Article - U.S. Supreme Court Employment Law Decisions: The Good, The Bad, And The Ugly

U.S. Supreme Court Employment Law Decisions:
The Good, The Bad, And The Ugly

by Joseph L. Beachboard* email
Ogletree, Deakins, Nash, Smoak & Stewart, P.C.

In one of its first opinions of the 2003-2004 term, the U.S. Supreme Court addressed an employment-related issue. On November 12, 2003, the high court unanimously upheld a decision to deny social security disability benefits to a worker who had lost her job and was unable to find similar employment.

The case involved Pauline Thomas, an elevator operator whose job was eliminated in August 1995. At that time, she was 53 years old and suffered from heart disease and back ailments. Not surprising given the technological advancements in elevators, Thomas was unable to locate alternative employment as an elevator operator; thus, she applied for disability benefits through the Social Security Administration (SSA).

The SSA and a federal district court concluded that Thomas was not entitled to benefits. The Third Circuit Court of Appeals disagreed, however, finding that the SSA had misinterpreted the applicable statute. The Supreme Court then agreed to hear the case.

The Social Security Act provides that a worker will be entitled to disability benefits only if he suffers from a physical or mental impairment that is of “such severity that he is not only unable to do his previous work but cannot, considering his age, education and work experience, engage in any other kind of substantial gainful work which exists in the national economy.” The SSA has interpreted that provision as creating two separate requirements: (1) the worker’s impairment must render him unable to perform his previous work; and (2) the impairment must preclude him from performing any other kind of gainful work that exists in the national economy.

Thomas argued that she should be awarded benefits because the work she was previously limited to as a result of her disability (elevator operator) no longer exists in significant numbers in the national economy. The SSA, however, does not consider the availability of work in the national economy until it evaluates whether there is other work the individual could perform.

The Supreme Court concluded that the SSA’s interpretation of the Act’s language is reasonable and therefore overturned the Third Circuit’s decision. According to the justices, Congress may have concluded that “an analysis of a claimant’s physical and mental capacity to do his previous work would in the vast majority of cases serve as an effective and efficient administrative proxy for the claimant’s ability to do some work that does exist in the national economy.” Barnhart v. Thomas, No. 02-763, U.S. Supreme Court (November 12, 2003).

The U.S. Supreme Court issued an important ruling in an employment case arising under the Americans with Disabilities Act (ADA). Unfortunately, the high court did not clarify the rehire rights of disabled workers discharged for misconduct as expected. The decision does, however, include language that will be helpful for employers that have established policies that bar reinstating workers in such situations.

Joel Hernandez was a long-term employee of Hughes Missile Company in Arizona. When he arrived at work on July 11, 1991, his appearance and conduct suggested that he might be under the influence of drugs or alcohol. Thus, pursuant to company policy, he was required to participate in a drug test. After testing positive for cocaine, he was allowed to resign rather than be terminated. The company’s employment documents reflected that he had “quit in lieu of discharge.”

Nearly three years later, Hernandez reapplied for a job with Hughes. He acknowledged in the application that he had been previously employed by the company. Attached to his application were two reference letters – one from his pastor (describing him as a “faithful and active member” of the church) and the other from his Alcoholics Anonymous counselor (stating that he regularly attends meetings and is in recovery from his drug and alcohol addictions).

A member of Hughes’ labor relations department reviewed Hernandez’s application and pulled his personnel file. Upon noticing that Hernandez had resigned from his previous term of employment in lieu of discharge, she concluded that he was ineligible for rehire. According to the labor relations representative, the company had an unwritten policy of not rehiring workers who either had been terminated or resigned in lieu of discharge. She also testified that she did not know the underlying facts of the separation or that he had a drug problem when she rejected his application.

Hernandez filed a discrimination charge with the Equal Employment Opportunity Commission (EEOC) alleging that he had been denied employment based on his past drug addiction. In a response drafted by Hughes and forwarded to the EEOC, the company defended its decision stating: “Complainant’s application was rejected based on his demonstrated drug use while previously employed and the complete lack of evidence indicating successful drug rehabilitation. The Company maintains its right to deny reemployment to employees terminated for violation of Company rules and regulations.” The letter did not mention the unwritten company policy barring reemployment of individuals who are terminated or resign in lieu of discharge.

The EEOC concluded that there was “reasonable cause” to believe that Hernandez was denied employment based on his disability. Shortly thereafter, Hernandez sued Hughes under the ADA arguing that he had been discriminated against based on his record of drug addiction or because he was regarded as a drug addict. After the company asked the trial judge to grant summary judgment in the case, Hernandez also contended that the company’s “no rehire” rule violated the ADA because the policy had a “disparate impact” on recovered drug addicts.

The federal trial judge assigned to the case rejected Hernandez’s allegations. The judge found that the evidence indicated that he had not been discriminated against under the ADA. Further, the judge refused to consider the challenge of the “no rehire” policy because he had failed to raise that allegation in a timely fashion. Hernandez appealed this ruling to the Ninth Circuit Court of Appeals.

The Ninth Circuit first agreed that the charge that the “no rehire” policy violates the ADA could not be considered as it was untimely. Turning to the allegation that he had been unlawfully discriminated against, the court applied the familiar “burden shifting” analysis commonly used in these types of cases.

