Corporate officers and directors can avoid personal liability under ERISA by recognizing that their actions may be those of a fiduciary rather than a corporate agent.
Corporate officers and directors often knowingly act as ERISA fiduciaries for their companies’ employee benefit plans, for example, as members of plan administrative and investment committees. Officers and directors named as fiduciaries are usually aware that they can be personally liable for breaches of their fiduciary duties.1 With this knowledge, corporate officials can govern their conduct in accordance with ERISA’s fiduciary requirements and, when necessary, seek the legal and investment advice needed to understand and fulfill their duties.
However, since ERISA also provides a functional definition of fiduciary (that is, the functions that one performs can determine who is a fiduciary), many officers and directors do not realize that they are fiduciaries.2 Such lack of awareness exposes those corporate officials to a significant risk of personal liability under ERISA.
The good news is that the law has traditionally distinguished between fiduciary functions for which an officer or director may be held personally liable and “corporate” functions for which no personal liability attaches under ERISA. Thus, not every act by an officer or director affecting a benefit plan is a fiduciary act. As one court has stated:
[f]iduciary status ... is not an all or nothing concept ... [A] court must ask whether a person is a fiduciary with respect to the particular activity in question.3
The bad news is that the courts have not drawn a clear line as to where corporate functions end and fiduciary functions begin.
BLURRING OF CORPORATE VS. FIDUCIARY CONDUCT
The line between “corporate” conduct and “fiduciary” conduct has become increasingly blurry, as the defendants discovered in LoPresti v. Terwilliger, 126 F.3d 34 (CA-2, 1997). Donald and John Terwilliger owned 100% of the stock of a unionized print shop. Donald oversaw the financial aspects of the business while John focused on production. The corporation was a party to a collective bargaining agreement with a local union and regularly withheld money from employees’ paychecks for contributions to the union’s pension fund. The withheld monies were deposited into the corporation’s general account and periodically paid over to the pension fund.
The corporation ran into financial problems. Donald, acting on the advice of the company’s vice- president of finance, paid creditors in the order of “who screamed the loudest” or was “most threatening.” The pension fund trustee—who was also the union president—apparently was not one of the most threatening creditors, because the contributions withheld from the employees were not paid to the pension fund.
The pension trustee ultimately brought claims against both Terwilliger brothers for breach of fiduciary duty under ERISA. The Terwilligers argued that they were “...simply exercising business judgment in deciding which Company creditors to pay and in what order,” and therefore were acting not as ERISA fiduciaries, but as corporate officers. The DOL and the pension trustee disagreed, contending that when the Terwilligers failed to timely segregate the employees’ contributions from the corporation’s assets, they became fiduciaries under ERISA, and were therefore personally liable for the loss of those funds sustained by the pension plan.4 (This is the same position taken by the DOL when sponsors of single employer plans fail to make deposits of employee deferrals to 401(k) plans.)
The district court held that neither Donald nor John Terwilliger was a fiduciary under ERISA. This decision was based primarily on the grounds that they did not administer the pension funds. The court also found that, while John did sign a few checks, he was not responsible for determining which of the company’s creditors would be paid, or in what order.
The Second Circuit reversed the district court’s decision as to Donald, holding that the lower court mistakenly emphasized the fact that the Terwilligers did not administer the pension funds:
[C]ommingling...plan assets with the Company’s general assets, and his use of those assets to pay Company creditors, rather than forwarding the assets to the [pension fund] means that he ‘exercised ... authority or control respecting ... disposition of [plan] assets,’ and hence is a fiduciary for purposes of imposing personal liability under ERISA [citing Yeseta v. Baima, 837 F.2d 380 (CA-9, 1988).
