Counsel for Debtors Beware Officers and Directors May Be Personally Liable for the 401(k) Contributions to Employees and Their Health Insurance Claims

Counsel for Debtors Beware Officers and Directors May Be Personally Liable for the 401(k) Contributions to Employees and Their Health Insurance Claims

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When times are tough and cash flow is tight, owners, directors, officers and/or employees of a company may be tempted to delay payment of contributions into the company's 401(k) plan and to delay payment of health insurance claims or premiums in order to use the withheld money as operating capital. While this approach solves an immediate problem for the company, it may convert the company's problem into a problem for the persons who make such decisions if the company is then unable to pay those contributions and claims.


The Employee Retirement Income Security Act of 1974 (ERISA) governs, inter alia, the operation of 401(k) plans and group health plans. The primary purpose of ERISA is to protect the benefits of employees from abuse by employers and persons who administer benefit plans. One of the ways this protection is provided is to designate certain individuals to be fiduciaries of a plan (see ERISA §§3(21) & 402(a); 29 U.S.C. §§1002(21) & 1102(a)) and to regulate the fiduciaries' conduct (see ERISA §§404(a) & 406; 29 U.S.C. §§1104(a) & 1106), and then to make the fiduciaries personally liable for breaches of fiduciary duty (see ERISA §409(a); 29 U.S.C. §1109(a)).

How does a director, officer or employee become a fiduciary of an ERISA plan? A director, officer or employee becomes a fiduciary of an ERISA plan if he (1) is designated a fiduciary in the plan document (see ERISA §402(a); 29 U.S.C. §1102(a)) or (2) if he has authority over the administration of the plan or its assets (see ERISA §3(21); 29 U.S.C. §1102(a); Board of Trs. of the Airconditioning and Refrigeration Indus. Health and Welfare Trust Fund v. J.R.D. Mech. Servs Inc., 99 F. Supp. 2d 1115, 1120 (C.D. Cal. 1999)).

What are the duties of a fiduciary? Fiduciaries are required to act (1) solely in the best interests of the plan participants and (2) with the care, skill, prudence and diligence that a prudent person familiar with such matters would use. ERISA §404(a); 29 U.S.C. §§1104(a) (emphasis added). A plan fiduciary's role is similar to that of a trustee of a trust or an executor of an estate.

ERISA expressly contemplates that an officer, employee or other representative of a company may also serve as a fiduciary of a plan. ERISA §408(c) (3); 29 U.S.C. §1108 (c)(3). Because of the obvious risks arising from their dual-capacity status, fiduciaries are expressly prohibited from dealing with the plan assets for their own advantage and from acting on behalf of a party whose interests are adverse to the participants. ERISA §406(b); 29 U.S.C. §1106(b). A fiduciary who does not pay contributions to a 401(k) plan or health insurance claims in order to pay the company's other creditors may be dealing with plan assets for his own account (i.e., his investment in the company) and/or acting on behalf of the interests of the company when its interests are adverse to those of the participants (i.e., they both want the same money). The fiduciary may also be construed to be loaning plan assets to the company, which is expressly prohibited. ERISA §406(a); 29 U.S.C. §§1106(b). See, also, IRC §4975(c).

Included in the duty to act in the best interests of the plan participants is a duty to inform participants of material information regarding their benefits. See Griggs v. E.I. DuPont de Nemours & Co., 237 F.3d 371, 380 (4th Cir. 2001). This duty obviously includes a duty to inform participants of circumstances that threaten their interests in a plan. Mira v. Nuclear Measurements Corp., 107 F.3d 466, 472 (7th Cir. 1997) (holding that the company and its officers breached their fiduciary duties by failing to advise employees in a fully insured health plan that their insurance coverage had lapsed because of the non-payment of premiums).

When does the company's money become an untouchable plan asset? Much of the fiduciary liability litigation focuses on determining when the company's money becomes a "plan asset." Once the money becomes a plan asset, the company can no longer use the money to pay other creditors, but must use it exclusively to provide benefits to participants.