First, the employee must establish a “prima facie” case of discrimination – which the court found existed in this case. This shifted the burden to the employer to establish that a legitimate, nondiscriminatory reason existed for the refusal to rehire him. Hughes argued that the labor relations representative’s application of the “no rehire” policy met this requirement. The Ninth Circuit disagreed, finding that such a blanket policy unlawfully “screens out persons with a record of addiction who have been successfully rehabilitated.”

Raytheon, which acquired Hughes Missile Company while the litigation was pending, asked the high court to review this ruling. The court agreed to do so in February of 2003 and oral argument was conducted in October.

The justices were asked to decide whether the ADA confers preferential rehire rights on disabled employees who are lawfully terminated for violating workplace conduct rules. They never addressed this important question. Rather, the Court focused on the difference between “disparate treatment” and “disparate impact” claims and the Ninth Circuit’s analysis of Raytheon’s explanation for the decision not to rehire Hernandez.

The Court first explained the difference between these two very distinct types of discrimination claims. Disparate treatment claims – the easier of the two to understand – involve allegations that an employer has treated some individuals less favorably because of their race, color, religion, sex, or other protected characteristic. The focus in these cases is whether the protected trait actually motivated the employer’s decision. Disparate impact cases, on the other hand, contend that a company’s facially neutral employment practices impact a protected group more harshly than others and cannot be justified by business necessity. In these cases, an employment practice may be deemed to be illegal without evidence of the employer’s intention to discriminate. The justices stressed that “courts must be careful to distinguish between these theories.”

The Supreme Court agreed that Hernandez raised his disparate impact claim too late in the legal proceedings. Thus, he was limited to litigating under the disparate treatment theory.

The high court did not, however, agree with the Ninth Circuit’s analysis of his disparate treatment claim. According to the unanimous decision, written by Justice Clarence Thomas, the Ninth Circuit improperly applied a disparate impact analysis in concluding that the “no rehire” policy was not a legitimate, nondiscriminatory reason for not rehiring Hernandez. Examining whether the policy tended to screen out recovered addicts may be relevant to a disparate impact claim but not a disparate treatment claim, the justices held.

In fact, Justice Thomas wrote that the policy is a “quintessential legitimate, nondiscriminatory reason for refusing to rehire an employee who was terminated for violating workplace conduct rules.” Further, if the company actually applied the policy in deciding not to rehire Hernandez, it “can, in no way, be said to have been motivated by respondent’s disability.” Thus, the Supreme Court sent the case back to the Ninth Circuit to conduct the analysis properly. Raytheon Company v. Hernandez, No. 02-749, U.S. Supreme Court (December 2, 2003).

The positive news for employers is that the high court clearly stated its belief that no rehire policies are a legitimate explanation for failing to rehire a disabled worker who was previously terminated for engaging in misconduct. However, a worker may still bring a disparate treatment claim arguing that the real reason for the decision was illegal discrimination. In such situations, it will be critical that the no rehire policy is well established and has been consistently applied. If some workers have been rehired who were terminated or allowed to resign in lieu of discharge, it will be very difficult to defend such a policy.

It should also be noted that the Supreme Court did not provide any guidance as to whether a no rehire policy might be challenged under the “disparate impact” theory. Thus, many questions remain – most of which unfortunately will only be resolved through additional litigation.

The U.S. Supreme Court recently issued its ruling in General Dynamics Land Systems, Inc. v. Cline – a decision that has been anxiously awaited by employers. The case was brought under the Age Discrimination in Employment Act (ADEA) by a group of workers between the ages of 40 and 50 who claimed that a benefit plan adopted by the company favored employees 50 years of age or older. The high court rejected this “reverse” discrimination claim, finding that “[t]he ADEA’s text, structure, purpose, history and relationship to other federal statutes show that the statute does not mean to stop an employer from favoring an older employee over a younger one.”

The workers at General Dynamics Land Systems’ facilities in Lima, Ohio and Scranton, Pennsylvania are represented by the United Auto Workers (UAW). The terms and conditions of their employment are governed by a collective bargaining agreement. Prior to 1997, full retiree health benefits were available to all employees who retired with 30 years of seniority with the company. The agreement that was renegotiated in 1997 by General Dynamics and the UAW, however, stated that only employees who were at least 50 years of age on July 1 of that year would be eligible for that benefit.

Shortly thereafter, a class action lawsuit was filed on behalf of approximately 200 workers who were between 40 and 49 years of age on July 1, 1997. The complaint alleged that the new collective bargaining agreement violated the ADEA because these workers lost the right to continued health benefits solely on the basis of their age.

A federal judge in Ohio dismissed the case after finding that the ADEA does not prohibit discrimination against younger workers (even if they are in the protected class). The judge concluded that the purpose of the ADEA is to protect older workers from discrimination, not to prevent them from receiving more favorable treatment than other workers who also happen to be covered by the statute.

In July of 2002, the Sixth Circuit Court of Appeals overturned that ruling and reinstated the workers’ suit on the basis that a “plain reading” of the statute indicated that Congress intended to bar any discrimination based on age against workers over 40 years of age – even if older workers were favored. This was the first federal appellate court to reach that conclusion. Two other circuit courts had previously held that employers may adopt policies that favor older workers over younger employees without violating the ADEA. The U.S. Supreme Court agreed to review the Sixth Circuit’s holding to resolve the divide between the courts.

