Tenth Circuit: Arbitration Provision in ESOP Was Unenforceable | Practical Law

Tenth Circuit: Arbitration Provision in ESOP Was Unenforceable | Practical Law

In litigation arising from an employee stock ownership plan's (ESOP's) purchase of employer shares from the employer's board members, the Court of Appeals for the Tenth Circuit held that the ESOP's arbitration provision requiring individual arbitration prevented a plan participant from effectively vindicating plan-wide remedies available under the Employee Retirement Income Security Act of 1974 (ERISA), and therefore was unenforceable.

Tenth Circuit: Arbitration Provision in ESOP Was Unenforceable

Practical Law Legal Update w-038-4883 (Approx. 6 pages)

Tenth Circuit: Arbitration Provision in ESOP Was Unenforceable

by Practical Law Employee Benefits & Executive Compensation
Published on 14 Feb 2023 • USA (National/Federal)
In litigation arising from an employee stock ownership plan's (ESOP's) purchase of employer shares from the employer's board members, the Court of Appeals for the Tenth Circuit held that the ESOP's arbitration provision requiring individual arbitration prevented a plan participant from effectively vindicating plan-wide remedies available under the Employee Retirement Income Security Act of 1974 (ERISA), and therefore was unenforceable.
In litigation arising from an employee stock ownership plan's (ESOP's) purchase of employer shares from the employer's board members, the Court of Appeals for the Tenth Circuit held that the ESOP's arbitration provision requiring individual arbitration prevented a plan participant from effectively vindicating plan-wide remedies available under ERISA, and therefore was unenforceable (Harrison v. Envision Mgmt. Holding, Inc. Bd. of Directors, (10th Cir. Feb. 9, 2023)).
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Background

The plaintiff in this case was a participant in an ESOP sponsored by his employer. The employer was owned by a shell corporation. According to the participant, the shell corporation's founders:
  • Served as members of the employer's board of directors and the ESOP committee.
  • Selected the ESOP trustee.
In the transaction giving rise to this litigation, the ESOP purchased 100% of the employer stock held by the board members. In order to finance the transaction, the ESOP borrowed money from the board members and the employer. Additionally, the transaction required the ESOP to pay two different prices for the same employer stock, even though there was only one class of common stock with the same par value. Despite selling 100% of their stock, the board members retained control of the employer and trustee.
The ESOP documents contained an arbitration provision which required claims to be brought "solely in the Claimant's individual capacity and not in a representative capacity or on a class, collective, or group basis." In addition, claimants could not "seek or receive any remedy which has the purpose or effect of providing additional benefits or monetary or other relief to any Eligible employee, Participant or Beneficiary other than the Claimant." (See Practice Note, Arbitration Provisions for Retirement Plans and Standard Clause, Plan Language, Arbitration of Disputes for Retirement Plans.)
The participant sued the employer, board of directors, board members, ESOP committee, trustee, and others under ERISA, alleging defendants breached their fiduciary duties and engaged in prohibited transactions by causing the ESOP to overpay for the employer stock, which resulted in debt for the ESOP and financial losses for the plan participants (see ERISA Litigation Toolkit). Citing the ESOP's arbitration provision, defendants moved to compel arbitration. The district court denied the motion, and the defendants appealed.

Outcome

On appeal, the Tenth Circuit affirmed, concluding that the arbitration provision was unenforceable.

Arbitration Provision Was Unenforceable Against the Participant

The Tenth Circuit acknowledged that there is a general policy favoring arbitration of disputes under the Federal Arbitration Act (FAA). In addressing whether the ESOP's arbitration provision was enforceable, the Tenth Circuit focused on the effective vindication exception to the FAA. Under this exception, an arbitration provision will be invalidated on public policy grounds if it functions as a prospective waiver of an individual's right to pursue statutory remedies. In this case, the Plan's arbitration provision acted as a prospective waiver of the right to pursue statutory remedies under ERISA because it disallowed plan-wide relief that was expressly contemplated by ERISA Sections 502(a)(2) and 409.
Siding with the participant, the Tenth Circuit concluded that the arbitration provision prevented the participant from effectively vindicating plan-wide remedies available under ERISA, and therefore the provision was unenforceable. In reaching this conclusion, the court reasoned that:
According to the court, the arbitration provision prevented the participant from obtaining the following forms of relief requested by the participant because they would benefit other plan participants and beneficiaries:
  • Imposing liability on the ESOP Committee members and the trustee for the plan losses.
  • Declaring that the defendants breached their fiduciary duties under ERISA.
  • Declaring the ESOP's indemnification provisions to be void on public policy grounds.
  • Enjoining the defendants from future breaches of their fiduciary duties.
  • Removing the trustee and barring it from future service as a trustee.
  • Appointing a new independent fiduciary to manage the ESOP.
  • Ordering the trustee to restore all losses the plan sustained and disgorge any profits made by using the ESOP's assets.
The court emphasized that the arbitration provision was problematic because it foreclosed statutory remedies, not because it limited the forum.
In support of its conclusion, the Tenth Circuit cited a Seventh Circuit opinion involving similar facts in which the court held that an arbitration provision was unenforceable because the provision prohibited participants (on a plan-wide basis) from invoking statutory remedies under ERISA (Smith v. Bd. of Dirs. of Triad Mfg., Inc., 13 F.4th 613 (7th Cir. 2021); see Practice Note, ERISA Litigation: Causes of Action and Remedies Under ERISA Section 502 for Benefit and Fiduciary Breach Claims: Limiting Arbitration of ERISA Section 502(a)(2) Claims: ESOP Litigation).
Because the provision limiting remedies in arbitration was not severable from the rest of the arbitration agreement, the court held that the entire agreement was unenforceable.

Miscellaneous Arguments

The defendants advanced several other arguments, all of which the Tenth Circuit rejected.
For example, the defendants pointed to ERISA's requirement that plan documents be strictly enforced. In response, the Tenth Circuit reasoned that a plan document cannot override ERISA's statutory remedies. Additionally, plan fiduciaries must act in accordance with applicable plan documents but only to the extent the documents are consistent with ERISA (see Practice Note, ERISA Fiduciary Duties: Overview: Duty to Follow Plan Documents).
The Tenth Circuit also rejected the defendants' argument that the court's decision would mean ERISA plans could never require individual arbitration of participants' claims because participants cannot waive the ERISA provisions that allow plan-wide remedies. According to the court, however, merely citing these ERISA provisions in their complaints would not be enough to avoid individual arbitration. Instead, participants would also need to seek the plan-wide remedies available under those provisions.
Finally, the defendants argued that the Secretary of the DOL could bring an action on behalf of the plan to recover plan-wide relief. In rejecting this argument, the Tenth Circuit reasoned that:
  • ERISA permits the DOL and plan participants, beneficiaries, and fiduciaries to seek relief for a breach of fiduciary duty.
  • The type of relief available for a breach of fiduciary duty does not depend on the type of plaintiff bringing the claim.
  • There is no guarantee that the DOL would bring a suit seeking plan-wide remedies in every instance.

Practical Implications

Plan administrators of plans that contain an arbitration provision should familiarize themselves with their plans' provisions and the Harrison case. They may want to evaluate if their plan contains language that could trigger the FAA's effective vindication exception and if so, they may want to consider modifying plan language.