Guest Article

(From the April 1, 2002 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Courts of Appeal Address COBRA Issues

The First and Third Circuit Courts of Appeal recently have addressed some fundamental COBRA questions. In Kerkhof v. MCI WorldCom, Inc., No. 01-1236 (1st Cir., March 7, 2002), the First Circuit Court of Appeals confirmed that ERISA does not require courts to assess civil penalties against plans that fail to satisfy certain COBRA notice requirements, although it gives them discretion to do so. And, in Glandorf v. W.G. Products Co., Inc., No. 99-cv-01418 (3rd Cir., March 8, 2002), the Third Circuit Court of Appeals reiterated the principle that individuals generally do not have COBRA rights unless they are participants in a group health plan when a "qualifying event" occurs.

These cases do not break new ground. Nonetheless, they are useful reminders of the circumstances under which COBRA obligations (and rights) apply and the potential penalties for failing to satisfy COBRA's notice requirements.

Courts Have Discretion to Impose Civil Penalties for COBRA Notice Violations

In Kerkhof, a former WorldCom employee asked a court to assess civil penalties against the company for failing to provide a COBRA notice to her in a timely fashion. In general, once an employer tells a group health plan administrator of participants and beneficiaries who have experienced "qualifying events," the administrator has 14 days to notify them of their COBRA rights. If the notice is late, ERISA gives courts discretion to assess a civil penalty of up to $100 per day against the plan administrator.

The First Circuit Court of Appeals upheld the district court's decision not to assess a penalty in this case because "WorldCom's failure was not in bad faith and did not harm Kerkhof." The facts do not indicate why the COBRA notice was late, but it was eventually sent and Kerkhof was given 60 days to elect coverage (she didn't), as ERISA requires.

Kerkhof argued it was wrong for the district court to refuse to impose a civil penalty absent a showing of bad faith and prejudice. Although the court of appeals agreed that a showing of bad faith and prejudice is not necessary for the sanction to apply, it concluded the district court could consider these factors in deciding whether to exercise its discretion to impose the penalty.

Excise Tax Still May Apply

Note that, in addition to the civil penalties available under ERISA, the Internal Revenue Code generally imposes a $100 per day excise tax for failing to comply with COBRA requirements, including the notice requirements. The IRS may assess this tax regardless of whether a court chooses to impose a civil penalty for the same failure. However, the excise tax may not apply if the failure is corrected within 30 days, and the IRS may reduce or waive the excise tax for unintentional violations.

COBRA Applies Only if There is a Group Health Plan

The issue in Glandorf is whether a terminated employee has COBRA continuation coverage rights if his former employer had a group health plan in effect before and after the employee's termination, but not at the time his termination occurred.

After W.G. Products terminated Mr. Glandorf's employment on March 2, 1998, the company notified him of his COBRA rights. Glandorf elected COBRA coverage and paid three months of COBRA premiums. In June, W.G. Products learned that its group health insurance issuer, Blue Cross/Blue Shield, canceled its policy on February 2, 1998-- a month before Glandorf's termination-- for not paying premiums. W.G. Products refunded Glandorf's COBRA premiums, and obtained new coverage through a different carrier on September 1, 1998.

The Third Circuit Court of Appeals ruled Glandorf is not entitled to COBRA coverage because W.G. Products did not have a group health plan in place when he was terminated. The Court's ruling is consistent with the basic rule that only "qualified beneficiaries" have COBRA rights. In order to be a "qualified beneficiary" with respect to a group health plan, the individual must have been covered under the plan on the day before a "qualifying event" (including termination of employment) occurs. Treas. Reg. Sec. 54.4980B-3, Q&A 1(a)(1)(i). Because no group health plan was in effect when Glandorf was terminated, he could not be a "qualified beneficiary."

Did W.G. Products Establish a Self-Insured Plan?

Glandorf argued that W.G. Products maintained a self-insured group health plan between February 2 and September 1, 1998. Apparently, W.G. Products retroactively paid all claims incurred during the coverage gap that Blue Cross/Blue Shield would have paid if the contract had not been terminated. The Third Circuit brushed this argument aside, noting that W.G. Products did not know the Blue Cross/Blue Shield contract had been canceled when Glandorf was terminated. Thus, the court reasoned, W.G. Products could not have established another group health plan at that time.

The court did not say that its analysis of the self-insured plan claim would have been different if Glandorf had been terminated after W.G. Products knew the Blue Cross/Blue Shield contract had been canceled. However, the court's opinion did not foreclose that possibility, either.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about this article, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Copyright 2002, Deloitte.