Over the past few years, qualified retirement plans, including employee stock ownership plans (ESOPs) have been adding provisions requiring participant breach of fiduciary duty claims to be resolved through mandatory arbitration on an individual basis rather than through the courts or on a class basis. One reason for doing so is to prevent plaintiffs from bringing spurious lawsuits that contain sufficient facts to survive a motion to dismiss, which would lead to expensive discovery exercises. The risk of such expense could create an incentive for ESOP fiduciaries to agree to substantial settlements to avoid the cost of further litigation regardless of the underlying merits of the allegations. However, there are downsides to having such mandatory arbitration provisions, including the risk of facing a non-appealable adverse arbitration decision and its impact on the ESOP, the ESOP sponsor and the ESOP fiduciaries. While courts have generally held that such provisions are not per se invalid, a number of courts, including the Southern District of Illinois, have limited their scope.
On January 25, 2021, a motion to compel arbitration was denied, allowing ESOP participants to bring their claims in court on a class-wide basis.[1] In this case, the ESOP was established in 2012 without an arbitration provision or class action waiver. The ESOP provided that the board of directors of the sponsoring entity could amend the ESOP, either prospectively or retroactively, at any time in any manner that the board deemed expedient or proper. On January 1, 2017, the board exercised that authority to amend the ESOP to add a mandatory and binding arbitration procedure and class action waiver.
While a number of circuits have ruled on whether claims brought under the Employee Retirement Security Act of 1974, as amended (ERISA) are arbitrable, the Seventh Circuit has not directly addressed the issue. Here, the court reviewed a number of cases from other jurisdictions and noted that there was a clear trend towards courts favoring arbitration provisions. The court also assumed that, at the appropriate time, the Seventh Circuit will find that ERISA claims are arbitrable.
However, here, the court stated that Section 2 of the Federal Arbitration Act requires arbitration only if there is a valid contract containing a provision where the parties agree to submit an issue to arbitration. Participants in this case argued that because they did not sign, give consent to, or receive consideration for the amendment to the ESOP, there was no contract, and therefore they cannot be required to submit to arbitration. In response, the defendants argued that (1) the ESOP granted authority for amendments to be made unilaterally without any new or additional consideration, (2) the participants received consideration by continuing to seek benefits under the ESOP after the amendment, and (3) under Illinois contract law, a nonsignatory is estopped from avoiding arbitration if a party knowingly seeks benefits of the contract containing the arbitration provision.
The court was not persuaded by the counterarguments. With respect to the first counterargument, the court stated that while the board of directors has the authority to amend the ESOP in its discretion, the use of that discretion still requires consideration to make the amendment binding on participants. The court concluded by stating that an amendment “implemented by the Board unilaterally and solely for its benefit is, at best, without necessary consideration, or at worst, illusory, and, in either case, unenforceable.”
With respect to the second counterargument, the court stated that there was no additional consideration given to the participants following the amendment. Any benefit available to the participants after the amendment was available to the participants before the amendment, and as such, no additional consideration was provided.
Finally, with respect to the third counterargument, the court stated that while a non-signatory is estopped from avoiding arbitration if it knowingly accepts the benefits of the contract containing the arbitration clause, the non-signing party is required to receive a direct benefit under such contract. Following its analysis with respect to the second counterargument, the court reasoned that neither continued employment nor the right to continue to participate in the ESOP is a direct benefit to ESOP participants that was not already present before and after the amendment was approved.
Therefore, because there was no additional consideration in connection with the amendment, the court decided that the arbitration provision here was not valid. This decision, along with its analysis, should be read as a caution to ESOP and other plan sponsors not just on arbitration provisions, but potentially on any amendment to a qualified plan. Following the reasoning outlined here, no amendment to a qualified plan will be valid unless participants receive something in return for such amendment (perhaps an enhanced benefit under the plan?). While this opinion sets forth the current position of the Southern District of Illinois, there is currently a case before the Seventh Circuit Court of Appeals seeking a determination on the validity of arbitration provisions and class action waivers.[2] A brief by the class of participants in this Seventh Circuit case was filed on January 14, 2021.
In the interim, ESOP sponsors, particularly those in the Seventh Circuit should continue to evaluate whether an arbitration provision and class action waiver is desired in their ESOP. Based on this order, such provision will be tough to uphold if the provision is added to an ESOP after the ESOP is established unless ESOP participants received something in return for the addition of the provision. This order does not provide any insight into what will happen to an arbitration provision and class action waiver if such provision and waiver were in the ESOP from the date the ESOP was established- perhaps the Seventh Circuit decision will shed light on that scenario. Until then, we wait.
[1] See Tom Hensiek, et.al, vs Board of Directors of Casino Queen Holding Company, Inc., et.al, No. 3:20-CV-377-DWD (7th Cir. January 25, 2021)
[2] James Smith v. Board of Directors of Triad Manufacturing, Inc., et. al, No. 20-2708 (7th Cir. January 14, 2021)