ESOP’s failure to honor plan diversification election was arbitrary and capricious

The administrator of an employee stock ownership plan (ESOP) acted arbitrarily and capriciously by failing to comply with participants’ elections to diversify their plan accounts, the U.S. Court of Appeals in Atlanta (CA-11) has ruled.

The ESOP entitled employees who participated in the plan for ten years and were at least 55 years old to diversify part of the company stock in their individual plan accounts. In 2009, two plan participants, a married couple, elected to have part of their plan accounts transferred to their individual retirement accounts. The participants’ elections entitled them to receive shares of company stock that they could “put” to the employer and the plan to redeem.

As of December 31, 2008, the value of employer stock was $11 per share. The employer, a bank, was struggling financially, which reduced the value of its stock. In September 2009, the employer entered into an agreement in which it agreed to refrain from purchasing or redeeming its stock without the consent of the Federal Reserve Bank and the Bank Commissioner. In October 2009, the employer obtained a special valuation of its stock. An independent appraiser valued its stock at $2.30 per share as of September 30, 2009.

In November 2009, the employer informed its plan participants about the written agreement with the Federal Reserve. The employer stated it lacked cash, or the ability to raise additional cash, to implement the participants’ diversification elections and that the participants had the right to change or retain their earlier elections to diversify. If the employer honored an election to diversify, it warned that it would distribute shares of common stock and would not offer a put option until the Federal Reserve lifted the restriction on redemption. The participants submitted revised election forms that requested their shares remain invested in the plan. As of December 31, 2009, the value of employer stock had dropped to $0.15 per share.

The federal district court entered an order granting an injunction that enforced the participants’ rights to diversify, to obtain shares of company stock equaling the part of their accounts covered by the election, and to redeem the stock based on the December 31, 2008 annual valuation. The district court also awarded the participants prejudgment interest as compensation for their losses. The Eleventh Circuit affirmed.

Failure to diversify

The written plan for the ESOP obligated it to comply with the participants’ elections to diversify their plan accounts. The employer argued that the plan administrator could disregard the terms of the plan because the administrator was entitled to interpret the contract in a way that “uniformly” avoided harm to the plan and other participants. However, the court ruled that, as a fiduciary, the plan administrator was required to administer the plan in accordance with the documents and instruments governing the plan. The employer next maintained that the language of the plan permitted the plan administrator not to strictly follow the diversification and put option terms of the plan. The court disagreed and cited plan language stating that the plan administrator “shall have no power to add to, subtract from or modify any of the terms of . . . [or] to change or add to any benefits provided by . . . the [p]lan.” The employer offered no reasoned basis for the plan administrator’s decision to override the mandatory and unequivocal terms of the plan, the court stated.

Finally, the employer contended that the plan administrator’s decision was supported by the fact that the Federal Reserve Bank had prohibited it from redeeming its stock. However, the appellate court, like the district court, rejected that argument as a post-hoc explanation for denying the participants’ elections to diversify. The plan administrator did not mention the prohibition on the original election form or on the revised election form dated November 2009, the court noted. Moreover, neither the plan administrator nor the employer mentioned the prohibition in their decisions denying the participants’ demands for payment or their administrative appeal.

The appellate court concluded that the district court did not err in entering judgment against the employer and in favor of the participants’ claim to enforce their rights under the plan. The refusal of the plan administrator to honor the participants’ elections to diversify was arbitrary and capricious, the court held, ruling that the explanations given for the plan administrator’s decision conflicted with the unambiguous and mandatory language in the written plan and with the information communicated to plan participants.

Prejudgment interest

The appellate court also held that the district court did not abuse its discretion when it used the Alabama interest statute to determine the rate by which to calculate prejudgment interest owed to the participants. The Alabama interest statute is intended to compensate beneficiaries when their health benefit plan fails to pay a written claim within the applicable time periods. The district court reasonably applied this statute by analogy to make the participants whole after the employer wrongfully refused to honor their elections and benefitted from withholding their money, the Eleventh Circuit ruled.

Source: Bryant v. Community Bankshares, Inc. (CA-11).
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