Ninth Circuit Issues Important Decision Limiting Indemnification for ESOP Fiduciaries

In Johnson v. Couturier, Nos. 08-17369, 08-17373, 08-17375, 08-17631 (Ninth Cir., July 27, 2009), the Ninth Circuit Court of Appeals reached a potentially major decision concerning both the role of ESOP fiduciaries in dealing with executive pay and the ability of companies to indemnify fiduciaries. In this case, the Noll Corporation (later part of a holding company called TEOHC) agreed to pay its CEO, Claire Couturier, an amount of compensation that, in its various forms, came to something over one-third of the ultimate value of the company when TEOHC was later sold. The amount is also considerably greater than what ESOP participants would receive, although these participants would also fare very well in the sale if legal issues can be resolved.

Participants sued Courturier, as well as the plan's ESOP attorney and other advisors, two of whom were, for a disputed period of time, on the company's board. In one action, the participants requested a preliminary injunction against indemnification for the defendants. Legal fees had absorbed the existing fiduciary insurance for five million dollars. The plaintiffs alleged that if the company indemnified the defendants for remaining fees, the ESOP participants would, effectively, have their potential distribution substantially reduced.

The Ninth Circuit upheld the district court's findings with respect to two key issues. First, it stated that the plaintiffs were likely to prevail in their case that the defendants had breached their fiduciary duties by overpaying Couturier. Second, it ruled that ERISA preempts state law concerning indemnification when a corporation is no longer an operating entity and its assets have been sold.

The case has an unusual fact pattern in many respects. Most notably, the company had already been sold, raising the issue of whether the indemnification argument would apply to an ongoing ESOP, especially if the ESOP owned less than 100% of the assets. If these rulings do hold up, they raise potentially important issues for ESOP fiduciaries, both with respect to stricter standards for setting executive pay and for the ability of companies to indemnify fiduciaries. Taken to its limits, the decision could make indemnification impractical or of limited value, since many ESOP lawsuits arise after a company is sold and many ESOP companies are 100% ESOP owned. In these cases, fiduciaries would have to rely entirely on insurance.