Two Wrongs Make a Right in Eighth Circuit's Denial of COBRA Penalties

For large companies with frequent employee turnover, the stakes for proper COBRA administration are high. As in-house benefit professionals are no doubt aware, the penalties for failing to provide a timely COBRA notice can be steep, running up to $110 per day of noncompliance. However, where a COBRA notice error is accompanied by a failure to drop the employee from coverage, two wrongs might actually make a right. This was the Eighth Circuit’s holding in Deckard v. Interstate Bakeries Corp., No. 11-1595 (8th Cir. Jan. 25, 2013).     


Hostess Brands (then known as Interstate Bakeries) (the “Company”) terminated the plaintiff on September 11, 2006. According to the plaintiff, the Company never provided a COBRA notice and, therefore, he never elected continuation coverage. Coincidentally, due to a processing oversight, Hostess did not immediately cancel the plaintiff’s coverage under the Company’s health plan. In fact, the plaintiff enjoyed free coverage under the plan for nearly two years. 

Two years after the plaintiff’s termination, the Company finally discovered the oversight and cancelled the plaintiff’s coverage retroactively to the date of his employment termination. Meanwhile, the plan’s third-party claims administrator initiated proceedings to “claw back” the amount of benefits paid for the plaintiff. Eight months later, the plaintiff filed an administrative claim in the Company’s ongoing bankruptcy proceeding, arguing that the Company failed to provide a COBRA notice at the time of his termination (The Company was also unable to prove that it provided a COBRA notice at the commencement of the plaintiff’s participation in the plan, although it routinely provided such notices upon the commencement of coverage). The plaintiff sought civil COBRA penalties under ERISA Section 502(c) of $110 per day for failure to provide a timely notice, as well as reimbursement for certain medical expenses. The Company investigated his claim and decided to reinstate the plaintiff’s coverage retroactively from the date of his employment termination to February 1, 2009 (the date when he became eligible for Medicare). In the meantime, however, the plaintiff experienced a six-month gap in coverage from August 2008 (when his coverage was terminated) to February 2009 (when it was retroactively reinstated). 

The bankruptcy court rejected the plaintiff’s claim, finding that he had suffered no prejudice (which is a factor in the determination of whether to award Section 502(c) penalties). The court ruled that the plaintiff’s free post-termination medical coverage outweighed any potential prejudice from not receiving a COBRA notice. Sitting in an appellate capacity, the U.S. District Court for the Western District of Missouri affirmed the bankruptcy court’s decision. The plaintiff then appealed to the Eighth Circuit. 

Free Coverage Negates Prejudice

In a 2-1 decision, the Eighth Circuit affirmed, finding that the circumstances for a penalty were not present. The Eighth Circuit considered whether it was appropriate for the bankruptcy court to have weighed the benefit of free medical care against the prejudice from failing to receive a COBRA notice. The plaintiff argued that it was improper for the court to have applied this type of “hindsight” analysis. Two of the three judges sitting on the Eighth Circuit panel disagreed, holding that the “free, ongoing coverage under the Plan despite the lack of a COBRA notice is plainly relevant to the degree of prejudice he suffered.” 

The plaintiff also argued that he was prejudiced due to the gap in coverage between the cancellation of his coverage and the reinstatement of his benefits eight months later. He claimed that this lapse in coverage forced him to pay retail prices for prescription drugs, switch to generics, and postpone medical treatment. The Eighth Circuit majority considered these facts, but held that they did not add up to a “physical impact” worthy of COBRA civil penalties. The majority also found no error in the lower court’s conclusion that the Company acted in good faith. The plaintiff argued that the Company’s termination of coverage in 2008 and “claw back” attempts were evidence of bad faith. The majority disagreed, and noted that these events occurred before the Company was aware that it had failed to provide a COBRA notice.  

The dissent sided with the plaintiff, finding that his six-month gap in coverage—which allegedly caused the plaintiff to forego and postpone medical treatment— was, standing alone, sufficient to warrant the imposition of penalties. The dissent also stated that the bankruptcy court erred by disregarding the Company’s “bad faith” conduct pre-litigation (e.g., failure to notify the plaintiff of the retroactive cancellation of coverage, attempts to cancel coverage required by a collective bargaining agreement) and “placing too much weight on the post-litigation damage control.” 

Lessons Learned

Cases like this highlight the importance of ensuring that benefit terminations are administered correctly and that COBRA notices are provided upon initial enrollment and again following all qualifying events. Additionally, periodic coverage audits can help weed out any employees who are no longer employed and should be terminated from the plan’s coverage (assuming COBRA notices have been sent). This will not only help defend against COBRA civil penalties, but also help prevent problems with insurers. If a plan inadvertently covers a participant beyond his or her termination date, the insurer of a fully-insured medical plan or the stop-loss insurer of a self-funded plan may refuse to pay claims incurred when the individual was not eligible for coverage.  

Lastly, the court’s close call on the issue of bad faith also sheds light on how closely courts will analyze a plan sponsor’s conduct when cancelling benefit coverage. In fact, had the dissent carried the day, the Company may have faced stiff civil penalties based largely on findings of bad faith.

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.