When Title VII of the Civil Rights Act was passed into law in 1964, Congress specifically chose not to include age as a protected category. Rather, the legislators directed the Secretary of Labor to conduct a study of age discrimination in America’s workplaces. The Secretary of Labor found that a problem requiring legislative attention did exist but that the issues involved were fundamentally different than the type of discrimination addressed by Title VII. The report specifically noted that the cost of employing someone generally rises with age, creating an incentive to employ younger workers.

Recommendations for legislative action were submitted by the Secretary of Labor in 1967, and a bill prohibiting age discrimination soon followed. The matter was debated at length during committees and on the floor of the House and the Senate. Most of the discussions described the problem as stemming from unjustified assumptions about the effect of age on the ability to work.

In 1968, the ADEA was passed into law. The “purpose and findings” portion of the statute specifically stated that the new law was designed to address the impediments faced by “older workers . . . in their efforts to retain . . . and especially to regain employment.” Originally, the ADEA only protected individuals “at least 40 years of age but less than 65 years of age.” The upper age limit was increased to 70 years in 1978, and then eliminated entirely in 1986.

Authority for enforcing the ADEA was first assigned to the Department of Labor. In 1978, however, that responsibility was transferred to the EEOC. Three years later, the EEOC issued controversial regulations stating:

It is unlawful . . . for an employer to discriminate in hiring or in any other way by giving preference because of age between individuals 40 and over. Thus, if two people apply for the same position, and one is 42 and the other 52, the employer may not lawfully turn down either one on the basis of age, but must make such decision on the basis of some other factor.

The EEOC failed to explain its position on this issue; however, legislative history existed supporting this view. One of the original sponsors of the ADEA took the position on the Senate floor that “the law prohibits age being a factor in the decision to hire, as to one age over the other, whichever way the decision went.”

Despite the regulations and this bit of legislative history, virtually every court that has considered this issue concluded that the ADEA does not prohibit favoring older workers over younger employees – until the Sixth Circuit considered this case.

In a 6-3 decision, the high court overturned the Sixth Circuit’s ruling. The key to the finding (and the source of disagreement between the justices in the majority and those who dissented) was the interpretation of one phrase in the ADEA – the provision that bars “discrimination . . . because of an individual’s age.” The workers who brought the suit argued that a plain reading of this provision – especially when combined with the legislative history and the EEOC’s regulations – must lead to the conclusion that favoring older workers violates the law. The Court disagreed.

The majority, in an opinion written by Justice David Souter, acknowledged that the word “age” often refers to the length of a person’s life and that applying this definition would support the workers’ position. However, the Court continued, “age” can also be understood as “common shorthand for the longer span and concurrent aches that make youth look good.” Age discrimination, the majority held, is generally understood to refer to bias against older individuals. The Court further explained, “One commonplace conception of American society in recent decades is its character as a ‘youth culture,’ and in a world where younger is better, talk about discrimination because of age is naturally understood to refer to discrimination against the older.”

The Court also noted the lack of evidence indicating that the ADEA was passed to protect younger workers who were suffering at the expense of their elders. According to the majority, “if Congress had been worrying about protecting the younger against the older, it would not likely have ignored everyone under 40.” The Court dismissed the comments of the bill’s sponsor, finding that this piece of legislative history cannot stand against a “tide” of context, history, and court rulings.

The Court spent surprisingly little time addressing the EEOC’s regulations. In just three paragraphs, the majority found that it need not defer to the federal agency’s interpretation of the statute “because the Commission is clearly wrong.”

Justice Clarence Thomas, joined by Justice Anthony Kennedy, submitted one of the two dissents filed in the case (the other was written by Justice Antonin Scalia). Justice Thomas commented that this “should have been an easy case.” He contended that the combination of the ambiguity in the use of the term “age” in the ADEA, the legislative history supporting a broad interpretation of the term, and the EEOC’s regulations requires that the Sixth Circuit’s conclusion be upheld. He chastised the majority for using “interpretive sleight of hand” to avoid applying the plain language of the ADEA. General Dynamics Land Systems, Inc. v. Cline, No. 02-1080, U.S. Supreme Court (February 24, 2004).

This is one of those cases that is primarily significant for what it did not do. Since only the Sixth Circuit had endorsed these “reverse” age bias claims, most employers had not yet begun to consider the significant ramifications of a broad interpretation of the ADEA’s prohibition of “age” discrimination. Fortunately for employers, the Supreme Court appears to have foreclosed this theory of liability.

A contrary result would have created great havoc for employers, especially with regard to many benefit plans (including early retirement programs). The ruling also would have created challenges for many union employers in terms of seniority and other provisions commonly contained in collective bargaining agreements. The extent of the problems posed by the Sixth Circuit’s ruling is demonstrated by the fact that the U.S. Chamber of Commerce, AARP, and AFL-CIO all submitted briefs supporting the company’s position.

As is always the case these days, employers must be cognizant of their obligations and potential liabilities under state as well as federal law. Several states, including Michigan, New Jersey and Florida, have laws not only prohibiting age discrimination between individuals over the age of 40, but also barring discrimination against younger workers based on their age.

