Be very afraid.  Danger lurks yonder.  If your company has an ERISA plan—and most do—make sure your corporate veil is intact.

The Employee Retirement Income Security Act (ERISA) is a federal law that sets minimum standards for pension and health plans offered by employers, including private businesses, to their employees.  ERISA covers health plans, retirement plans and many equity and option plans, including “phantom stock” plans.  For example, in the case of a privately owned company, a stock ownership plan offered to a broad range of employees in which the employees are given the opportunity to purchase shares of the employer’s stock at, say, 90% of book value, with a commitment by the employer’s to repurchase the shares at book value at the time of termination of employment, would be an ERISA plan.

Consider this hypothetical situation:  NewCo has a stock purchase plan that is subject to ERISA.  NewCo unexpectedly loses a number of important contracts and is forced into bankruptcy by its creditors.  NewCo’s stock is now worthless.  Who might the employees sue for the losses in their stock purchase plan accounts?  Newco, for not disclosing the risks of investment?  Maybe, but NewCo is insolvent, and besides, the employees were given a well drafted disclosure document before each purchase of shares that clearly identified the risk that the company’s financial condition depended entirely on retaining certain major contracts.  The directors, for breaching their duty of care to the company?  Perhaps, but the directors, who have the benefit of the “business judgment rule”, will argue that the loss of the major contracts was unforeseeable and, moreover, they obtained legal advice when setting up the plan and making proper disclosure to employees.

Who, then, can the employees sue?  There must be someone.  ERISA plan fiduciaries? Under ERISA, the individuals responsible for overseeing an employee benefit plan (plan fiduciaries) must act in the best interests of the plan participants; act prudently; and avoid conflicts of interest when managing the plan’s assets. Breaches of fiduciary duty can result in a lawsuit being filed against plan fiduciaries.  ERISA fiduciary liability can attach in two circumstances:  The first is when the plan expressly designates a person as a fiduciary, generally as the plan administrator, plan trustee, or member of an administrative committee.  No one is so named in our hypothetical scenario.  The second basis for ERISA liability is when a manager performs a function that ERISA deems a fiduciary function. Such functions include (i) discretionary authority or control over the management of the plan or any authority or control over management or disposition of the plan assets, (ii) the rendering of investment advice for a fee or other compensation, and (iii) discretionary authority or control in the administration of the plan.  If a court determines that a person is a fiduciary and has breached his or her fiduciary duty, liability attaches and the fiduciary is personally liable to make good the losses to the plan.  The former employees might try to use this “deemed fiduciary” argument against the directors because the directors did adopt the plan and had authority to amend it, but the directors will argue that they did not exercise any discretion over the plan and did not make any investments with plan assets.  They merely established the plan and let the employees make their own decisions.

Who is left?  What about the company’s owners on a theory of piercing the corporate veil?   Surprisingly, that idea might have legs, as suggested by the recent Federal court decision (Delaware) in Delaware court decision in Blair v. Infineon Tech. A.G., Civ. No. 09-295 (SLR), 2010 WL 2608959 (D. Del. June 29, 2010).   In its decision, the court noted that the standard for piercing the corporate veil was reduced in ERISA cases. Where does that come from?  The court cites two cases in support of its statement: United Elec., Radio & Mach. Workers of Am., 960 F.2d at 1092 (“In an ERISA case, the applicable federal standard can sometimes be less rigorous than its state common law counterparts. The rationale … is grounded on congressional intent.  ERISA clearly favors the disregard of the corporate entity in cases where employees are denied their pension benefits.”); and Alman v. Danin, 801 F.2d 1,4 (1st Cir. 1986) (“Allowing [the parent] of a marginal [undercapitalized subsidiary] to invoke the corporate shield in circumstances where it is inequitable for them to do so and thereby avoid financial obligations to employee benefits plans, would seem to be precisely the type of conduct Congress wanted to prevent.”).

In the Blair case, the plaintiffs, who were former employees of two subsidiary companies named as defendants, claimed that their former employer failed to make payments due under the companies’ group severance plan following a period of layoffs.  They sought to pierce the corporate veil of the subsidiary companies in order to hold the parent company liable for the severance payments.  The plaintiffs claimed that the parent misdirected funds, exercise crippling control and purposefully siphon profits from one subsidiary to prop up another.  Relying on these and other allegations, the court found that plaintiffs successfully alleged that the corporate parent and subsidiary defendants were a “single entity” under the alter ego doctrine, and that if the parent did what was alleged, then plaintiffs successfully alleged a sufficient case to pierce the corporate veil. While the Blair case (like United Elec) involved piercing the veil of a subsidiary to reach a parent corporation, the court in Blair noted that “the same principles apply to corporation/shareholders and parent/subsidiaries.”

Back to our hypothetical:  Suppose that the shareholders of NewCo were also the directors and senior executives of the company.  Suppose further that the former employees allege that the shareholders pulled cash out of the company in the form of bonuses and dividends too often and in excessive amounts, thereby causing the company to face a fatal liquidity crisis when the major contracts were lost.  Would a court find that the public policy underlying ERISA was more important than the corporate veil?  The question is impossible to answer because the concept of a “federal veil-piercing standard” seems to be little more than a court’s notion of what is fair.  One thing is certain.  The owners will incur significant legal fees to defend themselves in court.

If the dragon heads your way, it is better to have a castle with strong walls than a large sword. http://www.thecorpsec.com