I am not a fan of binding arbitration in the context of ERISA plans, and a new Sixth Circuit decision, Schafer v. Multiband Corp., demonstrates why.

Two individuals (Schafer and Block) founded a company. As part of a series of corporate transactions, two employee stock ownership plans (“ESOPs”) were formed. Schafer and Block were appointed as trustees of the ESOPs, and entered into indemnification agreements with mandatory arbitration clauses. While the DOL was investigating its suspicion that the ESOPs had purchased stock at inflated prices, and with knowledge of this, Multiband entered into a purchase agreement to buy the holding company. As part of the transaction, Multiband entered into indemnification agreements that contained essentially the same provisions as the prior agreements.

Subsequently, the DOL informed Schafer and Block that it believed they had breached their fiduciary duties by allowing the ESOPs to purchase stock at inflated prices, and offered to settle for $42 million. Schafer and Block asked Multiband to indemnify them in accordance with the agreements, and Multiband refused. Schafer and Block agreed to settle with the DOL, paying $1,450,000 each, and Multiband again refused to indemnify them.

Schafer and Block filed an arbitration complaint. The arbitrator concluded that under ERISA Section 410(a), an indemnification agreement is categorically void as against public policy. The arbitrator rejected a DOL interpretive bulletin permitting indemnification agreements, finding the bulletin “entitled to no deference.” The district court vacated the arbitrator’s decision on the basis that “manifest disregard for the law” survives as a basis for vacating an arbitrator’s decision. The Sixth Circuit agreed that the arbitrator’s decision was legally unsupportable under Sixth Circuit precedents, such that the Court would reverse the decision if made by a district court. But the Court held that clear legal error by itself is not sufficient grounds for vacating an arbitrator’s decision. In reversing the district court’s decision, the Court held that if the arbitrator relies on a colorable meaning of the words, the fact that Sixth Circuit precedent is contrary is not determinative.

As an aside, arbitration is not the only risk to trustee indemnification agreements. In a series of cases including Johnson v. Couturier, 572 F.3d 1067 (9th Cir. 2009), the DOL has argued that company assets are ERISA plan assets, and that indemnification agreements of ESOP trustees are invalid because they reduce the value of the company. The DOL has also argued against indemnification of a fiduciary in the context of settlement, and argued against advancement of the trustee’s defense costs. These arguments were rejected in the most recent decision, Harris v. GreatBanc Trust Co., Sierra Aluminum Co., & Sierra Aluminum ESOP, Case No. 5:12-cv-01648-R, 2013 U.S. Dist. LEXIS 43888 (C.D. Cal. Mar. 15, 2013). The willingness of individuals to serve as trustees, and the cost participants must bear to pay trustees, are impacted by these challenges.

Binding arbitration has its place, and may sound appealing to plan fiduciaries who are exposed to ERISA class actions. But before you drink the Kool-Aid, consider what happened in Schafer. The buyer entered into the purchase transaction fully informed, and signed indemnification agreements with apparently no intent to honor them. The ESOP trustees then appeared before an arbitrator who decided that the DOL’s longstanding guidance was subject to no deference, and rejected established Sixth Circuit precedence, under the “narrowest standards of judicial review in all of American jurisprudence.” The arbitrator’s decision was legally unsupportable, and the trustees lost anyway. Does binding arbitration control your costs in the context of ERISA plans, or expose you?

(For a more detailed discussion of arbitration in the context of the Schafer decision, check out our sister blog, Employer Law Report, here.)