Cases addressing issues such as whether a lawsuit was filed within the applicable statute of limitations are often discussed only in esoteric legal publications. However, a recent ruling from the U.S. Supreme Court on that very topic in a race discrimination case stands to have a direct impact on many companies and must be carefully considered by employers. This decision not only broadens employers’ potential exposure to race cases, but also may require that many companies change their record retention policies.

Several African-American former employees of R.R. Donnelley & Sons Company filed a class action lawsuit alleging that they were discriminated against on the basis of race and were subjected to a racially hostile work environment. Specifically, the complaint alleged that the workers were denied transfers based on their race when the plant they worked at was closed. They also contended that during their employment white employees dressed up in Ku Klux Klan outfits, racial literature was distributed at the plant, and racist graffiti was left on the walls of the workplace for extended periods of time.

The workers brought their lawsuit under a federal law commonly referred to as “Section 1981.” Originally passed in 1866, this statute provides that “all persons shall have the same right in every State and Territory to make and enforce contracts . . . as is enjoyed by white citizens.”

In a controversial ruling issued in 1989, the U.S. Supreme Court held that this law does not protect against conduct occurring after the formation of the contract (such as harassment or unlawful termination). In response, Congress amended Section 1981 in 1991 to define the term “make and enforce contracts” to include “termination” of the contract as well as the “enjoyment of all benefits, privileges, terms and conditions of the contractual relationship.”

There are several reasons why plaintiffs’ counsel might choose to bring a race case under Section 1981 rather than Title VII of the Civil Rights Act or state law. For instance, under Section 1981 there is no administrative exhaustion requirement (in other words, a charge need not be first filed with the EEOC). In addition, plaintiffs often have a longer period of time to bring their suit under Section 1981 than Title VII or most state laws.

This latter issue – the statute of limitations in Section 1981 cases – became the subject of the dispute that reached the high court in this case. Because Section 1981 does not contain a limitations period, courts were directed to apply the most analogous state statute – which caused a variety of problems.

In 1990, Congress passed a “catch-all statute” under which a four-year statute of limitations was adopted for all claims created after that date for which a specific limitations period is not established. The question before the high court was whether the amendments to Section 1981 (discussed above) created new claims that would be governed by the new statute of limitations.

This was a critical determination for the workers who brought this suit. The most analogous statute of limitations under Illinois law is two years – but they did not file their suit within this time period. If the four-year period applies, on the other hand, their lawsuit is timely.

The federal district court judge applied the new statute of limitations and refused to dismiss the workers’ suit as untimely. The Seventh Circuit Court of Appeals overturned this ruling and dismissed the case after applying the two-year statute of limitations contained in the most analogous state statute.

The high court began by noting that it is unclear from the language of the statute whether the wrongful termination and harassment claims brought by the workers “arose under” the amendments made in 1991 such that they would be covered by the four-year statute of limitations adopted in 1990. Therefore, the justices examined Congress’ intent in passing the “catch-all” statute of limitations.

The Supreme Court unanimously found that Congress recognized the problems created by borrowing state statutes of limitations and passed the 1990 law to minimize the need for this practice. This convinced the Court that amendments to existing statutes should also be included under the four-year period to bring suit – if the claim at issue was created after the law was passed in 1990. Since the 1991 amendments to Section 1981 created claims for wrongful termination and racial harassment that previously did not exist, the justices unanimously ruled that the four-year statute of limitations applied and that the workers’ suit was not untimely.

The company argued that this interpretation will create a variety of issues with regard to whether a claim was created after 1990 for purposes of the longer statute of limitations. In response, the Court wrote: “(S)uch hypothetical problems pale in comparison with the difficulties that federal courts faced for decades in trying to answer all the questions raised by borrowing appropriate limitations rules from state statutes.” Jones v. R.R. Donnelley & Sons Co., No. 02-1205, U.S. Supreme Court (May 3, 2004).

While this case addresses “technical timing issues,” there are significant ramifications for employers. First and foremost, the advantages of bringing race claims under Section 1981 will likely result in more cases being filed under this statute. Not only does the plaintiff have up to four years to file the case, they avoid dealing with the EEOC and are not restricted by the $300,000 damages cap under Title VII. Note that failure to hire claims will still be governed by the most analogous state statute as this cause of action existed prior to the passage of the 1990 “catch-all” statute.

Perhaps the most important practical impact for employers arises in the context of record retention policies. In light of this ruling, it is critical that employers ensure they are retaining the documents they will need to defend their employment-related decisions for at least four years. Many companies only retain these documents for three years (or in some cases even less), placing them in a vulnerable spot should they get sued after destroying critical information.

Virtually since the day the U.S. Supreme Court established an affirmative defense for certain harassment claims brought under federal law, employment lawyers (and subsequently the courts) have debated whether a “constructive discharge” constitutes a tangible employment action. On June 14, 2004, the high court resolved this debate in a key ruling.

Specifically, the justices held that an employer may generally assert the affirmative defense even if a worker claims he or she was forced to quit based on the harassment. The Court found, however, that the affirmative defense will not be available if “the [employee] quit in reasonable response to an adverse action officially changing her employment status or situation.”

In 1998, the Supreme Court addressed employers’ liability for the harassing conduct of their supervisors under Title VII of the Civil Rights Act of 1964. In two cases – Burlington Industries Inc. v. Ellerth and Faragher v. City of Boca Raton – the justices held that if a supervisor’s harassing or discriminatory conduct results in a “tangible employment action,” the employer will be held strictly liable for the misconduct.

