Craig v. Smith, 2009 WL 438635 (S.D. Ind. Feb. 20, 2009)
The U.S. District Court, Southern District of Indiana, recently ruled in Craig v. Smith, 2009 WL 438635 (S.D. Ind. Feb. 20, 2009) that a company and its ESOP are jointly and severally liable for a breach of fiduciary duties by violating the terms of the plan document and IRC Section 409(h)(5) - Right to demand employer securities; put option - Payment requirement for total distribution by issuing a 10-year promissory note rather than the statutory limit of 5 years:
(h) Right to demand employer securities; put option
(5) Payment requirement for total distribution
If an employer is required to repurchase employer securities which are distributed to the employee as part of a total distribution, the requirements of paragraph (1)(B) shall be treated as met if
(A) the amount to be paid for the employer securities is paid in substantially equal periodic payments (not less frequently than annually) over a period beginning not later than 30 days after the exercise of the put option described in paragraph (4) and not exceeding 5 years, and
(B) there is adequate security provided and reasonable interest paid on the unpaid amounts referred to in subparagraph (A).
For purposes of this paragraph, the term "total distribution" means the distribution within 1 taxable year to the recipient of the balance to the credit of the recipient's account.
The plan document required "a promissory note which provides that it shall become due and payable in full if the purchaser defaults in payment of any installment payment" as security. The court ruled that the acceleration clause requiring full payment in the event of default constituted adequate security.
The court also issued a ruling on the amount of the judgment.
ESOP Plan Sponsor Held Liable for Issuance of 10-Year Note to Satisfy Repurchase Obligation provides additional analysis of this case, including how an ESOP administrative committee does not eliminate the fiduciary responsibilities of the company:
The court found that the company was a fiduciary because it was the plan administrator. Although the company delegated most of its responsibilities to an ESOP committee, the court stated that the company retained a duty to monitor the ESOP committee and that it failed to do so. In this regard, the court noted that the president, a vice president, and the treasurer of the company were members of the ESOP committee and that they all knew that the ESOP committee was violating the plan and the Code when it approved the issuance of a 10-year note to Craig. The court stated that the ESOP committee members could not "simply forget the information they obtain as ESOP committee members when they are acting as corporate officers." Although the company's fiduciary duties were narrower than the duties of the ESOP committee, the company nevertheless violated its fiduciary duty to monitor the ESOP committee when officers of the company knew of the plan's violation and took no action to correct it.
It also discussed how a participant can only waive rights under ERISA on a knowing and voluntary basis and how the court stated that "ERISA does not excuse the violations of Plan terms because of good intentions."