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      Indemnifying ESOP Fiduciaries: Harris v. GreatBanc Trust Company

      When the Ninth Circuit Court of Appeals blocked an ESOP-owned company from advancing attorneys' fees to plan fiduciary defendants out of corporate assets in the 2009 decision in Johnson v. Couturier, the surprise and apprehension in the ESOP community was palpable. It was especially so on the West Coast where the Ninth Circuit is situated and the Couturier decision became binding authority. Traditionally, ESOP fiduciaries, including trustees, administrators and corporate directors, rely on the company sponsoring a retirement plan to provide protection in the form of indemnification if they are sued.

      Couturier appeared to blur (or worse, eliminate) the distinction between corporate assets and ESOP plan assets – despite the Department of Labor's (DOL) plan asset regulations that clearly distinguish the two.

      And then came Fernandez v. K-M Industries Holding Co., Inc. and Harris v. GreatBanc Trust Company, two lower court decisions in the Ninth Circuit that applied Couturier in different ways. The apprehension turned to confusion. What does it all mean to ESOP companies and their fiduciaries?

      First some background.

      Johnson v. Couturier

      In Couturier, plan participants accused the defendants of breaching their fiduciary duty by allowing the company to pay excessive compensation to an officer who was also a plan fiduciary. The plan fiduciaries had entered into indemnification agreements with the plan sponsor – a near universal practice because plan fiduciaries typically want assurance that the company will backstop them (when appropriate) if they are sued for acts or omissions related to their service to the company's plan.

      In Couturier, the agreements generally provided that the company would indemnify the fiduciaries so long as liability did not result from "gross negligence" or "deliberate wrongful acts," but did not specifically prohibit indemnification if the fiduciaries breached their fiduciary duties under ERISA. This was a fatal flaw, because the agreements could permit indemnification in circumstances where ERISA duties were violated (e.g., when acts or omissions violated ERISA but did not rise to the level of "gross negligence" or "deliberate wrongful acts"). In the court's view, these agreements ran afoul of ERISA section 410(a) which voids agreements that purport to relieve a fiduciary of liability – even though the indemnification here would have been paid from corporate assets rather than from plan assets.

      The ESOP was the 100% owner of a company that was in the process of liquidating. Any indemnification payment by the company would reduce dollar-for-dollar the liquidating distribution to the plan. Thus, the court maintained that the agreements placed the burden of the company's promise to indemnify (or advance defense costs) squarely on the ESOP. The court effectively captured the economic substance of the arrangement. But its reasoning was contrary to the DOL's plan asset regulations that clearly distinguish corporate assets from plan assets.

      The immediate practical implication of Couturier was that fiduciary liability insurance became more important for ESOP fiduciaries. If an ESOP fiduciary cannot count on the company for indemnification, then a good insurance policy is the thin red line protecting a fiduciary's personal assets. Practitioners in other parts of the country wondered whether their courts would follow Couturier.  Of course, this begs the question: "What, exactly, did the Couturier court decide?"

      Bad Facts Make Bad Law

      Many in the ESOP community hoped Couturier's influence would be limited by the rather unique combination of facts in the case. For example:

      • The ESOP owned 100% of the company.
      • The company was in the process of liquidating so that any amount expended by the company would reduce plan benefits dollar-for-dollar.
      • The defendants appeared to have permitted self-dealing by a company officer who was also a plan fiduciary.
      • In exchange for his existing deferred compensation agreements (which one accounting firm valued at almost $9 million), the officer received a buyout package valued at $34.8 million. On its face, the court found it difficult to understand how an ERISA fiduciary could acquiesce to a buyout package that exceeded fair market value by approximately $25 million.
      • The package included over $26 million in cash, title to a Palm Desert, California home (purchased for $5.5 million), a Bentley automobile valued at $200,000, and other benefits. The company had previously purchased the Palm Desert home and a $325,000 private golf club membership in Palm Desert for the officer's personal use.
      • The overall compensation package was approximately 65% of the company's assets.

      The plaintiffs satisfied the elements needed for the court to issue a preliminary injunction barring the advancement of attorneys' fees. The court determined that the plaintiffs were likely to prevail on the merits and they would likely suffer irreparable harm if the fees were advanced because they were unlikely to be recovered upon a finding of liability.

      For ESOP practitioners, there was reason for optimism. A large part of the Ninth Circuit's opinion is devoted to these unique factors. If the court was broadly asserting that an ESOP-owned company could not indemnify ESOP fiduciaries in any case, it probably would have said so in a more direct way.

      The court acknowledged the DOL's plan asset regulations distinguishing corporate assets from plan assets. The court also acknowledged that day-to-day business decisions concerning corporate assets were subject to the business judgment rule and not subject to ERISA. The court recognized it would be absurd if every corporate decision (such as the annual expenditure on office supplies) implicated ERISA responsibilities simply because an ESOP owns the company. The court therefore proposed what it believed was a "workable rule" that could be used in conjunction with the DOL's plan asset regulations: Where an ESOP fiduciary also serves as a corporate director or officer, ERISA duties would apply to business decisions from which that individual would directly profit.

