In prior issues, we have noted that the Employee Retirement Income Security Act of 1974 (“ERISA”) provides various measures to safeguard accrued retirement benefits from claims of a plan participants’ creditors. Employers generally are not allowed to use benefits to offset claims against employees/plan participants, such as a failure to repay loans or excess expense account charges. Other creditors generally are barred from attaching benefits to repay claims or debts. Although ERISA “spendthrift” or “anti-alienation” protections for such benefits are subject to certain exceptions, an employer or creditor is apt to be frustrated in collection attempts against a “bad boy’s” benefits.
Courts have applied ERISA anti-alienation provisions to stymie collection attempts where employees have breached contractual or fiduciary obligations, embezzled monies, or stolen company assets. Particularly interesting situations have arisen in bankruptcy proceedings, where employers or creditors have sought to include plan benefits as part of a bankrupt participant’s estate. For example, in Patterson v. Shumate, an employee-participant filed bankruptcy at the same time as his employer. The employer had maintained a pension plan in which the employee, Shumate, had vested benefits of $250,000. The employer terminated the plan and distributed plan benefits to all employees but Shumate. The bankruptcy trustee sought distribution of the benefits for application to payment of Shumate’s debts, under a line of cases that differentiated between state and federal protective laws when deciding whether to apply ERISA anti-alienation rules in bankruptcy proceedings. The Supreme Court eliminated the state-federal distinction and concluded that ERISA rules would apply in all bankruptcy proceedings, thereby barring creditor recourse to Shumate’s plan benefits.
Another case, Yates v. Hendon, involved another bankruptcy situation addressed by the Supreme Court. In that case, Yates, a doctor and the sole shareholder of a professional corporation that maintained a retirement plan, took out a plan loan which he promised to repay pursuant to a note executed in favor of the plan. He made no payments for many years, but repaid the loan in full just three weeks before his creditors filed an involuntary bankruptcy against him. The creditors claimed the repayment of the loan constituted a preferential transfer which could be set aside in the bankruptcy proceeding to recapture the funds for application to the payment of Yates’ debts. The creditors relied upon a narrow reading of the term “employee” to argue that Yates, as an owner, could not be an employee for ERISA purposes and, therefore, the anti-alienation rules did not apply, a position that had been adopted by various federal courts. The Supreme Court rejected that argument and overruled the other courts’ rulings. It then sent the matter back to the lower court to determine whether the funds could be attached.
The IRS has been permitted to execute federal tax levies against plan benefits and to collect judgments resulting from unpaid federal tax assessments. Benefits are also subject to claims resulting from crimes or violations under ERISA, as well as claims under qualified domestic relations orders. Of course, benefits also may be attached once they are distributed from a plan and creditors have been successful in obtaining injunctions to prevent benefit recipients from diverting funds as they are received.
If you desire additional information on “bad boy” claims, or guidance in attempting to recover plan benefits, please contact our office.