Plan advisors should be aware of the DOL regulations regarding timing of required segregation of “plan assets.” Employers that sponsor ERISA retirement plans must segregate amounts that a participant pays to the employer, or that have been withheld by the employer, for contribution to the plan as of the earliest date on which those contributions can reasonably be segregated from the employer’s general assets, but in no event later than (1) the 15th business day of the month following the month in which the participant contributions are received by the employer, or (2) the 15th business day of the month following the month in which the participant contributions would have been payable to the participant in cash.5 Once the earliest of those dates occur, the contributions are considered “plan assets,” and once the funds become plan assets, any person who exercises any control over the assets is a plan fiduciary,6 and can be personally liable for losses that occur from the failure to segregate the funds. Moreover, any use of the funds for corporate or business purposes once they are plan assets is a prohibited transaction under ERISA.7 Fiduciaries, as well as employers, officers, directors, and 10% shareholders, can be held personally liable for prohibited transactions.8
Nevertheless, in LoPresti, John escaped liability. The Second Circuit held that even though he was a signatory on the company’s account, signed some checks, and had some general knowledge that deductions were made from employees’ wages, his primary focus was on production, and he had no ongoing responsibility for determining the order of payment of the company’s creditors. Therefore, the court held, he was not personally liable for paying the missed contributions, because he was not an ERISA fiduciary.
UNEARNED COMPENSATION, GIFTS
One of the cases cited by the Second Circuit in LoPresti was Connors v. Paybra Mining Co., 807 F.Supp. 1242 (DC W.Va., 1992), which involved facts similar to those in LoPresti. In Connors, the shareholders of closely held corporations that participated in a union pension plan were also the officers and directors of those corporations. They favored general creditors over the pension fund in determining which bills to pay and when. Like the Second Circuit in LoPresti, the court in Connors found personal ERISA fiduciary liability on the part of the individual officers and directors who made the spending decisions that were adverse to the plan.
While the court in Connors focused most of its discussion on the conclusion that a breach occurred as soon as pension fund contributions came due (thus becoming plan assets)9 but went unpaid, the most significant aspect of the case is in a footnote. Specifically, the court noted that the corporation’s spending decisions “...were apparently not limited to the corporations’ expenses ... the individual Defendants’ wives and children received compensation from certain corporate Defendants without ever performing any services.”10 The court further observed that the corporate defendants purchased a Porsche sports car for the daughter of one of the officer/director defendants.
In the authors’ experience, evidence that corporate officers or directors lavished gifts on themselves and their families while not forwarding funds to a retirement plan may be the last grain of sand to tip the scales against an officer defendant. Although ERISA seemingly required the result reached by the court in Connors, there is no question that the unearned compensation and corporate gifts to the officers’ family members bothered the court and very likely influenced the outcome. As discussed below, there is authority (not cited in Connors) for a contrary conclusion. Absent self-serving behavior on the part of the officers/directors, a different court might have found that the defendants were acting in a strictly corporate—rather than fiduciary—capacity.
HEALTH AND WELFARE PLAN—WHY A DIFFERENT RESULT?
Lawyers are often asked why they do not simply answer “yes” or “no” to their clients’ questions. Comparing the decisions in LoPresti and Connors with that in Local Union 2134 v. Powhatan, 828 F.2d 710 (CA-11, 1987), one can see why. All three cases involved a collectively bargained plan. The only real difference was that in Powhatan, it was a health and welfare benefit plan, while in LoPresti and Connors it was a retirement plan. (The distinction should be irrelevant for purposes of this discussion.) In all other respects, the cases were similar.
