In a decision that may encourage other state and local governments to pass similar legislation, the US Court of Appeals for the Ninth Circuit recently ruled that a San Francisco ordinance requiring covered employers to make health insurance contributions for certain employees is not preempted by federal law.  Golden Gate Restaurant Association v. City and County of San Francisco, 2008 WL 4401387 (9th Cir. Sept. 30, 2008).

Golden Gate Restaurant Association (the Association) challenged the employer spending requirements of the newly enacted San Francisco Health Care Security Ordinance (the Ordinance). The Association argued that the federal Employee Retirement Income Security Act of 1974 (ERISA) preempts the employer spending requirements of the Ordinance either because those requirements create a “plan” within the meaning of ERISA or because they “relate to” employers' ERISA plans.

In July 2006, the San Francisco Board of Supervisors unanimously passed the Ordinance, and the mayor signed it into law. The Ordinance has two primary components: the Health Access Plan (HAP), and the employer spending requirements. The HAP is a City-administered health care program for low and moderate income persons. The Ordinance also requires all covered employers to make a certain level of health care expenditures on behalf of their covered employees. The Association did not challenge the HAP; rather, it challenged only the employer spending requirements. On December 26, 2007, the district court entered judgment for the Association, concluding that ERISA preempts the employer spending requirements.  The City appealed.

The Ordinance

The Ordinance mandates that covered employers make “required health care expenditures to or on behalf of” certain employees each quarter. “Covered employers” are employers engaging in business within the City that have an average of at least twenty employees performing work for compensation during a quarter, and nonprofit corporations with an average of at least fifty employees performing work for compensation during a quarter. “Covered employees” are individuals who (1) work in the City, (2) work at least ten hours per week, (3) have worked for the employer for at least ninety days, and (4) are not excluded from coverage by other provisions of the Ordinance.

The Ordinance sets the required health care expenditure for employers based on the Ordinance's “health care expenditure rate.” For-profit employers with between twenty and ninety-nine employees and non-profit employers with fifty or more employees must make health care expenditures at a rate of $1.17 per hour. For-profit employers with one hundred or more employees must make expenditures at a rate of $1.76 per hour. Under the Ordinance, “[t]he required health care expenditure for a covered employer shall be calculated by multiplying the total number of hours paid for each of its covered employees during the quarter ... by the applicable health care expenditure rate.”

Regulations implementing the Ordinance specify that “[a] health care expenditure is any amount paid by a covered employer to its covered employees or to a third party on behalf of its covered employees for the purpose of providing health care services for covered employees or reimbursing the cost of such services for its covered employees.” A “covered employer has discretion as to the type of health care expenditure it chooses to make for its covered employees,” including without limitation payments to health savings accounts, reimbursements to employees for health insurance premiums, payments to third party insurance providers and direct payment of treatment costs.

If an employer does not make required health care expenditures on behalf of employees in some other way, it may meet its spending requirement by making payments directly to the City (the “City-payment option”). If an employer elects the City-payment option, its covered employees who satisfy age and income requirements and are “uninsured San Francisco residents” may enroll in the HAP, and its other covered employees will be eligible for medical reimbursement accounts with the City. Covered employees may enroll in the HAP free of charge or at reduced rates.

The Association’s Argument

The Association argued that ERISA preempts the Ordinance either because it creates a “plan” within the meaning of ERISA or because it “relates to” employers' ERISA plans within the meaning of ERISA. The Ninth Circuit disagreed.  It noted that state and local laws enjoy a presumption against preemption when they “clearly operate[ ] in a field that has been traditionally occupied by the States.” According to the court, “[t]he field in which the Ordinance operates is the provision of health care services to persons with low or moderate incomes. State and local governments have traditionally provided health care services to such persons.”

