March 5, 2020

New DOL Process Agreement Adds Provisions on Indemnification and Control

A new process agreement between the Department of Labor and Farmers National Bank (FNB) was made public on February 28. It lays out a much more detailed process for evaluating whether an ESOP actually has and can pay for control. It also prevents FNB from accepting indemnification and sets new hurdles for the advancement of fees in legal cases. The agreement was included in a settlement in the case of Scalia v. The Farmers National Bank of Danville and Weddle Bros. Construction Company, No. 1:20-cv-674 (S.D. Ind. Feb 28, 2020). Process agreements apply only to the parties involved, but they may indicate how the DOL would proceed in other actions. While much of the agreement reiterates prior agreements, this new one lays out some potentially troubling issues.

Control Issues

On control issues, the agreement states that “to the extent permissible under state and federal law, FNB will only approve a Transaction where the ESOP pays for a controlling interest if, in fact, the ESOP obtains the right to control the company whose stock it acquires. The right to control the company includes all of the unencumbered rights that a shareholder would have that acquired the shares to be purchased by the ESOP, and the right to control the company’s direction.” The agreement then lists over a dozen specific aspects of control other than electing the board, selling shares, monitoring for a waste of corporate assets, and other rights typically exercised by a shareholder. ESOP attorneys have argued that many of the enumerated rights are inconsistent with or contrary to state law, as well as impractical for ESOP trustees, although it could be argued the ambiguous wording of the agreement is limited to what is allowed under state laws and is not necessarily proscriptive in each case

Indemnification

On indemnification, the agreement states that “FNB will not enter into any agreement providing that it will be indemnified by the ESOP or by an ESOP-owned company (irrespective of whether the ESOP owns some or all of the company’s stock) against and from any damages, expense, liabilities, and losses resulting from claims of fiduciary breach and/or prohibited transactions related to the Transaction or that otherwise would be in violation of ERISA.  Specifically, FNB will not agree to indemnification provisions by the ESOP or the ESOP-owned company that result in advancement of defense fees and expenses unless an entirely independent third-party determines that there has been no breach of fiduciary duty. Under those circumstances, a prudent arrangement must be in place that guarantees, through the posting of collateral or otherwise, a refund of the entirety of the advanced fees and costs should a fiduciary breach be determined by a court. Any appreciable settlement amount of claims of fiduciary breach and/or prohibited transaction, i.e. more than a nuisance settlement, must result in a full refund of any fees and expenses.”

Indemnification for fiduciaries is already excluded in the Ninth Circuit but is allowed to one extent or another in other circuits, barring gross negligence. ERISA and the DOL, however, allow indemnification for non-ESOP plans. The provision also provides a cumbersome and arguably impractical process for the advancement of fees in legal cases that could deter many would-be fiduciaries from taking on an ESOP, something that is already becoming more difficult.

Implications

This agreement is specific to FNB; it is not clear whether the DOL would take the same position in any given case or how, if contested, a court would respond.

The May-June 2020 issue of our newsletter for members will contain an article by Ted Becker of McDermott, Will & Emery. For a side-by-side analysis of the new agreement with prior agreements, see the article by Holland & Knight Law.