If, however, a supervisor’s harassment does not amount to a tangible employment action, an affirmative defense may be available to the employer. To avoid liability for the supervisor’s conduct, the employer must establish that:

1) It "exercised reasonable care to prevent and correct promptly any sexually harassing behavior”; and

2) The “plaintiff employee unreasonably failed to take advantage of any preventive or corrective opportunities provided by the employer or to avoid harm otherwise.”

The Supreme Court did not address whether a “constructive discharge” would constitute a tangible employment action in either of these decisions. However, the justices described a tangible employment action as “a significant change in employment status.” Further, the Court stated that tangible employment actions would include “hiring, firing, failing to promote, reassignment with significantly different responsibilities, or a decision causing a significant change in benefits.”

The federal courts of appeals have disagreed whether a constructive discharge constitutes a tangible employment action for purposes of the availability of the affirmative defense to claims of harassment. Two have found that constructive discharge is a tangible job action and two have found that it is not. This led the high court to agree to hear the case of Pennsylvania State Police v. Suders.

Nancy Suders – a wife and mother of three children – decided to apply for a position with the Pennsylvania State Police (PSP). She was encouraged to pursue this opportunity by high level officials in the local Republican Party, in which she was active. Although Suders heard that some of the PSP officers were opposed to her candidacy because they viewed her as a political appointment, she nonetheless accepted a job as a police communications operator on March 23, 1998.

According to Suders, she was harassed virtually from her first day of work. For instance, the station commander allegedly frequently discussed people having sex with animals and his wife’s breasts in her presence. Another supervisor allegedly had a practice of making obscene gestures toward her. Five to ten times per work shift this officer would “cross his hands, grab hold of his private parts and yell, suck it,” according to the complaint. A third supervisor allegedly called Suders a liar and said that “the village idiot could do her job.”

When this conduct continued for several weeks, Suders contacted PSP’s Equal Employment Opportunity (EEO) officer and stated that she may “need some help” (without providing additional details). The EEO officer gave Suders her phone number but did not take any further action.

Over the next few weeks, Suders received several reprimands with regard to her work performance. This prompted her to again contact the EEO officer. This time she specifically mentioned the harassing conduct. According to Suders, the EEO officer was insensitive and unhelpful – simply directing her to complete a standard complaint form.

The final incident allegedly occurred on August 20, when the officers in Suders’ department falsely accused her of stealing the results of tests she had taken to be promoted. Suders was handcuffed, photographed and questioned as a part of the “investigation.” In response, Suders submitted her resignation, at which point she was released from custody. She later sued for a variety of claims, including sexual harassment.

The federal district court judge assigned to the case dismissed her suit in its entirety. With respect to the harassment claims, the judge concluded that judgment should be entered in favor of PSP under the affirmative defense established in Faragher and Ellerth. Specifically, the judge held that she failed to avail herself of the internal procedures available for reporting harassment. Suders appealed this ruling.

The Third Circuit Court of Appeals overturned this finding. The court first found that Suders offered sufficient evidence to establish a pervasive pattern of sexual harassment. The court then turned to the availability of the affirmative defense. Even if the defense may be asserted by PSP, the court held, there are some legitimate questions as to whether an effective remedial program was in place. However, the Third Circuit primarily focused on whether PSP could even raise this defense.

Under Title VII, to establish a constructive discharge a worker must show: (1) she suffered harassment or discrimination so intolerable that a reasonable person in the same position would have felt compelled to resign; and (2) her decision to resign was reasonable given the totality of the circumstances. If these two elements exist, a constructive discharge “operates as the functional equivalent of an actual termination.”

The Third Circuit concluded that a constructive discharge should be considered a tangible employment action such that the affirmative defense would not be available. According to the court, this conclusion “more faithfully adheres to the policy objectives set forth in Ellerth and Faragher and to our own Title VII jurisprudence.” The court specifically found important the fact that “the direct economic harm suffered [as a result of a constructive discharge] is identical to that of a formally discharged employee.” In December of 2003, the U.S. Supreme Court agreed to review this finding.

The Supreme Court began with the points in which it was in agreement with the Third Circuit. The majority opinion, written by Justice Ruth Bader Ginsburg, acknowledged that to establish a hostile environment harassment claim a worker must show that the offending behavior was “sufficiently severe or pervasive to alter the conditions of the victim’s employment and create an abusive working environment.” Establishing a hostile environment constructive discharge claim requires even more – specifically a showing that “the working conditions were so intolerable that a reasonable person would have felt compelled to resign.”

The Court continued by noting that a constructive discharge involves both a decision by the employee to leave his or her job and some precipitating conduct. This precipitating conduct, the justices noted, may or may not involve official action. If an official act does not lead to the constructive discharge, then the Ellerth/Faragher defense should be available to the employer. According to the decision, official acts that might result in the loss of this defense would include “a humiliating demotion, extreme cut in pay, or transfer to a position in which [the employee] would face unbearable working conditions.”

In reaching this conclusion, the Court noted in a footnote that although Ellerth alleged in her underlying complaint that she was constructively discharged, the high court’s ruling in that case did not list constructive discharge among the examples of tangible job actions. Further, the Court specifically held that Ellerth had not alleged that she suffered a tangible employment action – although she claimed that she had been constructively discharged.

