Opinion ID: 693407
Heading Depth: 3
Heading Rank: 2

Heading: The Use of Residual Plan Surplus as Collateral

Text: 105 Plaintiffs allege that PLC also engaged in a prohibited transaction in violation of ERISA Sec. 406, 29 U.S.C. Sec. 1106, in obtaining a bridge loan to finance MGI's takeover of PLC. In obtaining the loan, PLC pledged as collateral the right to receive the future residual distributions from the Plan after the Plan's termination, the purchase of annuities, and other required distributions. Plaintiffs asserted below that this transaction violated the prohibition in Sec. 406 on dealing with a plan asset for the benefit of a party in interest. The district court dismissed this claim, ruling that the pledge of collateral was not a prohibited transaction because the collateral pledged was a contingent right and not an actual plan asset. 106 Neither Plaintiffs nor Defendants cite any authority addressing whether a contingent right to receive plan surplus following distribution constitutes a plan asset. Defendants cite numerous cases supporting the proposition that residual plan assets can legally revert to the employer after plan termination. However, this point is not disputed and is inapposite to whether the use of a contingent right of reversion prior to plan termination constitutes a prohibited transaction. Defendants also cite case law on security interests indicating that the pledge of the right to receive anticipated funds is the pledge of a general intangible, not an interest in the underlying asset. 107 This court has adopted a broader functional definition of what constitutes an asset of the plan for purposes of Sec. 406. In Acosta v. Pacific Enterprises, 950 F.2d 611 (9th Cir.1991), this court stated:ERISA's legislative history makes clear that the crucible of congressional concern was misuse and mismanagement of plan assets by plan administrators and that ERISA was designed to prevent these abuses in the future. In light of Congress' overriding concern with the protection of plan participants and beneficiaries, courts have generally construed the protective provisions of Sec. 406(b) broadly.... 108 Appellees argue that the term assets of the plan encompasses only financial contributions received by the plan administrators. We decline to cabin the term in such a restrictive definition. Congress' imposition of a broad duty of loyalty upon fiduciaries of employee benefit plans counsels a more functional approach. To determine whether a particular item constitutes an asset of the plan, it is necessary to determine whether the item in question may be used to the benefit (financial or otherwise) of the fiduciary at the expense of plan participants or beneficiaries. 109 Id. at 620 (citations omitted). It is clear from Acosta that assets of the plan is not defined in strictly financial terms, but rather is determined by examining whether the item in question may be used to the benefit (financial or otherwise) of the fiduciary at the expense of plan participants or beneficiaries. Id. In Acosta, the alleged asset of the plan was a participant-shareholder list. In Acosta, however, we did not reach the question of whether or not this list was a plan asset; rather, we affirmed on the ground that the fiduciaries' use of the list did not constitute self-dealing. Id. 14 110 Therefore, in this circuit there is a twofold functional test as to whether an item in question constitutes an asset of the plan: (1) whether the item in question may be used to the benefit (financial or otherwise) of the fiduciary, and (2) whether such use is at the expense of the plan participants or beneficiaries. In this case, it is unquestionable that the contingent interest at issue was used to the benefit of the fiduciary, by helping finance the takeover. The question is whether it was used at the expense of the Plan participants. 111 PLC correctly points out that the loan transaction did not jeopardize the assets of the Plan, nor did it affect Plaintiffs' vested benefits under the Plan. The loan document cited by Plaintiffs, which indicates that the loan would be in default if the plan incurred liabilities, evidences the bank's concern with its future interest, but it does not in any way indicate that the bank would be able to reach plan assets upon such a default. Therefore, the Plan assets were never at risk by being indirectly put up as collateral. 112 In enacting ERISA, Congress was concerned about the mismanagement of plan assets to the detriment of the plan and its beneficiaries. Although in this case the Plan assets themselves were never put at risk, the Plan fiduciary used funds--which were plan assets--as collateral for a purpose which did not benefit the Plan. The purpose and end result of this use was the termination of the Plan. While this did not directly hurt the beneficiaries, since annuities were purchased, it can hardly be argued that it was for the benefit of the Plan. 113 It is clear from legislative history that in enacting Sec. 406, Congress was not only concerned with deals between the plan and a fiduciary: 114 As in other situations, this prohibited transaction may occur even though there has been no transfer of money or property between the trust and any party in interest. For example, securities purchases or sales by the trust in order to manipulate the prices of securities to the advantage of a party in interest constitute a use by, or for the benefit of, a party in interest of any income or assets of the trust.S.Rep. No. 383, 93d Cong., 2d Sess. (1974), reprinted in 1974 U.S.C.C.A.N. 4890, 4982. The legislative history goes on to indicate a policy against conflicting interests when contemplating termination: 115 The bill also treats as a prohibited transaction investments which jeopardize the income or assets of the trust.... Of course, the prohibited transaction provisions do not prevent an employer, on termination of his plan, from recovering assets not needed to pay plan benefits.... If termination is contemplated, it should be clear that investments are not being made or maintained with the interests of potential remaindermen in mind in any case where this is in conflict with the interests of the participants or beneficiaries. 116 Id. at 4984-85. 117 In light of the legislative history revealing a policy against self-dealing in plan termination and this court's policy of interpreting the fiduciary duty broadly, we hold that the collateral for the bridge loan was a plan asset. Corporations should not be permitted to rely on their ERISA plan assets to finance takeovers or other risk ventures. One of the reasons Sec. 406 was included in ERISA was that Congress was apprehensive that exceptions to the common law rules against self-dealing were unduly eroding the underlying principle and included Section 406 as a barrier to such erosion. Lowen v. Tower Asset Management, Inc., 829 F.2d 1209, 1215 (2d Cir.1987) (citing S.Rep. No. 127, 93d Cong., 2d Sess., reprinted in 1974 U.S.Code Cong. & Admin.News 4838, 4865). It is clear that the fiduciaries involved here had in mind only their own interests, or those of a party in interest, when setting up the bridge loan. Such conflicting loyalties should be discouraged. We reverse the district court's dismissal of this prohibited transaction claim.