When a fiduciary breach occurs, some fiduciaries may be more culpable than others. And when that’s the case, the court can order those parties to indemnify other fiduciaries who were, despite their technical status as fiduciaries, without blame. That was the opinion of the U.S. Court of Appeals for the Seventh Circuit in a recent case.
The facts of the case
In Chesemore v. Fenkell, the CEO was the controlling owner of a company that sponsored an employee stock ownership plan (ESOP). Under the ESOP’s terms, participants could sell their employer stock shares back to the company after a prescribed period. A senior executive was approaching the date when he could do this, which would have required the company to make a substantial cash outlay.
The CEO didn’t want to see that happen, so after failing to find independent buyers willing to pay his price, he engineered the sale of the company to the ESOP at a price the court deemed “inflated.” The CEO also installed ESOP trustees beholden to him, according to the court.
The ESOP had to borrow heavily to buy all of the shares, and the burden of servicing that debt contributed to the company’s subsequent demise. The employees sued, and the trial court ordered the CEO to compensate the employees and pay their attorneys’ fees.
The court decides
On appeal, the CEO didn’t deny liability, but argued that it should be spread among all of the ESOP’s fiduciaries. The court found that the trustees appointed by Fenkell “lacked the experience and the incentive to assess” the sale and that the CEO “orchestrated the entire complex transaction.” Therefore, his culpability “vastly exceeded theirs.”
The appeals court noted that, although ERISA “contemplates the allocation of fiduciary obligations among co-fiduciaries, thereby limiting subsequent losses,” it’s not an absolute standard. Noting that the Supreme Court has interpreted ERISA as “incorporating the law of trusts,” the appeals court reasoned that trial courts are permitted to order “appropriate equitable relief.”
This court had ruled similarly in an earlier case. Courts can provide an award to make the injured plan whole, while also equitably apportioning the damages among wrongdoers.
Technically, this ruling applies only in the Seventh Circuit, which covers Wisconsin, Illinois and Indiana. But the Second Circuit, covering New York, Connecticut and Vermont, has ruled the same way. The ruling also could sway courts in other circuits that haven’t already dealt with a case involving this question. Two other circuits, the Ninth and the Eighth, have taken the opposite view, leaving five more circuits and 30 states in limbo.
The moral of the story
The ESOP trustees in the Chesemore case appear to have dodged the bullet. Of course, the moral of the story is to not put yourself in a situation like this in the first place. Be sure that all plan fiduciaries act in the best interests of plan participants.
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, contact Jenise Gaskin at (925) 296-1016 or visit us at www.bpmcpa.com/ebp.