The Court was also concerned by the confusion that would be created if the Third Circuit’s standard was allowed to stand. For instance, a jury hearing one of these cases “would be cautioned to consider the affirmative defense only in reaching a decision on the hostile work environment claim, and to ignore or at least downplay that same evidence in deciding the closely associated constructive discharge claim.”

Thus, the Supreme Court ruled that the Third Circuit erred in declaring that the affirmative defense is never available in hostile environment constructive discharge claims. However, the justices did find that there are genuine issues of material fact with regard to Suders’ claims; thus, the case was returned to the Third Circuit for further proceedings.

Justice Clarence Thomas filed a dissenting opinion taking issue with the majority’s analysis of constructive discharge claims. He argues that under the standard established by the Court, a constructive discharge is no longer equivalent to an actual discharge but is more like “an aggravated case of sexual harassment.” He describes this as a “hostile work environment plus” framework.

Justice Thomas contends that an employer should be held liable in such circumstances “if, and only if, the plaintiff proves that the employer was negligent in permitting the supervisor’s conduct to occur.” Because Suders did not meet this standard, he concludes, her case should be dismissed. Pennsylvania State Police v. Suders, No. 03-95, U.S. Supreme Court (June 14, 2004).

The high court’s ruling will have a significant impact on employers. Had the justices upheld the Third Circuit’s ruling, it would have increased employers’ exposure to harassment litigation by encouraging workers who planned to sue to “create” a constructive discharge claim by not aggressively seeking to end the conduct. The bottom line is that for the most part an employer will, to quote the majority opinion, “be afford[ed] . . . the chance to establish, through the Ellerth/Faragher defense, that it should not be held vicariously liable,” even in cases of constructive discharge.

In another important development, the Court endorsed the general principles of constructive discharge. The key question in such cases: Did working conditions become so intolerable that a reasonable person in the employee’s position would have felt compelled to resign? “[U]nless conditions are beyond ‘ordinary’ discrimination,” the high court noted, “a complaining employee is expected to remain on the job while seeking redress.”

The U.S. Supreme Court has issued another Employee Retirement Income Security Act (ERISA) preemption decision. This latest ruling clarifies its prior decision in Pegram v. Herdrich, which held that eligibility and treatment decisions were inextricably mixed and therefore were not within the purview of ERISA’s fiduciary standards to the extent they were made by a health maintenance organization (HMO) through its physicians.

Relying on Pegram, a group of individuals asserted state law claims in Davila for failure to exercise ordinary care under the Texas Health Care Liability Act. They sued their HMOs after certain treatments recommended by their physicians were denied. The Fifth Circuit Court of Appeals held that the HMOs’ decisions were mixed eligibility and treatment decisions, and therefore not traditional fiduciary decisions covered by ERISA.

The Supreme Court held that the tort actions were duplicative of ERISA’s civil enforcement provisions, and thus preempted. The justices reasoned that the plan participants were essentially bringing suit for the denial of benefits under the terms of an ERISA-governed plan independent of which there would be no legal duty owed by the HMOs to these individuals.

To distinguish Pegram, the Court noted several factual differences. The plaintiff in Pegram sued her physician-owned-and-operated HMO, and the treating physician in that case was also the person who administered plaintiff’s benefits; however, in Davila, the facts presented nothing more than a benefit determination under ERISA. For instance, the physicians in Davila were independent of the HMOs, and had in fact recommended the very treatment that the HMOs had denied. The facts lacked the mix of eligibility decision and treatment decision, and indicated that the suit against the HMOs, without regard to how it was couched, was merely a suit for denial of benefits under an ERISA-governed plan, which the Court stated is generally a fiduciary act.

In closing, the Court reflected on Pegram and noted that the decision “only makes sense where the underlying negligence also plausibly constitutes medical maltreatment by a party who can be deemed to be a treating physician or such a physician’s employer.” On the other hand, however, Davila lacked the nexus between the treating physician and the HMO to constitute malpractice, as the HMOs were “neither respondents’ treating physicians nor the employers of respondents’ treating physicians. [C]overage decisions, then, [were] pure eligibility decisions, and Pegram [was] not implicated.”

Because the decisions were pure eligibility decisions, the cases were subject to ERISA’s civil enforcement provisions and could be removed to federal court. Aetna Health Inc. v. Davila, No. 02-1845, U.S. Supreme Court (June 21, 2004).

The method of payment of attorneys’ fees frequently is an issue in the settlement of employment claims. Plaintiffs’ attorneys routinely request that any settlement agreement provide for payment of fees directly to the attorney so that the plaintiff can avoid inclusion of the fee in income so as to avoid both having to take the payment of the fee as an itemized deduction subject to the two percent of adjusted gross income limitation, and, more importantly, to avoid triggering the alternative minimum tax.

The Fifth, Sixth and Eleventh Circuit Courts of Appeals have ruled that if the fees are paid directly to the plaintiffs' attorney, the amount paid is not income to the plaintiff. The Third, Fourth, Seventh, Ninth, Tenth and Federal Circuits have held to the contrary. In March of 2004, the U.S. Supreme Court agreed to hear cases from the Sixth and Ninth Circuits which will resolve these issues.

