Thinking ESOPs: Enforceability of Arbitration Provisions — There Might Be More to the Analysis

Recently, the Sixth Circuit Court of Appeals held that a plaintiff was required to request attorneys’ fees during an arbitration of an ERISA claims dispute. Having failed to do so, the plaintiff could not subsequently seek a fee award from the district court. The Sixth Circuit held that because the parties were obligated to arbitrate their ERISA disputes, the court’s jurisdiction was limited, and the parties were obligated to raise any remedy issues during the arbitration.

Although the case was not an ESOP case, but it was an ERISA case, the Sixth Circuit’s decision reminds us that arbitration is not prohibited by, or inconsistent with, ERISA. In fact, the Sixth Circuit reaffirmed that federal law strongly favors arbitration of ERISA disputes, and if a valid agreement to arbitrate exists, then the court must send the arbitrable disputes to arbitration, and the court’s ability to review the arbitrator’s decision is extremely limited.

The question of arbitrability becomes more complicated in situations where a plaintiff brings an ERISA 502(a)(2) claim against a fiduciary to recover losses to the “plan” caused by a fiduciary breach. An ERISA 502(a)(2) claim is the principal claim for money damages that participants in ESOPs and 401(k)s bring against fiduciaries. Because an ERISA 502(a)(2) claim is limited to losses to the plan itself, many courts have wrestled with the question of whether the plan itself agreed to arbitrate disputes, and whether any particular plaintiff agreed to arbitrate such disputes.

As background, the Federal Arbitration Act requires courts to enforce a “written provision” requiring arbitration in a “contract evidencing a transaction involving commerce.” Importantly, the Federal Arbitration Act does not set forth the rules for determining whether a “contract” exists; the Act does not, for example, provide that courts must apply federal or state-law principles of contract formation when determining whether a contract with an arbitration provision exists. The U.S. Supreme Court, however, has held that the interpretation of private contracts for purposes of the Federal Arbitration Act is “ordinarily a question of state law.” Thus, courts considering whether a valid agreement to arbitrate exists with respect to an ERISA plan have applied state-law principles of contract formation.

When an arbitration provision is found in an ERISA plan document itself, courts have applied state-law principles when evaluating whether the plan document contains a binding agreement to arbitrate between and among the plaintiff, the plan itself and the defendants named in the lawsuit. Yet these courts have either ignored, or not adequately addressed, the fact that ERISA itself contains rules for contract formation. The ERISA rules for contract formation — and not state-law principles — might govern whether an agreement to arbitrate exists in an ERISA plan document.

There is support for the idea that ERISA rules for contract formation should apply when the arbitration provision is found in an ERISA plan document. The Supreme Court has not mandated that courts apply state-law principles of contract formation to determining whether an arbitration agreement exists under the Federal Arbitration Act. In 2010 the Supreme Court held that federal — not state — principles of contract formation would apply to the question of whether a binding arbitration provision existed in a collective bargaining agreement. This was because federal law governed collective bargaining agreements, and therefore federal law had to be used to determine the existence of the arbitration provision.

Similarly, the Supreme Court historically has used ERISA rules for contract formation when resolving questions about the enforceability of ERISA provisions. In many instances, the Supreme Court recognized that an ERISA plan document is itself a type of contract. The Supreme Court also has acknowledged that ERISA is a comprehensive statute that broadly preempts state law, and ERISA has express rules for adopting, amending and terminating an ERISA plan contract. Pursuant to ERISA’s rules of contract formation, plan documents may be amended, at any time and for nearly any reason, except as expressly prohibited by ERISA.

Consider also that the Supreme Court upheld the enforceability of a limitations provision in an ERISA plan that limited the time period for a participant to bring a lawsuit. In so holding, the Supreme Court observed that the provision was found on the face of the ERISA plan document itself. State-law principles of contract formation played no role in the Court’s assessment of whether the ERISA plan was binding on participants.

As plan sponsors consider whether to add an arbitration provision to plan documents, plan sponsors should be aware of the fact that the ERISA arbitration cases are still working their way through the federal appellate courts, and courts are grappling with the proper legal analysis. There is an argument to be made that ERISA’s rules for contract formation, and not state law, should apply to determining whether an agreement to arbitrate exists in an ERISA plan. This is one of many considerations for plan sponsors that are thinking about adding a mandatory arbitration provision to an ERISA plan.