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How Is a Health Plan Reimbursement Provision Like Living in a Submarine?

The Supreme Court has handed down another important case in its line of decisions on enforcing the reimbursement provisions of self-funded ERISA welfare plans.  The lesson in US Airways, Inc. v. McCutchen is, once again, the importance of an airtight reimbursement provision.

The Perennial Reimbursement Issue

In a typical reimbursement case, a participant is injured in an accident caused by a third party.  The plan pays for the participant’s medical treatment, after which the participant recovers again for the same injuries from the third party.  Pursuant to the plan’s reimbursement provision, the plan administrator seeks to recover from the participant.  The participant refuses, and the administrator sues to enforce that provision.  The court must then decide whether the reimbursement provision is enforceable.

In earlier decisions, the Court has made clear that a plan’s reimbursement provision is enforceable if it properly creates a lien against the participant’s future recovery from the third party. So what is different about this case?  In McCutchen, the Court considered whether a participant could rely on general equitable doctrines meant to prevent “unjust enrichment” to defeat a plan’s otherwise enforceable reimbursement provision.  According to the Court, the answer depends on how the reimbursement provision is drafted.

The facts in McCutchen fit squarely within the typical scenario.  Mr. McCutchen was injured by a third party, and his employer’s welfare plan (the “Plan”) paid $66,866 for his medical expenses.  He then sued the third party and recovered $110,000.  His attorney retained a contingency fee of $44,000, leaving Mr. McCutchen $66,000. 

The Plan’s reimbursement provision clearly stated that the Plan was entitled to recover the full amount of medical expenses paid.  Relying on that provision, the plan administrator sought $66,866 out of Mr. McCutchen’s recovery.  When he refused, the administrator sued.

Citing the Supreme Court’s earlier decisions upholding such reimbursement provisions, the trial court granted the Plan’s motion for summary judgment.  The federal appellate court reversed, holding that even if a plan includes an enforceable reimbursement provision, general equitable principles and doctrines can limit the recovery available under that provision.  Because the federal appeals courts from different judicial circuits disagreed on this question, the Supreme Court agreed to hear the case.

The New Issues Raised in McCutchen

Mr. McCutchen argued that two particular equitable doctrines trumped the Plan’s otherwise enforceable reimbursement provision.  The first of these doctrines is the “double recovery” rule.  If applicable, this rule would limit the Plan’s reimbursement rights to the portion of Mr. McCutchen’s recovery that was earmarked for his medical expenses.  Other parts of the recovery (such as those for pain and suffering or loss of future earnings) would be shielded from the Plan’s reimbursement claim, even if that meant the Plan would not be fully reimbursed for the medical expenses it had paid.  The Plan specifically stated that the double-recovery doctrine would not limit its reimbursement rights.

The second doctrine Mr. McCutchen relied on is the “common fund” rule.  Under this rule, someone who recovers a common fund (i.e., a fund for the benefit of others, as well has himself) is entitled to use a portion of the whole fund to pay his attorneys’ fees.  The common-fund rule is designed to prevent parties who do not contribute to the recovery effort from freeloading on those who do.  The Plan’s reimbursement provision did not specifically address the common-fund rule.

The Two Faces of the Court’s Holding

The Court’s holding is in two parts, both of them refreshingly straightforward.  They are really two sides of the same coin.

The first part of the Court’s holding resolved a long-standing disagreement among the circuit courts:  in an action to enforce a reimbursement provision, the terms of the plan will govern.  In other words, when the plan speaks on an issue, general principles of equity cannot override it.  Thus, when the Plan in McCutchen specifically rejected the double-recovery rule, Mr. McCutchen could not invoke that rule to limit the Plan’s reimbursement rights.

The second, subtler part of the holding is the flip-side of the first:  if a plan is silent on a particular issue, general principles of equity will fill the gap.  The trick is spotting the “silence.”  In McCutchen, the Court saw a gap in the Plan’s reimbursement provision even though that provision unambiguously said that the Plan was entitled to full, first-dollar recovery. 

The gap was the Plan’s failure to specifically reject the common-fund rule.  Although the Plan required full recovery, it did not specifically address the allocation of attorneys’ fees. The Court therefore held that the applicable “background rule”—here, the common-fund doctrine—would determine how attorneys’ fees should be allocated.  It therefore determined that the Plan was responsible for a proportional share of the costs of obtaining the recovery.

It is worth pausing to reflect on the Court’s attitude towards “default” rules of equity, such as the double-recovery and common-fund rules.  They apply unless they are specifically excluded.  In other words, the Court views them as an automatic feature of any reimbursement provision, unless they are expressly rejected. A properly drafted reimbursement provision must therefore do more than create an enforceable lien:  it must anticipate all potentially applicable principles of equity and control them.

This is a bit like proving a negative or trying to keep dry in a submarine.  No matter how clearly a reimbursement provision states that the plan is entitled to full recovery, the terms of the plan must plug any potential leak.  Otherwise, “background legal rules” that are not part of the agreement can seep in and control the outcome.

What Does This Mean for Plan Sponsors?

Although the rules and the Supreme Court decisions governing reimbursement actions are quite complex, the Court’s lessons for plan sponsors tend to be rather simple.  We know from earlier decisions that a plan’s reimbursement provision must be carefully drafted to include the necessary lien. McCutchen teaches us that it must just as carefully exclude any equitable doctrines that might be used to interpret the provision against the plan’s interests. 

Thus, the obvious next step is for plan sponsors to carefully review their reimbursement provisions to ensure that they not only create the necessary lien but leave no gaps through which default rules of equity can seep and control the outcome.

Of course, sponsors must first determine exactly what the plan’s interests are.  That probably will not mean full recovery in every case.  For example, recall that Mr. McCutchen netted only $66,000 from his lawsuit against the third party.  If the Plan had recovered the full $66,866, Mr. McCutchen would have ended up worse off for having prosecuted and won his case, to the tune of $866.

Although full recovery might have been in the Plan’s short-term interest, it would not take many such “victories” for participants to figure out that it simply is not in their interest to sue the third parties.  This would shift the full burden of recovering medical expenses for third-party claims to the plan.  Thus, a well-drafted reimbursement provision not only (i) creates a lien, and (ii) holds general principles of equity at bay, it also (iii) leaves the plan administrator the flexibility to negotiate an outcome in each case that is in the best interests of the plan.

Spencer Fane’s Employee Benefits Group has decades of experience drafting, reviewing, and enforcing reimbursement provisions.  Contact any member of our Group for assistance in exercising your plan’s rights.