The Sixth Circuit case is Commissioner v. Banks. John Banks had worked as an educational consultant with the California Department of Education (CDOE) from 1972 to 1986, when he was terminated. Banks then sued CDOE (and various past and present employees of CDOE) in federal court, claiming race discrimination in violation of state and federal law, intentional infliction of emotional distress, and slander. Banks sought general damages, future medical and hospital expenses, punitive and exemplary damages, back pay and related employee benefits, various injunctions, and attorneys’ fees.

Banks’ attorney agreed to represent him under a contingency fee agreement. The case was tried in 1989. After nine days of trial, the case settled for $464,000, which the parties characterized as payments for “personal injury.” Banks actually received the settlement proceeds in 1990, at which time Banks paid $150,000 to his attorney in fees under the contingency fee arrangement. Banks did not include any of the $464,000 settlement proceeds as gross income on his federal income tax return.

On May 30, 1997, the IRS issued a $101,168 Notice of Deficiency to Banks for the tax year ending December 31, 1990. Banks responded by suing in Tax Court, requesting a redetermination of the deficiencies.

The Tax Court ruled that the entire $464,000 received in settlement was taxable income because none of it was attributable to a claim of personal injury. The Tax Court also determined that the $150,000 Banks had paid to his lawyer as attorneys’ fees were not excludable from income.

Banks appealed to the Sixth Circuit. The Sixth Circuit agreed with the IRS that the payments were not for “personal injury” but instead were payments in the nature of income under Section 104(a)(2). However, the Sixth Circuit disagreed with the IRS’ ruling that the contingency fees paid were includable in income.

The Sixth Circuit relied on a prior ruling and held that the amount of the contingency fee was not income because (1) the contingency fee never passed through Banks’ hands nor was it controlled by Banks, and (2) only the attorney’s services resulted in converting the uncertain claim into an item of value.

In Banaitis v. Commissioner, the Ninth Circuit reached the same conclusion based on its analysis of the status of claims by attorneys to fees under Oregon state law.

From 1980 until late 1987, Sigitas Banaitis worked in Oregon as a vice president and loan officer with the Bank of California. Banaitis had access to private information of the companies with which he worked. This private information included, among other things, data regarding these companies’ comparative financial, inventory, and margin strengths, as well as information on their respective profitability.

In 1984, Mitsubishi Bank acquired a controlling interest in the Bank of California. Mitsubishi Group, Ltd., the parent company and then the largest company in the world, controlled and operated firms competing directly with a number of Banaitis’ loan customers. Anticipating the potential conflict engendered by Mitsubishi Bank’s acquisition of the Bank of California – namely, the potential exposure of sensitive financial information – many of Banaitis’ customers contacted him, asking him to keep the financial information with which he was entrusted confidential; indeed, some went so far as to request that their financial information be sequestered under lock and key. Banaitis complied with his customers’ wishes to keep this information confidential, refusing to disclose the data when asked to do so by employees of Mitsubishi Bank and the Bank of California.

Within months of the takeover, Banaitis received an unfavorable performance review, which criticized him for inadequate business performance and accused him of dishonesty and improper employee conduct. Banaitis was placed on probation.

Banaitis then suffered a host of physical problems, such as headaches, insomnia, gastrointestinal disorders, bleeding gums, and various orthopedic problems. On December 30, 1987, Banaitis left following the receipt of a letter from his employer stating that Banaitis had resigned and had only 30 minutes to clean out his desk.

In November of 1989, Banaitis retained a law firm to represent him, and entered into a contingency fee arrangement. He sued Mitsubishi Bank and the Bank of California in Oregon state court. Banaitis sought general and punitive damages. He alleged that Mitsubishi Bank intentionally and willfully interfered with his employment agreement and economic expectations and caused the Bank of California to discharge him. He also alleged that Bank of California wrongfully discharged him and improperly attempted to force him to breach his fiduciary duty to customers by appropriating trade secrets and other confidential information.

The case was tried on February 25, 1991. After a three-week trial, the jury awarded Banaitis nearly $6.3 million in compensatory, “noneconomic,” and punitive damages.

The trial court reversed the punitive damages award but upheld the remainder of the jury verdict. Both sides appealed, with the Court of Appeals ruling entirely in Banaitis’ favor. After the Oregon Supreme Court initially granted review in 1995, the court dismissed the review as improvidently granted. Shortly thereafter, the parties entered into a confidential settlement agreement, under which the defendants issued checks totaling more than $8.7 million ($3.8 million of which went directly to Banaitis’ lawyers).

In his 1995 return, Banaitis reported a total income of $1.4 million, most of which was what Banaitis deemed “taxable interest” in his return. Banaitis excluded from his gross income the full predicate $8.7 million settlement total claiming that it was excludable as amounts received for personal injuries.

The IRS disagreed with the exclusion. That determination resulted in not only a limited deduction for the amounts paid to his lawyers but also triggered the alternative minimum tax. This resulted, in effect, in taxing the portion of Banaitis’ gross income that was paid to his lawyers, even though he was able to deduct the same amount as a miscellaneous itemized deduction and thereby reduce his taxable income by that amount. Banaitis received a deficiency notice contending that Banaitis owed an additional $1.7 million in 1995 income tax.