In Powhatan, the mining company defendant (Powhatan) experienced financial difficulties following a national mine workers’ strike. In the two years following the strike, some of the health insurance premiums—which the bargaining agreement required the signatory companies to pay— were not paid when due. Medical expenses of employees and their dependents went unpaid. The plaintiffs alleged that Osborne, Powhatan’s president, was a fiduciary of Powhatan’s health plan, and was personally liable for the failure to pay the insurance premiums, and the resulting unpaid benefits incurred by the participants. The district court agreed, and held Osborne personally liable. The court’s rationale was that Osborne’s decision to pay Powhatan’s business expenses, as opposed to its employees’ insurance premiums, was a breach of his fiduciary duties. The Eleventh Circuit reversed, first commenting, as many courts have, that:
ERISA contemplates such a situation where an officer of a corporation wears two hats—when acting in the capacity of an employee of the corporation, the officer owes a duty to act on behalf of the corporation ... [O]n the other hand, when the officer is acting in the capacity as a fiduciary of the health plan, the officer owes a duty to act in the best interest of the plan’s beneficiaries.11
In defining the conduct that fell within the officer’s fiduciary duties, the court downplayed the funding or premium payment obligation: “As fiduciary of the health plan, Osborne certainly had an obligation to attempt to maintain sufficient funds with which to properly administer the plan for the employee-beneficiaries.”12 The court further held that:
Osborne’s decision to pay the business expenses of Powhatan, in an attempt to keep the corporation from financial collapse, was a business decision Osborne made in his capacity as president of the corporation. It is not unusual in a closely held corporation for the president and majority stockholder to control the corporation’s operations.13
Consequently, the court concluded that in deciding not to pay the health insurance premiums required by the collective bargaining agreement, Osborne was not acting in his capacity as a plan fiduciary.
It is nearly impossible to reconcile the decision in Powhatan with those in LoPresti and Connors. While the court in Powhatan mentioned, in passing and without reference to any authority, that the unpaid health insurance premiums were not plan assets, the court did not base its decision on that point. Rather, the decision rested squarely on the court’s conclusion that in favoring other creditors over the plan in an attempt to salvage the corporation’s business, Osborne was not acting in a fiduciary capacity.
Although Powhatan remains good law (in that it has not been overturned), LoPresti and Connors—which arose in different circuits and were decided later—reached the opposite conclusion on the same issue. Notwithstanding the conflict, no corporate officer or director should ever feel safe in failing to segregate assets earmarked for employee benefit plans. While corporations may be sued by general business creditors, their officers and directors usually will not be personally liable to those creditors for corporate obligations. Conversely, ERISA imposes personal liability on breaching fiduciaries. Officers and directors can avoid that personal liability only if they recognize that their actions may be acts of a fiduciary rather than of a corporate agent. The trend in the cases— and the position of the DOL, as seen in the cases discussed above—is that the control of “plan assets” that at first appears to be corporate activity, is in fact fiduciary behavior under ERISA.
THE TROUBLE WITH ESOPs
Nowhere is the overlap between corporate conduct and fiduciary duties greater than in the context of ESOPs, which are required to invest primarily in stock of the employer-sponsor.14 Consequently, in ESOPs sponsored by closely held businesses, almost all significant corporate acts have some impact on the value of the stock, and therefore on the value of the ESOP plan assets. If the courts treated all corporate decisions that might result in adverse consequences to the ESOP’s value as fiduciary conduct—and fiduciary breaches—the corporate officers and directors would face almost limitless personal liability for their corporate decisions. Presumably to guard against this “black hole” of potential liability, Congress exempted ESOPs from several of ERISA’s fiduciary requirements, including the requirements to diversify the investments of the plan15 and to avoid self-dealing, i.e., “dealing with the assets of the plan in his own interest or for his own account.”16
In Martin v. Feilen, 965 F.2d 660 (CA-8, 1992), the Eighth Circuit carved a path circumventing the exceptions to ERISA’s fiduciary requirement for ESOPs. Martin involved the Feilen Meat Company (“FMC”), a meat-packing company that formed an ESOP in the mid-1970s. In 1977, the company’s founder sold his controlling interest to his son and others in connection with a leveraged buyout. Between the time of sale and 1985, when FMC failed, the corporate officers engaged in a series of complex transactions with the company, its stockholders (and related entities), and the ESOP. The DOL, which filed the lawsuit, alleged that these transactions resulted in FMC’s demise and that, when FMC closed its doors, its employees lost not only their jobs, but also the entire value of their retirement accounts in the ESOP. The district court held that all of the individual defendants—including the ESOP trustees and the company’s accountants—were ERISA fiduciaries who had breached their duties of undivided loyalty17 with respect to the transactions at issue, but declined to award damages because it found that the DOL had failed to prove that the breaches caused monetary loss to the ESOP.
