We have been discussing ESOP Corporate Governance and the responsibilities of the Board of Directors. A recent court case raises the question of whether corporate indemnification for ESOP companies is limited to any amount covered by fiduciary insurance.

Johnson v. Couturier, 2007 WL 3151802 (E.D. Cal. October 26, 2007) was recently discussed in What's New in Employee Benefits:

Johnson v. Couturier, 2007 WL 3151802 (E.D. Cal. October 26, 2007), addressed the extent to which the prudence standard requires ESOP trustees to oversee corporate management, as well as when corporate managers become ERISA fiduciaries. The informally reported opinion is extremely sketchy as to the facts, but it appears that one of the counts was brought against an individual (Couturier), a corporate director and erstwhile ESOP trustee, for violating ERISA by approving his own allegedly excessive compensation from the company. The court observed that, as a fiduciary of the ESOP and director and officer of the corporation, Couturier was aware of his own compensation package, and stated: "If, in fact, Couturier's executive compensation package was excessive, the fiduciaries of the ESOP, including Couturier, had an obligation in administering the ESOP assets, to exercise the ESOP's rights as a shareholder, remove the existing directors and elect new directors." Id. at *5. Couturier might not face liability alone, however, as the court also held that board members who had the right to appoint fiduciaries such as Couturier were themselves ERISA fiduciaries. Id. (citing Batchelor v. Oak Hill Med. Group, 870 F.2d 1446 (9th Cir. 1989), in turn citing 29 C.F.R. § 2509.75-8 (Q&A D- 4)). See also Fenwick v. Merrill Lynch & Co., Inc., 2007 WL 2727436 (D. Conn. Sep. 19, 2007) (declining to dismiss complaint alleging that fiduciaries breached their fiduciary responsibilities by not investigating and, if necessary, bringing suit against an employer that failed to fund an ostensible "top hat" plan that the complaint alleged should have been funded).

Johnson v. Couturier, 2008 WL 4443085 (E.D. Cal. Sept. 26, 2008) found that the ESOP-owned company may not advance the costs of defense as provided under corporate officer indemnification agreements because the participants had shown a "substantial likelihood of success" and would effectively lack recourse against the fiduciaries as provided under ERISA Section 410(b), 29 U.S.C. Section 1110(b) - Exculpatory provisions; insurance:

(a) Except as provided in sections 1105(b)(1) and 1105(d) of this title, any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.

(b) Nothing in this subpart ^[1] shall preclude—

1. a plan from purchasing insurance for its fiduciaries or for itself to cover liability or losses occurring by reason of the act or omission of a fiduciary, if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary;
   
2. a fiduciary from purchasing insurance to cover liability under this part from and for his own account; or
   
3. an employer or an employee organization from purchasing insurance to cover potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan.

29 CFR 2509.75-4 - Interpretive bulletin relating to indemnification of fiduciaries provides additional guidance on the indemnification of fiduciaries:

On June 4, 1975, the Department of Labor issued an interpretive bulletin, ERISA IB 75-4, announcing the Department's interpretation of section 410(a) of the Employee Retirement Income Security Act of 1974, insofar as that section relates to indemnification of fiduciaries. Section 410(a) states, in relevant part, that ``any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.''

The Department of Labor interprets this section to permit indemnification agreements which do not relieve a fiduciary of responsibility or liability under part 4 of title I. Indemnification provisions which leave the fiduciary fully responsible and liable, but merely permit another party to satisfy any liability incurred by the fiduciary in the same manner as insurance purchased under section 410(b)(3), are therefore not void under section 410(a).

Examples of such indemnification provisions are:

1. Indemnification of a plan fiduciary by (a) an employer, any of whose employees are covered by the plan, or an affiliate (as defined in section 407(d)(7) of the Act) of such employer, or (b) an employee organization, any of whose members are covered by the plan; and
   
2. Indemnification by a plan fiduciary of the fiduciary's employees who actually perform the fiduciary services.

The Department of Labor interprets section 410(a) as rendering void any arrangement for indemnification of a fiduciary of an employee benefit plan by the plan. Such an arrangement would have the same result as an exculpatory clause, in that it would, in effect, relieve the fiduciary of responsibility and liability to the plan by abrogating the plan's right to recovery from the fiduciary for breaches of fiduciary obligations.

While indemnification arrangements do not contravene the provisions of section 410(a), parties entering into an indemnification agreement should consider whether the agreement complies with the other provisions of part 4 of title I of the Act and with other applicable laws. [40 FR 31599, July 28, 1975. Redesignated at 41 FR 1906, Jan. 13, 1976]

Court Bars ESOP-Owned Company from Advancing Defense Costs of Officers Accused of ERISA Fiduciary Breach notes that this case demonstrates that there may be practical limits to corporate indemnification when a company is ESOP-owned and that fiduciary insurance may be the only secure source of money to defend a suit:

The court reasoned that, as a practical matter, the assets of the ESOP would be wasted if the wholly owned company were allowed to expend its funds to defend this lawsuit. As the court explained: If Defendants are advanced their legal expenses and judgment is rendered against them, the Court finds it highly unlikely that the ESOP, and therefore the Plaintiffs, will ever be fully compensated for the depletion of funds from the [company]. The Court is well aware that the Defendants have used up fully $5 Million in insurance funds to defend this suit. The Court has no doubt that this litigation has the potential to deplete all or most of [the company's] remaining liquid assets. The prejudice to the Plaintiffs would be immense. The court also concluded that, even if the company's assets were not considered plan assets under ERISA, since the company was wholly owned by the ESOP, the ESOP had an equitable interest in the company's assets sufficient to support an injunction. ERISA § 410 has long been understood to permit indemnification of fiduciaries using corporate assets, including through the Department of Labor's guidance at 29 C.F.R. § 2509.75-4. Johnson illustrates, however, that there may be practical limits to corporate indemnification when the company at issue is wholly or substantially owned by an ESOP. In these circumstances, fiduciary insurance previously purchased with the defendant's or employer's funds may be the only secure source of money to defend the suit or cover any liability.