Fiduciary breach claim by ESOP participants not barred by three-year “actual knowledge” limitation

ESOP participants who received proxy materials regarding the substance of a stock buyout, but not about the procedures used to determine the fairness of the buyout, did not have “actual knowledge” of alleged breaches of fiduciary duty for purposes of the three-year limitations period under ERISA Sec. 413, the U.S. Court of Appeals in Chicago (CA-7) has ruled. Thus, the appellate court reversed the district court’s grant of summary judgment to the fiduciaries on the statute of limitations issue.

Stock buyout

The owners of a privately-held company decided to pursue a stock buyout that would leave the company’s ESOP as its sole shareholder. According to the court, the goals of the transaction included allowing the owners to cash out their shares at a favorable price. To implement the transaction, the company would make a tender offer for all shares of stock, with the express condition that the ESOP would decline the offer (making it the only shareholder). The company would use $150 million in borrowed money to purchase the shares.

In addition, the company was contractually obligated to pay an agreed-upon “put protection price” (PPP) in accord with Code Sec. 409(h) for any employee stock cash-outs that occurred in the three years after the buy-out. Further, the company adopted a new distribution policy under which participants who retired would immediately begin to receive payment for their stock (the prior policy required a five-year wait).

In order to comply with ERISA’s prohibited transaction rules, the company and its owners asked a bank to become an ESOP trustee on a temporary basis to make an independent decision as to the fairness of the transaction. Reports analyzing the impact of the transaction prepared for the bank by its financial advisor gave no indication of the potential negative impact the PPP and the new distribution policy would have on the transaction. Once the transaction closed, many employees took advantage of the PPP and the distribution policy to cash out their shares. This started a downward spiral that resulted in the company declaring bankruptcy, which rendered the shares of the remaining ESOP participants worthless.

Fiduciary duty

ESOP participants filed suit against the bank and company owners for breach of fiduciary duty under ERISA. They alleged the bank failed to take reasonable steps to evaluate the fairness of the buyout, while company owners failed, among other things, to monitor the bank.

The district court granted summary judgment to the bank and to company owners, concluding the participants’ suit was time-barred under ERISA Sec. 413 because participants had “actual knowledge” of the alleged fiduciary breaches more than three years before filing suit.

The appellate court reversed the lower court’s grant of summary judgment for the defendants. The participants’ claims for breach of fiduciary duty do not depend solely on the substantive terms of the buy-out transaction, which were disclosed in proxy materials. They also needed information about the processes used to evaluate the transaction. Participants who assert a process-based claim under ERISA Secs. 404 or 406(a) do not have actual knowledge of the procedural breaches unless and until they have actual knowledge of the procedures used or not used by the fiduciary.

Thus, the three-year limit is not triggered by knowledge of the transaction terms alone. Proxy materials mailed to participants did not provide actual knowledge of the alleged violations because they did not describe the methods used by the bank to determine the fairness of the buyout. For example, the proxy materials did not mention the PPP and the new distribution plan or that the bank’s financial advisor’s analysis did not take those changes into account. The court also rejected other arguments in favor of summary judgment for the fiduciaries, including the suggestion that participants had received sufficient information but were “willfully blind” to it.

Source: Fish v. GreatBanc Trust Company (CA-7).

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