Contributions that have been deposited into a plan are clearly plan assets. However, in some instances, contributions become plan assets even before they are deposited into a plan. For example, employee deferral contributions to 401(k) plans become plan assets as of the earlier of (1) the earliest date that the money can be segregated from the employer's general assets, or (2) the 15th of the month after the month the money was withheld from the employee's wages. 29 C.F.R. §2510.3-102. See, also, United States v. Grizzle, 933 F.2d 943, 948 (11th Cir. 1991). The Department of Labor has made it clear that the 15th day of the next month is not a safe harbor, but the latest possible date on which the 401(k) deferrals must be contributed to a plan. See 29 C.F.R. §2510.3-102(f) (providing relevant examples 1, 2 and 3).

In some instances, employer contributions (other than deferral contributions) may also become plan assets before they are deposited into the plan's trust account if an underlying wage agreement (e.g., collective bargaining agreement) so provides. NYSA-ILA Med. & Clinical Servs. Fund v. Catucci, 60 F. Supp. 2d 194, 200 (S.D.N.Y. 1999); Hanley v. Giordano's Rest., No. 94 CIV, 4696 (RPP), 1995 WL 442143, *4 (S.D.N.Y. July 26, 1995); Galgay v. Gangloff, 677 F. Supp. 295, 301 (M.D. Pa. 1987), aff'd., 932 F.2d 959 (3rd Cir. 1991) (holding that contributions were plan assets pursuant to the terms of the wage agreement).

The authors were personally involved in a case where an ERISA plan filed a complaint in a former officer's individual bankruptcy proceeding seeking to hold him as an officer and director of a company liable for contributions that remained unpaid after the company's bankruptcy. The plan's theory was that the plan contributions became plan assets on payday pursuant to the terms of the underlying collective bargaining agreement. The individual defendants, after expensive pre-trial wrestling, chose to accept an order determining their personal liability and the non-dischargeability of that debt rather than risk paying their attorneys' fees, the plan's attorneys' fees and the contributions. See 11 U.S.C. §523(a)(4) (providing that an individual debtor is not discharged from any debt arising from fraud or defalcation that is committed while acting in a fiduciary capacity). See, also, J.R.D Mechanical Services Inc., 99 F.Supp. 2d at 1115.

Who is liable for breaches of fiduciary duty, and what are they liable for? ERISA expressly provides that a fiduciary who breaches his fiduciary duty is personally liable to make good to the plan any losses to the plan resulting from his breach of fiduciary duty. ERISA §409(a); 29 U.S.C. §1109(a); Lopresti v. Terwilliger, 126 F.3d 34, 40 (2nd Cir. 1997) (holding that the president of a closely held corporation who diverted paycheck deductions from a union pension fund to other company creditors was personally liable as an ERISA fiduciary, where it was undisputed that the employee's contributions were plan assets).

In addition, it is a federal crime for any person to embezzle, steal or unlawfully and willfully convert to his own use any of the assets of a retirement plan. 18 U.S.C. §664. This offense is punishable by a fine of up to a maximum of $10,000, or imprisonment of up to five years. It is also important to know that a fiduciary may be liable for another person's breach of fiduciary duty if he (1) knowingly conceals the other's breach, (2) fails to act prudently and in the interests of the plan participants and beneficiaries in carrying out his own duties, thereby enabling the other fiduciary to breach his duty, or (3) he discovers the breach, but fails to exercise reasonable efforts to remedy it. ERISA §405(a); 29 U.S.C. §1105(a).

So what do directors, officers and employees need to watch out for in time of financial distress? Most company officials are very careful to pay over income taxes and social security taxes in tight financial times because they know that they are personally liable for those taxes. All company officials and their lawyers also need to pay particular attention to ERISA benefits in tight times to avoid personal liability. Specifically, they need to pay attention to 401(k) plan deferrals by employees and to health insurance claims under self-insured health plans.

