"Highly compensated" doesn't mean that everyone is paid well. Don't quote me on this because I'm not expert on benefit plan testing but basically, the employer has to list all employees in order of salary, from high to low, and then draw a line after the top 10% of the most highly compensated. Then there is a formula that must be applied that the top 10% of HCE's can't contribute more than X% of the average (or maybe it's total) deferral of the rest. Like I said, I'm a little fuzzy on this.
So if the eight salaries are as follows:
$200,000
$199,999
$199,998
$199,997
$199,996
$199,995
$199,994
$199,993
only the person earning $200,000 is considered to be an HCE for discrimination testing. It's quite possible that the HCE's could have money refunded if the non-HCE's don't contribute enough.
If you want a more detailed explanation, you might ask your former employer if you can speak directly to the plan advisor who can, I'm sure, explain this better than I can. Since all this is a pain-in-the-fanny for the employer and there is no benefit whatsoever to the employer to refund 401(k) contributions to participants, you can readily assume your employer's only motivation here is to comply with federal regulations.
P.S. Since this was a very small company and nothing is known at this end about how the Plan was designed and what type of 401(k) it was (there are quite a few variations), it's possible there are some particular discrimination requirements that apply that can't be addressed here.