The appeals court took a more circuitous approach to its conclusion, first noting that in the context of an ESOP:
ERISA’s fiduciary duties under [ERISA section 404] attach only to transactions that involve investing the ESOP’s assets or administering the plan. Accord, Canale v. Yegan, 782 F.Supp. 963, 967 (D.N.J., 1992). A broader rule would make ESOP fiduciaries virtual guarantors of the financial success of the plan (which is indeed the result the Secretary seeks in this case).18
Nevertheless, the court went on to hold that certain purchases of FMC stock by the ESOP were overvalued, relative to nearly contemporaneous purchases of FMC stock by certain company executives and accountants. According to the court, the fiduciaries could be held personally liable because these transactions involved direct alleged manipulation of the purchases of ESOP assets.
However, other aspects of the court’s ruling are more troubling. Some of the transactions that the DOL questioned did not involve direct investment of plan assets, or plan administration. For instance, FMC had an option to purchase shares from one of its shareholders for $30,000. The principal shareholders, who were also ESOP trustees, personally exercised the option and purchased shares that were worth nearly $1 million. The court found that FMC’s gratuitous transfer of the option (which, in effect, had a value of approximately $970,000) to the controlling shareholders was a corporate transaction that did not involve investing the ESOP’s assets, and therefore did not directly implicate ERISA fiduciary liability.
The DOL argued, however, that the ESOP’s fiduciaries had a duty to challenge the alleged misappropriation of the corporate opportunity—the stock option—and that the fiduciaries’ decision not to challenge the transaction was a matter of plan administration, and therefore subject to ERISA’s fiduciary rules. In other words, the transaction itself—which benefitted the corporate officers who were also the ESOP trustees—did not fall within ERISA’s purview, but the failure by the ESOP trustees to challenge the transaction did, and was a breach of their fiduciary duties. In effect, the court held that what the DOL could not legitimately attack directly, it could attack indirectly.
Martin should raise concerns for any corporate officer or director who is also an ESOP fiduciary. In most closely held businesses, corporate officers—who are generally also the corporation’s majority shareholders—will have a personal stake in most of the corporation’s financial decisions. The vast majority of these decisions are not directly related to administration of the subject plan and therefore should not give rise to fiduciary liability. But Martin may have the practical effect of narrowing the ESOP exceptions to ERISA’s fiduciary requirements by providing an ERISA claim against corporate officers who fail to assert a derivative claim on behalf of an ESOP.
Because of the particularly egregious facts of Martin (in which the corporate insiders usurped an extremely valuable option right belonging to the corporation), the Eighth Circuit’s decision may have been appropriate. The problem for officers and directors of companies sponsoring ESOPs, however, is that the line between corporate actions and ESOP administration has been permanently blurred. Any corporate act that benefits officers, directors, or other shareholders—even payment of officer compensation—or that invokes the use or diversion of corporate assets is now arguably subject to scrutiny by ESOP fiduciaries. And when the ESOP fiduciaries are also the corporate officials engaged in the business activity, they may breach their ERISA fiduciary duties by failing to investigate the activity and, possibly, failing to sue to set aside certain transactions. While it is highly unlikely that day-to-day business actions are within the scope of this decision, significant corporate transactions involving corporate officials may be subject to attack, and Martin gives no guidance on where courts should draw the line.
Corporate officers and directors should be aware of the functional definition of an ERISA fiduciary and should scrutinize their conduct in light of that definition. Unfortunately, rather than clarifying the situation, the courts have muddied the waters with inconsistent—and sometimes irreconcilable—decisions. In this uncertain environment, fiduciary liability insurance is a must, even for those officers and directors who previously believed they had no responsibility for their companies’ employee benefit plans.
