In an intensely litigated ESOP (employee stock ownership plan) case involving 14 counts of ERISA violations, on April 22, 2019, Judge Staton, District Judge, Central District of California, certified a class of ESOP participants.
The certification came after the court denied the Defendants’ motions to dismiss all 14 counts. The case, as a whole, has many interesting legal issues, however, most interesting is the continued litigation of whether indemnification agreements for breaches of fiduciary duty are void.
As background, ERISA § 410 categorically voids indemnification agreements and states, in part “any provision in an agreement…which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty…shall be void as against public policy.” However, Department of Labor regulations have interpreted this to permit employer indemnification but not plan indemnification. (29 CFR 2509.75-4). The regulations also permit indemnification agreements so long as it does not relieve a fiduciary of responsibility or liability.
In 2009, we heard the first case in the 9th circuit that interpreted ERISA § 410 and its regulations, giving some clarity on the validity of indemnification agreements. In Johnson v. Couturier, 52 F.3d 1067 (9th Cir. July 27, 2009) the ESOP participants alleged defendants breached their fiduciary duties by allowing the company to pay excessive compensation to an officer who was a fiduciary to the plan.
The company in Johnson was 100% ESOP owned and was in the process of liquidation. The indemnity agreement between the officer-fiduciary and plan sponsor (company) provided indemnity unless due to gross negligence or deliberate wrongful acts. Despite the indemnity being paid from corporate assets, which would typically be permitted under DOL regulations, here, because the company was liquidating, the Court held that payment of indemnification by the company would reduce, dollar-for-dollar, the liquidating distribution from the plan – essentially paid by ESOP.
Taking it a step further, the following month, the Northern District of California decided Fernandez v. K-M Industries Holding Co., Inc. 2009 WL 2579643 (N.D. Cal., August 21, 2009). K-M Industries was a family-owned company that had entered into two stock purchase agreements, resulting in a 42% owned ESOP. Unlike Johnson, K-M Industries was not in the process of liquidating.
The founder of K-M Industries was the sole trustee for two alleged stock overpayment transactions. After the Trustee’s health began declining, a trust company was appointed as Trustee. The ESOP participants sued K-M Industries and its shareholders for overpayment on the stock and sued the trust company for failing to investigate the transactions. The newly appointed Trust company tried to rely on various indemnification provisions, however, the Court, relying on Johnson, found that indemnification agreements are invalid any time the ESOP and participants bear the burden of the expense – directly or indirectly.
Fast forward to 2013, Judge Real in the Central District of California decided Harris v. GreatBanc Trust Company, 2013 WL1136558 (C.D. Cal. March 15, 2013), where the Department of Labor sought to void the indemnification agreement for GreatBanc Trust. The DOL advanced several arguments, relying on Johnson, including:
1. 100% ESOP-owned company that indemnified Trustee is the same as ESOP indemnifying trustee in violation of 410(a).
2. Requirement of judgment for breach of fiduciary duty allows the trustee to settle the claim and get indemnity.
3. Johnson decision is controlling.
But Judge Real found the facts of Johnson distinguishable. In rejecting the DOL’s arguments, the court held that because the indemnification provision contained a claw back provision if the fiduciary was found to have breached ERISA fiduciary duties, requiring reimbursement of fees advanced prior to judgment, the agreement was not invalid.
This left fiduciaries in the dark about whether these types of indemnification agreements are enforceable. However, the Hurtado case raises the issue again, potentially giving the Central District, and perhaps even the Ninth Circuit, another chance at shedding light on this issue. In the Hurtado case, the Judge refused to dismiss the claim that the indemnity provisions in the plan document are unlawful.
Here, Judge Staton, relying on Johnson and Pfeifer v. Wawa, Inc., 214 F. Supp. 3sd 366 (E.D. Pa. 2016), explained “[u]nder the majority view, indemnification by an ESOP sponsor functionally equates to an impermissible indemnification by the ESOP itself.” Quoting Pfeifer v. Wawa, Inc. (citing, inter alia, Johnson, 572 F.2d at 1079).
Judge Staton explained that the indemnification provision is the equivalent of asking the ESOP participants to pay for defense costs. Judge Staton further explained that the Johnson holding supports the denial of the motion to dismiss the claim because “indemnification agreements are invalid any time an ESOP would bear the financial burden of indemnification, whether directly or indirectly.”
Hurtado at *16, citing Fernandez, 646 F. Supp. 2d at 1155. Of note was the court somewhat scolding the defendants for relying on Harris v. GreatBanc and “repeatedly point[ing] to it as a decision by this Court in which a similar provision was held enforceable.” Hurtado at Fn. 5. Judge Staton gracefully explained that although she has great respect for other judges in the Central District, a decision by another judge is not a decision by her and “should not be referenced as such.” Id.
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