      The defendants appeared to have placed the interests of a co-fiduciary ahead of the interests of the company and ultimately the plan. The court determined the plaintiffs would "likely prevail" in showing that the defendants permitted "obvious self-dealing…to the detriment of plan beneficiaries." It is unlikely that the $200,000 Bentley and the $325,000 golf membership helped the defendants' argument that the officer received reasonable compensation from a company wholly owned by a pension plan. In the end, the court was not going to order the rank and file employees to pay the fiduciaries' defense costs regardless of the DOL's plan asset regulations.

      In spite of established expectations, some cases are decided the way they are decided because the court has no palatable alternative.  This may be one of those cases.  Unfortunately, such cases often cause confusion. There have been only two district court decisions in the Ninth Circuit that have cited Couturier regarding the indemnification of ESOP fiduciaries. Unfortunately, those two decisions reached opposite conclusions about what the Couturier court decided. We look at them next.

      The Immediate Aftermath:  Fernandez v. K-M Industries Holding Co., Inc.

      Within two months of the Couturier decision, the apprehension in the ESOP community turned to fear. In Fernandez, the Northern District of California (citing Couturier) held that indemnification was unavailable to the ESOP fiduciary serving as successor trustee. The successor trustee was accused of having failed to investigate and correct a prior fiduciary's alleged breach.

      In Fernandez, the ESOP owned only 42% of the company – not 100% – and the company was not liquidating. Also, the successor trustee was not a party to the original alleged breach – facts very different from Couturier. The court acknowledged that indemnification in Couturier would have more directly affected plan participants than the indemnification challenged in this case. However, the Fernandez court maintained that the rationale of Couturier was that indemnification agreements are invalid any time an ESOP would bear the financial burden of indemnification – whether directly or indirectly.  

      For over three years, the Fernandez decision was the sole district court decision in the Ninth Circuit that cited Couturier for the proposition that a company's indemnification arrangement with an ESOP fiduciary may be limited. The Fernandez court appeared to disregard the unique factors present in the Couturier case and in doing so appeared to take a more expansive stance.

      According to the Fernandez court, the Couturier decision changed the landscape of ESOP fiduciary indemnification by disallowing indemnification any time the plan would bear the financial burden of indemnification – whether directly or indirectly. Because an ESOP owns part or all of the company, the Fernandez court's position effectively precludes indemnification of ESOP fiduciaries because there would always be at least some indirect burden on the plan.

      The Opposing View:  Harris v. GreatBanc Trust Company

      With the March 15, 2013 GreatBanc decision, the landscape changed again and became more confusing. GreatBanc is a Central District of California case in which the DOL asked the court to void an indemnification agreement between an ESOP fiduciary and a 100% ESOP-owned company. The DOL based its request on the purported rationale of the Couturier court that ERISA section 410(a) barred such an agreement. The court declined the DOL's request.

      The GreatBanc court noted that the Couturier court's decision to invalidate the indemnification agreement "turned on three factors not alleged here."  In Couturier, (i) the agreement did not exclude indemnification for breach of fiduciary duty under ERISA, (ii) the plaintiffs showed that they were likely to prevail, and (iii) the company was liquidating and the ESOP would receive the net proceeds.

      The GreatBanc court referred to the "rather unique circumstances present in the Couturier case" where payments to indemnitees would reduce dollar-for-dollar the funds to be distributed to ESOP participants. Without these unique factors, the DOL's plan asset regulations would have applied and the indemnification agreement would not have violated ERISA section 410(a). Because the factors in Couturier are not typical of ERISA litigation generally, the GreatBanc court effectively disregarded Couturier as a one-off decision.


      The Ninth Circuit has not weighed in on this issue again since the 2013 GreatBanc decision. In the meantime, while there is still confusion in the ESOP community, there is a sense that the GreatBanc case is a step in the right direction. The GreatBanc decision returned to the traditional understanding of the DOL's plan asset regulations that distinguish corporate assets from plan assets – a view that allows plan sponsors to indemnify ESOP fiduciaries.

      First, make sure you have the correct language in your indemnification agreements. The fiduciaries in both the Couturier and Fernandez cases suffered because the indemnification agreements used only "gross negligence" and "willful misconduct" exceptions. Your indemnification agreement should clearly preclude indemnification if there is an ERISA violation.

      Second, the plan sponsor (or the fiduciary) should purchase and maintain fiduciary liability insurance. These policies are complex and difficult to decipher. Therefore, it is useful to have an attorney review the policy to make sure it covers those you want covered in the way that you want them covered.  Too often, reviews of fiduciary liability insurance policies reveal fatal flaws. Many policies contain ERISA or ESOP-specific exclusions. Many policies define covered individuals in a way that excludes people intended to be covered (e.g., plan committee members or trustees might not fit the definition of covered individual because they are not company employees).

      Finally, if you are an ERISA fiduciary and you have a choice between the Northern District of California and the Central District of California, choose the latter. District courts in the Ninth Circuit (as well as other panels of the Ninth Circuit) must follow the Couturier decision as required by stare decisis, the policy under which lower courts give deference to higher court decisions. But as discussed above, the meaning of Couturier is anything but clear. We have only two relevant district court decisions in the Ninth Circuit and they could not be more different.  District courts are not bound by other district courts – the GreatBanc court did not even cite Fernandez. But, as a practical matter, judges are likely to give deference to decisions in their district.

      Check your indemnification agreement. Check your fiduciary liability insurance policy. What the court decided in Couturier is anyone's guess.

      Editor's Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government's rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660.