DC arbitration clauses facing uncertain fate

For defined contribution plan executives who believe arbitration clauses can reduce or eliminate the risk and expense of ERISA lawsuits, beware of the fine print.

The fine print shows up in different opinions by federal judges in different jurisdictions, leading to a lack of consistent case law regarding how sponsors can use their plans' arbitration clauses to defend against fiduciary breach lawsuits.

The fine print shows up in the arbitration agreements that, if not carefully devised, can lead to unintended consequences, unanticipated expenses and unpleasant rulings against the sponsors. And just because sponsors add arbitration clauses to their plan documents, that doesn't mean they are inoculated from lawsuits.

Sponsors "are not getting a uniform or unified answer" from federal courts, said Joseph J. Torres, a Chicago-based partner at Jenner & Block.

As a result of court rulings and the challenges of creating arbitration clauses that don't run afoul of ERISA or states' laws or legal precedent, the theoretical allure of arbitration to avoid an expensive ERISA court battle may be tempered by unclear reality. Mr. Torres said his clients are cautious not only because of conflicting legal rulings but also because their cost-benefit analyses indicate arbitration might not be worth the time and expense.

"There is a lot of uncertainty," he said. Although some clients have asked about arbitration clauses, Mr. Torres said he hasn't talked to a sponsor actively considering adding one in the last six to eight months. That client decided to wait, Mr. Torres said, adding that, anecdotally, he believes arbitration clauses in DC plans are uncommon.

"In my experience, most DC plans do not have arbitration clauses — but a growing minority do," said Carol I. Buckmann, founding partner of the New York law firm Cohen & Buckmann PC.

Arbitration clauses are "not in the majority of DC plans," said Kimberly A. Jones, Chicago-based partner at Faegre Drinker Biddle & Reath LLP, referring to sponsors.

Still, some sponsors "believe it's a best line of defense" against fiduciary breach lawsuits, she said. In the past two years, 10 to 15 of her clients have talked to Ms. Jones about arbitration clauses and five to seven have added them, she said.

Enforcement of arbitration clauses come up in a variety of cases in which plaintiffs in retirement plans allege fiduciaries have violated ERISA for, among other things, charging excessive fees, retaining poor-performing investments and engaging in self-dealing through their choice of service providers.

Because rulings in one judicial district aren't binding on other districts, sponsors often are unsure how to proceed.

"I'm not seeing a push by plan sponsors to add arbitration clauses to retirement plan documents," said Michael Weddell, Southfield, Mich.-based director of retirement for Willis Towers Watson PLC, in an email.

"One of the problems with putting arbitration into plan documents, SPDs (summary plan descriptions) and claims procedure denial letters is one doesn't avoid litigation but instead has to litigate about whether the mandatory arbitration clause is enforceable, something that the courts don't agree upon," Mr. Weddell wrote.

One example of disagreement often cited by ERISA attorneys are rulings by the 9th U.S. Circuit Court of Appeals, San Francisco, and the 7th U.S. Circuit Court of Appeals, Chicago.

In August 2019, the 9th Circuit judges supported the argument by Charles Schwab Corp. that an ERISA complaint by a former 401(k) plan participant was subject to arbitration.

The appeals court said the key issue here was that the arbitration clause was part of the 401(k) plan rather than as part of an individual employment agreement. Because the arbitration clause was part of the plan, all participants were considered to have consented, the judges wrote.

However, in September 2021, the 7th Circuit judges arrived at a different conclusion in Smith vs. Board of Directors of Triad Manufacturing Inc. et al.

The appeals court supported a ruling by a federal District Court that had rejected the defendants' claim that allegations of ERISA violations in managing an employee stock ownership plan should have been resolved through arbitration.

Even though Triad had an arbitration clause built into the ESOP, the provision contained terms that "prohibits the relief that ERISA expressly permits," wrote the judges, rejecting the defendants' argument that the complaint was governed by arbitration.

Different rulings in different jurisdictions mean "some sponsors want to wait," Ms. Buckmann said. The key to writing an arbitration clause for a DC plan is to "craft a provision that all courts will accept," she said.

As federal district and appeals courts offer different interpretations, some ERISA attorneys said the Supreme Court may be asked to address how arbitration fits in with ERISA.

"It's risky to predict what the Supreme Court will do," Ms. Buckmann said.

Attorneys also noted that Congress might get involved. In May, Sen. Tina Smith, D-Minn., and Rep. Mark DeSaulnier, D-Calif., introduced legislation that would declare arbitration clauses unenforceable in retirement and other benefits plans covered by ERISA. However, interviewees said they were unsure when or if Congress might act — but certainly not before the midterm elections in November.

In assessing the pros and cons of arbitration clauses, ERISA attorneys said the pros are relatively simple. "All things being equal, arbitration could be more efficient and less costly," Mr. Torres said.

The cons, however, are more complex. For example, arbitrators aren't held to any legal precedent even though judges are, and there's virtually no chance of appealing an arbitrator's decision unless the parties could prove corruption, fraud or some other significant error, Ms. Jones said.

"Courts are very reluctant to second-guess an arbitrator," Mr. Torres said.

Attorneys said sponsors who hope an arbitrator will deliver a complete victory could be disappointed if the arbitrator isn't familiar with ERISA or if the arbitrator, being deferential to both parties, issues a split decision rather than a winner-take-all ruling. Arbitration isn't cheap; the parties still must prepare documents to educate the arbitrator.

Arbitration can produce uncertainty for plan fiduciaries, said Mark B. Blocker, a Chicago-based partner at Sidley Austin LLP. "There's some hesitancy (among clients) as to how it would work," he said. For example, what would fiduciaries do if an arbitrator said an investment option was imprudent in the past by ERISA standards but they believed the investment was prudent today, Mr. Blocker said.

As a result, "we haven't had any groundswell of (sponsors) asking about arbitration," Mr. Blocker said. "We do not see them (arbitration clauses) that frequently now."

ERISA attorney Todd D. Wozniak said sponsors can build their arbitration clauses with certain features, such as requiring a panel of perhaps three arbitrators to reduce the risk of a single adverse opinion. Of course, that will add to the cost, said Mr. Wozniak, an Atlanta-based partner at Holland & Knight LLP.

Another feature is setting a statute of limitations on participants filing an arbitration claim. Judges have looked to state courts for guidance because ERISA doesn't have a statute of limitations for arbitrating benefits claims, he said. Courts have said such a time frame should be "reasonable" without providing a one-size-fits-all guideline.

Mr. Wozniak recommends this strategy regardless of whether a plan has an arbitration clause, adding that sponsors also should insert a provision in their plans that mandates a specific venue for resolving disputes. If, for example, a company is based in one state and an employee leaves or retires to another state in a different judicial district, any plaintiff claim would be governed by the laws of the employer's judicial district. Sponsors should have venue mandates whether they have or lack an arbitration clause, he said.

Clients "are looking for ways to defend themselves proactively," Mr. Wozniak said. "They are concerned about the extensive fee litigation and investment lineup litigation."