Banaitis sued in Tax Court and lost in all respects. The Ninth Circuit concluded that the Tax Court erred in holding that the attorneys’ fees paid to Banaitis’ lawyer should be included in Banaitis’ gross income total. The Ninth Circuit reasoned that the question of whether attorneys’ fees paid under a contingent fee arrangement with a plaintiff should be included in the plaintiff’s gross income involves two related questions: (1) how state law defines the attorney’s rights in the action, and (2) how federal tax law operates in light of this state law definition of interests.

The Ninth Circuit concluded that Oregon law operated to provide the plaintiffs’ attorney greater rights than the lawyer would have under a contingent fee arrangement because Oregon law provided attorneys a specific lien on the action, which the parties to the action could not extinguish or affect by any means (such as settlement) other than by satisfying the underlying claim of the attorney for the fees incurred in connection with the action.

The Supreme Court’s decision should resolve a frequently debated issue in settlements. However, should the Court uphold the IRS’ position, the cost of settlement may well significantly increase in cases where plaintiffs have access to sophisticated tax advice.

The “run-of-the-mill” employment discrimination case involves a claim of “disparate treatment,” i.e., that a protected trait actually motivated the employer’s decision. However, from time to time, courts are called upon to consider whether a facially neutral nondiscriminatory policy in fact is discriminatory because the policy adversely affects a traditionally disadvantaged group on a statistically significant basis.

In a disparate impact case, liability may result without any demonstration of discriminatory motive. In Griggs v. Duke Power Co., the U.S. Supreme Court struck down the employer’s requirement that all applicants possess a high school diploma as violating Title VII of the Civil Rights Act. The basis of the Court’s decision was that people of color were excluded from employment opportunities in a much greater percentage than were whites. In so ruling, the Court noted the link between the history of educational discrimination on the basis of race and the use of that discrimination to continue to disadvantage individuals on the basis of their race.

As noted above, the Court was presented in Cline with the issue of whether this disparate impact theory should be applied in actions claiming that a facially neutral policy in fact violates the ADEA where the policy has a greater impact on employees over 40 than it does on employees under 40. However, the Court in fact did not reach that issue but instead decided the case on other grounds.

In March of 2004, the Court agreed to face the issue squarely by agreeing to hear Smith v. City of Jackson. The case involves claims by city police officers and public safety dispatchers over 40 years of age that the city’s implementation of a facially neutral performance pay plan violated the ADEA because the plan resulted in pay increases to officers under 40 that were higher than the raises received by officers over 40.

The trial court granted summary judgment in all respects for the defendants. The Fifth Circuit Court of Appeals reversed regarding certain disparate treatment claims, but, in a 2-1 decision, upheld the dismissal of the disparate impact claims against the city and police department, holding that disparate impact claims are not actionable under the ADEA.

The plaintiffs consisted of 30 police officers and public safety dispatchers employed by the City of Jackson – all over the age of 40 who brought suit under the ADEA challenging a plan implemented on October 1, 1998, and revised on March 1, 1999. Under the plan, those officers and dispatchers with five or fewer years of tenure with the City received proportionately greater raises when compared to their former pay than those with more than five years of tenure.

One of the theories advanced by the plaintiffs was that the implementation of the facially neutral plan by the defendants gives rise to liability without a showing of intentional age motivation because the plan resulted in pay increases to officers under 40 years of age that were four standard deviations higher than the raises received by officers over 40. In support of their disparate impact theory, the plaintiffs produced statistical data demonstrating that the average pay increases made under the plan differed by age and that older officers received smaller raises than their younger counterparts.

The Fifth Circuit noted that in a disparate impact case, liability may result without a demonstration of discriminatory motive, and that disparate impact claims arise from “employment practices that are facially neutral in their treatment of different groups but that in fact fall more harshly on one group than another and cannot be justified by business necessity.”

The Fifth Circuit also noted that the Second, Eighth and Ninth Circuit Courts of Appeals had applied the disparate impact theory to ADEA actions, while the Seventh and Eleventh Circuits had refused to do so. The Fifth Circuit joined the Seventh and Eleventh Circuits, reasoning that while Title VII and the ADEA have similar language, the ADEA statute (and the purpose behind its enactment) differed in important respects from Title VII in both language and purpose such that the disparate impact theory was inapplicable.

In large part, the Fifth Circuit based its decision on the express provision in the ADEA allowing employers to base employment decisions on “reasonable factors other than age,” an exception not found in Title VII.

The Fifth Circuit also based its ruling on legislative history and policy considerations, especially the fact that the ADEA was designed to remove barriers to the employment of older workers, not to remedy societal discrimination generally as was the case with Title VII.

The impact of a potential reversal of the Fifth Circuit will be huge. “Age” and “long service” frequently go hand-in-hand in most workplaces, and employers attempting to deal with issues that have arisen over the years due to favoritism of long-term employees will face a Hobson’s choice if the Court concludes that employment decisions aimed at correcting years of mismanagement can be challenged on a disparate impact theory.

* Joseph L. Beachboard, a nationally recognized expert on employment law issues, is a shareholder in the Los Angeles office of Ogletree, Deakins, Nash, Smoak & Stewart, P.C. In addition to representing management in a wide variety of employment and labor matters, Mr. Beachboard oversees the business development activities of the firm’s 250 attorneys in 21 offices across the country. He speaks regularly before human resource, personnel and employer groups on cutting edge employment law topics and is frequently quoted in such leading publications as the Los Angeles Times, HR Executive, and Workforce.