1 ERISA defines “named fiduciaries” as fiduciaries who are named in the plan instrument, or who, pursuant to a procedure specified in the plan, are identified as fiduciaries by a person who is an employer or employee organization, or by an employer and employee organization acting jointly with respect to the plan. (ERISA section 402(a)(1).)
2 A person—including a director, officer, or employee of the plan sponsor—is a fiduciary to the extent that he (1) exercises any discretionary authority or control over the management of the plan or any authority or control over management or disposition of its assets; (2) renders investment advice for a fee or other compensation; or (3) has discretionary authority or control in the administration of the plan. ERISA section 3(21)(A).
3 Maniace v. Commerce Bank, 40 F.3d 264 (CA-8, 1995).
4 The Terwilligers did not dispute that the amounts withheld from the employees for contribution to the pension fund were plan assets governed by ERISA. The relevant regulations provide in part that “... the assets of the plan include amounts ... that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution to a plan as of the earliest date on which such contributions can reasonably be segregated from the employer’s general assets.” DOL Reg. 2510.3-102(a).
5 DOL Reg. 2510-3.102(b)(1). For SIMPLE plans that involve SIMPLE IRAs, the amounts paid to or withheld by an employer for contribution to the plan must be segregated no later than the 30th calendar day following the month in which the participant contribution amounts otherwise would have been payable in cash to the participant. DOL Reg. 2510-3.102(b)(2). During the time in which the events in LoPresti occurred, the applicable regulation provided a 90-day period from the date on which the amounts were received by the employer as the outer limit within which to segregate the assets (i.e., the 90-day portion of the regulation was replaced by the 15th day of the month following the month in which the amounts were received by the employer). See former DOL Reg. 2510-3.102(a), effective August 15, 1988.
6 ERISA section 3(21)(A).
7 ERISA section 406(b) provides that a fiduciary with respect to a plan may not (1) deal with the plan’s assets in his own interest or for his own account; (2) act in any transaction involving the plan or on behalf of a party whose interests are adverse to those of the plan or its participants or beneficiaries; or (3) receive any consideration for his own personal account from any party dealing with the plan in connection with a transaction involving the assets of the plan. Any fiduciary who engages in any of these “prohibited transactions” is personally liable for any losses to the plan sustained as a result of his conduct. ERISA section 409(a).
9 The bargaining agreement in Connors stated that “[t]itle to all the monies paid into and/or due and owing to the Trusts specified in this Article shall be vested in and remain exclusively in the Trustees of those Trusts.” While DOL Reg. 2510.3-102(a) currently provides that funds become plan assets as soon as the funds can reasonably be segregated, the court in Connors held that, under the terms of the agreement and the plan documents, the unpaid assets actually became plans assets once they were “due and owing.” See Galgay v. Gangloff, 677 F.Supp. 295 (DC Pa., 1987) at 302.
10 Connors v. Paybra Mining Co., 807 F. Supp. 1242 (DC W.Va., 1992) at 1245, fn. 6.
11 Local Union 2134 v. Powhatan 828 F.2d 710 (CA-11, 1987) at 713, citing Amato v. Western Union International, Inc. 773 F.2d 1402, 1416-17 (CA-2, 1985), cert den.
12 Id. at 713 (emphasis added).
13 Id. at 714.
14 See generally ERISA section 407(d)(6)(A).
15 ERISA sections 404(a)(1)(C) and (2).
16 ERISA section 406(b)(1).
17 See generally ERISA section 404(a)(1), which provides, in part that: a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and—
(A) for the exclusive purpose of:
(i) providing benefits to participants and their beneficiaries; and
(ii) defraying reasonable expenses of administering the plan;
(B) with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims....
18 Martin v. Feilen, 965 F.2d 660 (CA-8, 1992) at 666.
19 The court noted that “[t]o recover under this theory, the Secretary must prove both a breach of the ESOP fiduciaries’ duties, and that the derivative suit against the corporate insiders would have prevailed.” Id. at 667.