If you are a board member or senior executive of a company that is rapidly failing, what do you about employee benefits? No one has ever liked my answer: freeze the benefits. This is counterintuitive advice for someone who is trying to keep the company afloat, and who would be personally affected by the loss of benefits. But let me explain why this is so important, using a complaint that was recently filed by the DOL, and the facts as they were alleged.

In January 2010, Home Valu ceased operations due to financial difficulties. Creditors then filed an involuntary petition for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the District of Minnesota (Minneapolis). According to the complaint, Home Valu employees and beneficiaries incurred approximately a half million dollars of health care expenses that were not covered as of the filing. The company may purchase stop-loss coverage for large claims, but the coverage does not protect the employees from the company’s inability to pay.

Section 704(a)(11) of the Bankruptcy Code provides:

If, at the time of the commencement of the case, the debtor (or any entity designated by the debtor) served as the administrator (as defined in section 3 of the Employee Retirement Income Security Act of 1974) of an employee benefit plan, continue to perform the obligations required of the administrator.

Here, the bankruptcy trustee sought to recoup any payments the company made in its final three months, on the basis that the company was insolvent in its final months of operation, and the matter is still pending. This DOL filing suggests that the bankruptcy trustee has not helped these employees, which is a terrible result for people who believed they had medical coverage.

Given that the former employees apparently cannot recover on their Section 502(a)(1)(B) benefit claims, we next look to other ERISA claims, such as fiduciary breach and prohibited transactions, the next step is to look for “plan assets.” In the context of 401(k) plans, the DOL will rely on its regulation regarding timely contribution to trust to assert that any elective deferrals and loan repayments not paid to trust constitute plan assets, and that a fiduciary is liable for fiduciary breach and prohibited transactions for failure to make timely contributions. But if a company is failing and creditors are sweeping its corporate accounts, how does an executive have control of those accounts and “ensure” that the employee money is timely contributed to trust? While a 401(k) plan was not at issue in Home Valu, the DOL made essentially the same argument about life insurance premiums that were withheld from one payroll period.

The company could have made the settlor decision to terminate its welfare benefits when the company became insolvent, but did not. Recall, when making a settlor decision, the company is acting in its own best interests, and is not subject to ERISA fiduciary standards regarding participants’ best interests. When a company is failing rapidly, the board of directors and executives may believe that the financial decline can be reversed, and decide that it is in the company’s best interests to try to maintain the status quo with employees.

Home Valu maintained self-insured medical and dental plans, and a flexible spending account plan. As is typical, payments flowed through corporate accounts rather than through a trust. The plan sponsor announced on January 21, 2010 that it was terminating its plans effective the next day. The plan administrator last paid a claim on December 24, 2009, and the complaint argues that this means the plan sponsor actually terminated the plan on December 25, 2009. The complaint further alleges that employee contributions were plan assets, and that the executives were fiduciaries who breached their fiduciary duties and committed prohibited transactions with respect to these purported plan assets. The complaint also argues that the excess of flexible spending account contributions over reimbursements constitutes plans assets.

The amounts at issue appear to be less than $43,000. In many cases like this, a major creditor may be sweeping the corporate accounts, leaving executives with little or no control over the employee contributions. To the extent executives have any control over corporate assets, they lose that control when they lose their jobs, and certainly lose it when the bankruptcy trustee takes over. The claims may not have much chance on the merits, but may be enough to persuade the former executives and/or a fiduciary liability insurance provider to settle.

 Key Takeaway

If you are ever in the position of being a board member or executive whose company is declining rapidly, we suggest you consult immediately with your ERISA counsel about the right way and right time to freeze and terminate your employee benefit plans. These are difficult decisions, and you need to make the decisions from the proper perspectives, fully informed of the risks. Maintaining the status quo with the employees may seem like a good idea, but might not look so attractive once you realize the potential impacts on your employees and key executives.