Court Denies Summary Judgment for Lawsuit Against ESOP Fiduciaries

U.S. District Judge Dale A. Drozd from the U.S. District Court for the Eastern District of California has denied a motion by defendants in a lawsuit against Kruse Western Inc. for judgment on the pleadings, converted by the court into a motion for summary judgment.

The lawsuit alleges that the company’s employee stock ownership plan (ESOP) had purchased the defendants’ outstanding stock for almost 10 times its actual value as of the end of 2017. The defendants moved for judgment on the pleadings on the basis that the plaintiff knowingly and voluntarily released the claims brought in this action against each of the defendants when he signed a severance agreement with the company. They also said he lacks standing to bring the claims on behalf of the ESOP because he became a participant in the plan after the initial stock purchase.

The Severance Agreement

According to the judge’s order, upon resignation from his position at the company, the plaintiff signed a severance agreement that provided in part, “Employee  .. hereby releases and forever discharges employer, its subsidiaries and affiliates, and their respective present, former and future officers, directors, employees, stockholders, attorneys, insurers and agents, and their respective heirs, executors, administrators, successors and assigns … from any and all claims, demands, causes of action, obligations and liabilities whatsoever, whether or not presently known or unknown, or fixed or contingent … including, but not limited to, claims, demands or causes of action under … the Employee Retirement Income Security Act [ERISA].”

The defendants allege that the severance agreement was presented to and discussed with the plaintiff during his exit interview and that he was not told he had to sign the severance agreement on that same day. However, the plaintiff says the agreement was not discussed “in any detail with him during the exit interview.” He contends he understood that he would not receive an offered severance payment if he did not sign the documents but was not otherwise told what he was signing.

Drozd agreed with the plaintiff that his claims are brought on behalf of the ESOP, seeking to restore losses to the ESOP as a whole under ERISA Sections 502(a)(2) and (3), and that he cannot have released those claims without the ESOP’s consent.

The judge cites the case Bowles v. Reade, in which a retired plan participant filed an ERISA breach of fiduciary duty lawsuit on behalf of the plan. Two years after the plaintiff’s first complaint was filed, she signed a settlement agreement with the representative of the estate of one of the individual defendants and sought to dismiss all her claims against that defendant. A district court dismissed “all claims against [that individual defendant] belonging to Bowles” but found that “the agreement released ‘only those claims legally brought by Bowles and that Bowles [could not] and did not release the plans’ claims against [the individual defendant].’”

The 9th U.S. Circuit Court of Appeals affirmed the district court’s decision, holding that a plan participant cannot settle, without the plan’s consent, a Section 502(a)(2) breach of fiduciary duty claim seeking “a return to the plan and all participants of all losses incurred and any profits gained from the alleged breach of fiduciary duty.”

In addition, the 9th Circuit affirmed the district court’s decision that Bowles “remained as a plaintiff in her representative capacity on behalf of the plans and the participants notwithstanding the release of her individual claims against [the individual defendant].”

Standing

On the issue of the plaintiff’s standing in the Kruse Western case, the defendants rely on the decision in the Dorman v. Charles Schwab Corp. case to argue that plaintiff’s standing turns on his individual injury because Section 502(a)(2) claims are “inherently individualized when brought in the context of a defined contribution [DC] plan.”

The plaintiff argues that even if he became a participant in the ESOP after the ESOP’s purchase of Kruse Western stock, he “still suffered a concrete loss that is redressable in this lawsuit because the value and number of the shares in his ESOP account were and are affected by the ESOP’s payment of more than fair market value for the stock purchased in 2015.” He asserts that “the loan for this transaction was inflated by the amount of overpayment, thereby reducing the number of shares allocated to ESOP participants each year.”

The plaintiff supports his assertion by pointing out that the ESOP plan document notes that the ESOP borrowed funds for its purchase of the Kruse Western stock, shares are allocated to ESOP participants annually when the ESOP makes loan payments, and the number of shares released to participants is based on the amount of the transaction loan. He asserts that he suffered an injury in fact because he would have been allocated more shares if the ESOP had paid less for the stock than the allegedly greatly inflated value.

However, the defendants argue that the plaintiff suffered no redressable injury because he resolved any claims he might have by signing the severance agreement and its release of claims in exchange for a severance payment. They also dispute the contention that the plaintiff would have received a greater aggregate value in his individual ESOP account if he had in fact received more Kruse Western shares pursuant to an allegedly more accurate valuation of the stock.

Drozd was not persuaded by the defendants’ arguments. He noted that in Dorman, the 9th Circuit held that a former employee’s ERISA claims were subject to arbitration under the plan document’s arbitration provision because both the plan “expressly agreed in the plan document that all ERISA claims should be arbitrated,” and the plaintiff had agreed to arbitration on an individualized basis. However, the appellate court limited the arbitration to “individual claims … seeking relief for the impaired value of the plan assets in the individual’s own account resulting from the alleged fiduciary breaches.”

Drozd said that, unlike in Dorman, in the present case, even if the plaintiff’s release of claims were found to be valid, the defendants do not point to any evidence demonstrating that the ESOP released any of its Section 502(a)(2) claims.

As for whether the plaintiff suffered an injury, Drozd held that even though he became a participant in the plan after the initial stock purchase, he “has an equitably vested interest in those alleged ill-gotten profits held in a constructive trust held for the benefit of the ESOP.” In addition, he said, the losses in a breach of fiduciary claim arising from an ESOP’s purchase of private company stock are determined based “not only on the purchased shares’ price, but also on their value.”

Finally, Drozd found that the plaintiff presented evidence in the form of the ESOP’s plan document to support his contention that if the valuation of Kruse Western’s stock had not been grossly inflated at the time of the initial purchase, he would have been allocated more shares of Kruse Western stock when he became an ESOP participant. “If the alleged valuations prove to be accurate, the plaintiff will have suffered an injury in fact by receiving fewer shares of Kruse Western stock on January 1, 2017,” Drozd wrote in his order.