ERISA Litigation Roundup: Seventh Circuit Weighs in on Arbitration and Class Waiver Provisions in Defined-Contribution Plans

On September 10, 2021, the Seventh Circuit decided Smith v. Board of Directors of Triad Manufacturing Inc., No. 20-2708, holding that benefit plans may require claimants to arbitrate claims under the Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001, et seq. (ERISA), but may not preclude claimants from obtaining relief that ERISA provides.

Triad Manufacturing, acting through its board of directors, established an employee stock ownership plan (Plan) in December 2015, when several of Triad’s largest shareholders (Selling Shareholders) sold all of their stock to the Plan. The Plan was a defined-contribution employee retirement plan governed by ERISA. Triad, acting through the Board, was the Plan’s sponsor, GreatBanc served as the Plan’s trustee and James Smith was a former Triad employee and a participant in the Plan. When the value of Triad’s stock dropped significantly in the weeks following the ESOP transaction, the value of Smith’s interest in the Plan decreased commensurately, eventually prompting Smith to sue.

Before that, in July 2018, the Plan Sponsor amended the Plan to add a mandatory arbitration and class-waiver provision (Arbitration Provision). The Arbitration Provision (1) required participants to arbitrate “any claim which arises out of, relates to, or concerns” the Plan, “including without limitation, any claim for benefits under the [P]lan; any claim asserting a breach of, or failure to follow, the [P]lan; and any claim asserting a breach of, or failure to follow, any provision of ERISA or the Internal Revenue Code”; (2) precluded participants from bringing any claim in a ”representative capacity or on a class, collective, or group basis”; and (3) prohibited participants from “seek[ing] or receiv[ing] any remedy which has the purpose or effect of providing . . . relief to any[one] other than the [participant pursuing claims].” Order at 4 (quotations and brackets omitted). The Plan specified that these provisions were non-severable.

On behalf of himself and a putative class, Smith sued the Plan Sponsor, the Selling Shareholders, and the Trustee (collectively, Plan Defendants) under ERISA §§ 502(a)(2) and 502(a)(3) for breaches of fiduciary duties and several other provisions of ERISA in connection with the transactions establishing the Plan and the significant loss in the Plan’s value that quickly followed. Smith sought a variety of relief, including removal and replacement of various Plan fiduciaries. Invoking the Plan’s Arbitration Provision, the Plan Defendants moved to compel arbitration and dismiss Smith’s claims, but the district court denied their motion.

On appeal, the Seventh Circuit affirmed the district court’s decision. In reaching its ultimate holding, the Seventh Circuit made several important pronouncements:

• It held, for the first time, that ERISA claims generally are arbitrable.
• It adopted the line of cases distinguishing between defined-benefit and defined-contribution plans and explicitly held that individualized arbitrations are not inherently incompatible with defined-contribution plans (as opposed to defined-benefit plans).
• It agreed that class-waiver provisions generally are permissible even as to claims under ERISA § 502(a)(2).

Despite finding arbitration and class-waiver provisions enforceable in the ERISA context, the court applied the infrequently invoked “‘effective vindication’ exception” to preclude enforcement of the Plan’s Arbitration Provision because it concluded the Plan’s provisions impermissibly acted as a “prospective waiver” of Plan participants’ rights to statutory remedies. Specifically, the court found that, if enforced, that provision would preclude the Plan’s participants from obtaining equitable relief that ERISA unambiguously makes available—in this case, the removal of an ERISA fiduciary. Because the court premised its holding on the specific language of the Plan’s Arbitration Provision, it distinguished its ruling from that of the Ninth Circuit in Dorman v. Charles Schwab Corp., 780 F. App’x 510, 513 (9th Cir. 2019), which it observed was based on different arbitration and class-waiver language. The court did not address (a) whether Smith had consented to the arbitration provision, (b) whether Smith had received notice of the provision and (c) whether a plan sponsor can permissibly unilaterally amend a plan to include an arbitration provision.

Takeaways

• The Seventh Circuit has now joined other Circuits in deeming ERISA claims arbitrable.
• The Seventh Circuit appears to have endorsed arbitration and class-waiver provisions in defined-contribution plans and indicated that it is likely to enforce those provisions against claimants who sue defined-contribution plans under ERISA § 502(a)(2).
• A defined-contribution plan’s arbitration and class-waiver provisions may not preclude a plan participant from accessing a process consistent with ERISA to obtain statutorily prescribed relief.
• Courts will scrutinize, and will preclude use of, any arbitration or class waiver provision that attempt to limit rights to relief that ERISA provides.
• To maximize the enforcement potential of plan provisions, plan sponsors should ensure that arbitration and class-waiver provisions do not preclude relief available under ERISA and severability provisions should authorize courts to sever only those portions of a plan that are unenforceable or contrary to law.