Working business owner was a plan participant for ERISA purposes.

The Supreme Court recently held that the working owner of a business may qualify as a "participant" in a pension plan covered by the Employee Retirement Income Security Act of 1974 (ERISA), provided the plan covers one or more employees, other than the business owner and his or her spouse. Such a working owner, in common with other employees, qualifies for the protections ERISA affords plan participants and is governed by its rights and remedies.

Facts

Y was the sole shareholder and president of Y. P.C., a professional corporation, that maintained the X profit sharing plan. Y was the Plan administrator and trustee. From X's inception, at least one person other than Y or his wife was a participant. X qualified for favorable tax treatment under Sec. 401. As required by both Sec. 401(a)(13) and Title I of ERISA (29 USC Section 1056(d)), X contained an anti-alienation provision, which stated in relevant part,"[e]xcept for ... loans to Participants as [expressly provided for in the Plan], no benefit or interest available hereunder will be subject to assignment or alienation, either voluntarily or involuntarily."

Y borrowed $20,000 front the X money purchase pension plan, which later merged into the X profit sharing plan. The loan agreement required Y to make monthly payments over the five-year loan period. However, Y failed to make these payments. In June 1992, coinciding with the plan mergers, Y renewed the loan for five years and again made no monthly payments. In November 1996, he used the proceeds from the sale of his house to make two payments totalling $50,467, which fully paid off the loan's principal and interest.

Three weeks after Y repaid the loan to X, Y's creditors filed an involuntary Chapter 7 bankruptcy petition against Iron. The bankruptcy court determined that the loan repayment qualified as a "preferential transfer" under 11 USC Section 547(b). Thus, it voided Y's repayment of $50,467 to X and ordered X and Y as X's trustee, to pay the sum to the bankruptcy trustee.

Issue

The bankruptcy court held that, as a self-employed owner of the professional corporation that sponsored the pension plan, Y could not "participate as an employee under ERISA and ... [therefore could not] use its provisions to enforce the restriction on the transfer of his beneficial interest in the Defendant Plan." Thus, X and Y, as trustee, could not rely on X's ERISA anti-alienation provision to prevent the bankruptcy trustee from recovering the loan repayment.

The district court and the Sixth Circuit affirmed the bankruptcy court's judgment. The Supreme Court granted certiorari in view of the division of opinion among the circuits on the question of whether a working owner may qualify as a participant in an ERISA employee benefit plan.

Analysis

Because ERISA's definitions of "employee" and "participant" are uninformative, the Court looks to other provisions of the Act for instruction. ERISA's text contains multiple indications that Congress intended working owners to qualify as plan participants. Because these indications combine to provide "specific guidance," there is no cause to resort to common law.

Most notably, several Title I provisions partially exempt certain plans, in which working owners likely participate, from otherwise mandatory EP, ISA provisions. For example, under 29 USC Section 1101 (a), ERISA's fiduciary responsibilities do not apply to:

1. a plan which is unfounded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees; or

2. any agreement described in section 736 ... which provides payments to a retired partner or deceased partner or a deceased partner's successor in interest.

Under Sec. 414(q)(1)(A), a highly compensated employee is any employee who was a 5% owner. Under these rules, some working owners would fit this description. Similarly, agreements that make payments to retired partners, or to deceased partners' successors in interest, surely involve plans in which working partners participate. Exemptions of this order would be unnecessary if working owners could not qualify as participants in ERISA-protected plans.

In addition, under 29 USC Section 1321(b)(9), ERISA Title IV does not apply to plans established and maintained exclusively for substantial owners, a category that includes sole proprietors, shareholders and partners. However, it does cover plans in which substantial owners participate along with other employees (29 USC Section 1322(b)(5)(A)).

Particularly instructive, Title IV and the Code, as amended by Title II, clarify/a key point missed by several lower courts. Under ERISA, a working owner may have dual status; he or she can be an employee entitled to participate in a plan and, at the same time, the employer (or owner or member of the employer) who established the plan. Both Title IV and the Code describe the "employer" of a sole proprietor or partner; see 29 USC Section 1301 (b)(1) ("An Individual who owns the entire interest in an unincorporated trade or business is treated as his own employer, and a partnership is treated as the employer of each partner who is an employee within the meaning of [[section]401(c)(1) of [the IRC]."). Sec. 401 (c)(4) states, "[a]n individual who owns the entire interest in an unincorporated trade or business shall be treated as his own employer. A partnership shall be treated as the employer of each partner who is an employee within the meaning of [[section]401 (c)(1)]." These descriptions expressly anticipate that a working owner can wear two hats, as an employer and employee.

Congress' aim is advanced by this reading of the text. The working employer's opportunity personally to participate and gain ERISA coverage serves as an incentive to the creation of plans that will benefit employer and nonowner employees alike. Treating working owners as participants furthers ERISA's purpose to promote and facilitate employee benefit plans. Recognizing the working owner as an ERISA-sheltered plan participant also avoids the anomaly that the same plan will be controlled by discrete regimes: Federal-law governance for the nonowner employees; state-law governance for the working owner.

Finally, a 1999 Department of Labor (DOL) advisory opinion confirms that working owners may qualify as participants in ERISA-protected plans (Pension and Welfare Benefits Admin., U.S. DOL Advisory Opinion 99-04A). This agency view on the qualification of a self-employed individual for plan participation reflects a "body of experience and informed judgment to which courts and litigants may properly resort for guidance" (Steidmore, 323 US 134, 140 (1944)).

The Sixth Circuit read a DOL regulation (29 USC Section 2510.3-3(c)) to rule out classification of a working owner as an employee of the business. However, that regulation describes employees only for purposes of defining employee benefit plans; see 29 CFR Section 2510.3-3(b). According to the DOL advisory, opinion, the regulation clarifies that "employee benefit plan" includes a plan that covers one or more common law employees, in addition to the self-employed individuals. It does not govern who is a participant, once the existence of a plan is established.

Courts have also mistakenly relied on ERISA's "anti-inurement" provision (29 USC Section 1103(c)(1)), which prohibits plan assets from inuring to the employer's benefit. However, the anti-inurement provision does not preclude Title I coverage of working owners as plan participants. It states, with enumerated exceptions, "the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purposes of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan. "That provision demands only that plan assets be held to supply benefits to plan participants. Like file DOL regulation, the anti-inurement provision does not address the discrete question of whether working owners, along with nonowner employees, may be participants in ERISA-sheltered plans.

The anti-inurement provision, like the DOL regulation, establishes no categorical barrier to working-owner participation in ERISA plans. Thus, the judgment is reversed, and the case is remanded for further proceedings, to determine if (1) the November 1996 close-to-bankruptcy repayments become a portion of Y's interest in a qualified retirement plan, excluded from his bankruptcy estate and (2) if so, whether the repayments were beyond the reach of the bankruptcy trustee's power to avoid and recover preferential transfers.

RAYMOND YATES, M.D., P.C., S.Ct. (3/2/04)