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Northern District of Illinois Nixes Mandatory Arbitration in ERISA Lawsuit

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Appeal pending before the Seventh Circuit

Chicago, ILOn January 25, the Northern District of Illinois denied Triad Manufacturing’s attempt to force ESOP participants to individually arbitrate their claims of fiduciary self-dealing. The ERISA lawsuit, James Smith v. Board of Directors of Triad Manufacturing Inc., alleged that the Board of Directors caused the plan to buy Triad stock at an inflated price, harming retirement savers for the benefit of individual board members who were also, not coincidentally, the sellers of the stock. The Court held that plan participants may now continue to the merits of their fiduciary breach lawsuit on a class-wide basis.

The District Court’s opinion stands in stark contrast to the Ninth Circuit’s holding in Dorman v. Charles Schwab Corp., which compelled arbitration of ERISA breach claims. Whether and when ERISA claims must go to arbitration has been a thorny question for years. The Seventh Circuit will hear Triad’s appeal on March 30. If the Seventh Circuit upholds the District Court opinion, it is likely that Triad will petition for certiorari to the U.S. Supreme Court.

The underlying ERISA claims

Smith v. Board of Directors, which focuses specifically on the arbitration issue, has a considerable back story. It is a further iteration of Smith v. GreatBanc Trust Company. In the GreatBanc lawsuit, participants and beneficiaries in the Triad Manufacturing, Inc. Employee Stock Ownership Plan (Triad ESOP) argued that David Caito, Robert Hardie, and Michael McCormick (the Selling Shareholders), and the ESOP’s Trustee, GreatBanc, violated ERISA.

In December 2015, the Selling Shareholders sold all of the company’s stock to the newly-created Triad ESOP for approximately $106 million. Roughly two weeks later, the value of the stock dropped to $3.3 million, a decline of 97 percent. The participants lost their shirts, and the Directors who sold the stock pocketed a tidy profit.

This was, the participants argued, more than just a bad deal. The participants claimed that the ESOP was induced to pay more than fair market value for the Triad stock because the Directors and the Trustee violated ERISA’s fiduciary requirement that plan assets be managed solely in the interest of participants and beneficiaries.

The forced arbitration issue

On its face, the latest kerfuffle is not about that, however. In theory, Smith v. Board of Directors is only about whether the participants can bring a class action ERISA lawsuit or whether they must arbitrate their claims individually.

In truth, the procedural battle is pretty much the whole story because individual arbitration is notoriously unfavorable to plaintiffs. The circumstances of the ESOP’s arbitration requirements are also suspicious.

When the Triad ESOP was established, it contained no arbitration provision or requirement that participants waive their right to proceed in a class action lawsuit in the event of a dispute. In 2018, the Board amended the ESOP to add these provisions. This was
  • after the alleged ERISA fiduciary breach;
  • after Smith and other participants filed Smith v. GreatBanc Trust Co., the underlying ERISA lawsuit;
  • after plaintiff, James Smith, left his job at Triad Manufacturing; but
  • before he had the right to access his retirement funds and plausibly claim that he had suffered an injury.

District Court goes for the public policy argument

The Northern District of Illinois seems to have particularly focused on the after-the -fact amendment, ruling that Smith was not bound to an agreement that he had not had the chance to accept or refuse. In short, the court rejected the contract argument advanced by Triad.

The Seventh Circuit has now been briefed on broader arguments that re-visit the old (but troubling) legal maxim that the law does not have a remedy for every injury. Hoary though it may be, it seems unjust to many, including lawyers.

AARP, for example, argues that Sections 409 and 502 of ERISA, permit participants to seek remedies that would protect the entire plan, rather than just the rights of an individual beneficiary. This would imply a legal right to pursue a class action lawsuit, rather than individual arbitration. The remedy, it claims, already exists in the law.

The loss of that remedy seems to come from a contractual provision to which the plaintiffs were not parties. It’s an old dance that falls into an often-repeated pattern: corporate defendants argue contract law, while employee plaintiffs argue about the public policy that animates the statute enacted by a legislature. Which trumps which?

What about the Ninth Circuit?

In its 2019 decision in Dorman, the Ninth Circuit went for the contract argument, as expanded in the U.S. Supreme Court’s decision in American Express Co. v. Italian Colors Restaurant. The Ninth Circuit embraced the general rule that “[c]laims alleging a violation of a federal statute such as ERISA are generally arbitrable absent a ‘contrary congressional command.’”

If the Seventh Circuit reaches for a broad public policy argument and rules for the participants on the arbitration issue, the stage is set for a Supreme Court battle. The high Court may or may not decide to take the case. If it declines to do so, it would likely only be a matter of time before the question comes up again.


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