost to the employer is being reduced, and using forfeitures as a substitute for employer contributions is a prohibited transaction. There is a saving case, however, Naylor v. BAE Systems, wherein the plan indicated that the forfeitures “shall” be used to offset employer contributions, and the court held that there was no breach of fiduciary duty as the fiduciary was required to follow the terms of the plan.
In order to provide a shield from the cost of potentially having to defend a forfeiture lawsuit, employers and practitioners should review current plan documents to determine if the ability to use forfeitures is discretionary and, if so, consider amending the plan to specifically outline the use of forfeitures. Other options would be not to charge fees to the participants or to apply forfeitures to fees first.