A. Always, always pay into the 401(k) plan 100 percent of the 401(k) deferrals. All 401(k) plans permit participants to defer a portion of their compensation into the plan on a pre-tax basis. On payday, typically a company pays the payroll and withholds from the checks the amounts deferred by the employees. Those amounts are then paid over to the 401(k) plan on payday or at some regular interval. If those deferrals are not in fact paid to the plan at all, or are not paid promptly, that is a breach of fiduciary duty for which the responsible persons may be held personally liable. It is also important to note that creditors that take over management of the company's money in tight times, but who fail to or refuse to pay these deferrals and contributions into the plan, may be fiduciaries over these plan assets and personally liable for the loss to the plan.

B. Be sure there is money to pay claims under self-insured health plans or that participants are fully informed of the risk that their claims may not be paid. Many companies pay the health insurance claims of their employees directly from the company's funds. In these health insurance plans, the company itself bears the risk of covering the medical claims of its employees, instead of paying premiums to a health insurance company so that the insurance company will bear this risk. This type of group health insurance plan is commonly called a "self-insured plan." Although self-insured health plans typically do purchase an insurance policy to pay catastrophic claims (i.e., a stop-loss policy), the company must pay from its own coffers all claims up to a certain dollar amount each year. Most of these self-insured health plans do not have cash reserves or a trust set aside to cover claims in bad financial times or after shutdown or sale of the company or its assets.

In times of financial distress, companies are first tempted to delay payment of medical claims and divert the cash to pay creditors, and then they may completely fail to pay the claims. If the company's assets are going to be bought as part of a workout, critical issues arise concerning health insurance claims in self-insured health plans. If the purchaser is not going to assume the medical claims, and the seller has no reasonable basis to believe that it will be able to pay the medical claims, then the directors and officers of the seller must decide whether to (1) tell the employees that there is probably not enough money to pay their health insurance claims or terminate the plan, or (2) say nothing. If they tell the employees that they may not really have health insurance, or if they terminate the health plan, morale will be severely damaged and employees may look for other jobs just when the company's chance of survival depends on their staying and being more productive than ever. If the directors and officers say nothing and do nothing, then the participants will assume that they have real health insurance that pays real claims, and they may incur discretionary medical expenses or fail to enroll in other medical insurance that is available to them (e.g., through their spouse's employment). One can argue that silence of directors and officers at a time like this is a fraud upon the participants.

Fiduciaries are not required to personally guarantee the payment of benefits to participants or the continuation of any particular benefit, but they are required to use the employee's contributions to the plan to pay the benefits of the plan, and they are required to advise the employees of material facts regarding the ability of the plan to provide the promised benefits. When the fiduciaries know that there is a substantial risk that the benefits of the plan (i.e., the medical claims of the employees) will not be paid (because there is simply not money available, or the creditors will not permit the claims to be paid, or the company negotiating to buy the assets will not agree to pay the medical claims), then the fiduciaries must either bluntly communicate the true, but painful, facts to the participants, terminate the health insurance plan or face the risk of personal liability for medical claims incurred.

When negotiating with creditors or buyers of assets in a workout, the company may want to have a health actuary calculate the dollar amount of the claims reasonably expected to be incurred prior to termination of the plan based on prior claims experience and the age and health of the participants in the plan. In turn, the company, the creditors and a buyer of the assets should be able to safely rely on those calculations and set aside the calculated dollar amount to pay claims. All persons should then be protected from liability even if the money set aside turns out to be insufficient to pay the claims actually incurred because of unexpectedly large claims, provided participants are clearly informed that the plan is self-insured and that the company has set aside the amount calculated by the plan actuary, but that the company cannot be sure that the amount set aside is adequate to pay all claims because no one can determine with certainty what claims will in fact be incurred over any time period. At a minimum, claims must be paid equal to the amounts the employees have paid to the company for health insurance (including COBRA premiums) for the relevant time period.


Directors, officers and employees who administer ERISA plans for their employers must always remember that in addition to the duties owed to the company in tough financial times, they owe a duty to the participants in their ERISA plans to act in their best interests, to use the employees' money to provide the benefits promised, and to ensure that the participants have all of the facts necessary to make sound decisions regarding their benefits. A failure to meet these fiduciary responsibilities could lead to expensive and protracted litigation and ultimately to personal liability.

Journal Date: 
Sunday, July 1, 2001