The Association and the amicus, the Secretary of the US Department of Labor, made two central arguments. First, they argued that the City-payment option under the Ordinance creates an ERISA plan. The Association argued that the Ordinance's administrative obligations on employers, in combination with a reasonable person's ability to ascertain “benefits, beneficiaries, source of financing and procedures for receiving benefits” creates an ERISA plan. The Secretary of Labor argued that the HAP itself is an ERISA plan. They also argued that even if the City-payment option does not establish an ERISA plan, an employer's obligation to make payments at a certain level-whether or not the payments are made to the City-“relates to” the ERISA plans of covered employers and is thus preempted.

The Ordinance Does not Create an ERISA Plan

The Ninth Circuit observed that the employer payments at issue under the Ordinance are not made directly to employees. Rather, they are made to the City. But even if the employers made the payments directly to the employees, those payments would not be enough to create an ERISA plan: “Under the Ordinance, employers make the payments on a regular periodic basis and calculate those payments based on the number of hours worked by the employee. The fact that an employer makes its payments to the City rather than to the employees confirms, if confirmation were needed, that the employer's administrative obligations under the City-payment option do not create an ERISA plan.” That is because the Court reasoned that an employer has no responsibility other than to make the required payments for covered employees, and to retain records to show that it has done so. “The payments are made for a specific purpose, but the employer has no responsibility for ensuring that the payments are actually used for that purpose. Many federal, state and local laws, such as income tax withholding, social security, and minimum wage laws, impose similar administrative obligations on employers; yet none of these obligations constitutes an ERISA plan.”

The Secretary of Labor argued that the HAP itself is an ERISA plan. The court disagreed:  “[t]he HAP, administered by the City, is not an ERISA plan. Rather, the HAP is a government entitlement program available to low- and moderate-income residents of San Francisco, regardless of employment status.” It is funded primarily by taxpayer dollars. Employer payments under the Ordinance provide only a small portion of the HAP's funding.  According to the Ninth Circuit, “[t]he fact that a minority of HAP enrollees pay a discounted enrollment fee because their employers participate in the City-payment option is not enough to make the HAP a ‘plan, fund or program’ within the meaning of ERISA.”

The court reasoned that “[a]n employer electing the City-payment option does not ‘establish[ ] or maintain[ ]’ the HAP through its payments. The HAP exists, and will continue to exist, whether or not any covered employer makes a payment to the City under the Ordinance.” Further, the court noted that the employer has no control over whether its employees are eligible for the HAP. Under the terms of the ordinance, HAP eligibility is based on income level, age, uninsured status, and City residence, but the City is free to change the conditions of eligibility for HAP enrollment as it sees fit simply by amending the Ordinance.

The Ordinance does not “Relate To” an ERISA Plan

The Association's and the Secretary of Labor's second argument was that, even if the City-payment option does not create an ERISA plan, the Ordinance is preempted because it “relates to” employers' ERISA plans. According to the court, “[t]he Ordinance does not require any employer to adopt an ERISA plan or other health plan. Nor does it require any employer to provide specific benefits through an existing ERISA plan or other health plan. Any employer covered by the Ordinance may fully discharge its expenditure obligations by making the required level of employee health care expenditures, whether those expenditures are made in whole or in part to an ERISA plan, or in whole or in part to the City.”

Further, the Ordinance does not “bind[ ] ERISA plan administrators to a particular choice of rules” for determining plan eligibility or entitlement to particular benefits. Finally, the Ordinance does not impose on plan administrators any “administrative [or] financial burden of complying with conflicting directives” relating to benefits law. The Ninth Circuit reasoned that because the City-payment option offers San Francisco employers a realistic alternative to creating or altering ERISA plans, the Ordinance does not “effectively mandate[ ] that employers structure their employee healthcare plans to provide a certain level of benefits.”

Conclusion

Over the past few years, cities and states have passed legislation imposing onerous requirements on employers, from “living wage” to paid sick leave to health insurance contribution laws. While each law must be examined on its own terms, the experience in San Francisco may encourage other state and local governments to pass similar legislation.  Because of the upcoming change in administrations, there may be similar efforts at the federal level.  All of these developments make it increasingly important for employers to remain vigilant about legislative initiatives that could materially impact their business.