Guest Article

(From the April 17, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

DOL Updates Prohibited Transaction Exemption for Interest Free Loans to Plans

The Department of Labor's Employee Benefits Security Administration (EBSA) has updated its prohibited transaction class exemption (PTE 80-26) relating to interest free loans to plans by removing the three-day duration limit that applied to loans for purposes incidental to the plan's ordinary operation. However, the updated exemption adds a new requirement for such loans to be in writing if their terms are for 60 days or more. Plan sponsors might find the updated prohibited transaction exemption useful if their plans are experiencing short-term liquidity problems.

Background

In general, both ERISA and the Internal Revenue Code prohibit certain transactions between employee benefit plans and "parties in interest." These prohibited transactions include the "... lending of money or other extension of credit between the plan and a party in interest," and the "... transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan." See ERISA § 406(a)(1)(B), (D) and IRC § 4975(c)(1)(B), (D). Additionally, a plan fiduciary may not "... in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries." See ERISA § 406(b)(2). A "party in interest" with respect to a plan includes the plan sponsor, a plan fiduciary, and a service provider to the plan. See ERISA § 3(14).

If a plan is experiencing temporary cash flow problems, it may make sense for the plan sponsor to loan money to the plan to pay benefits, insurance premiums, expenses, etc. But the prohibited transaction rules clearly preclude plan sponsors from making such loans to plans. However, the Department of Labor exercised its authority under ERISA § 408(a) to issue PTE 80-26 to permit such loans in certain circumstances. As originally issued, PTE 80-26 applied to loans between a party in interest and a plan only if --

The Department of Labor previously has supplemented PTE 80-26 with temporary exemptions for loans relating to the "Y2K" problem and the temporary market disruption caused by the September 11, 2001 terrorist attacks. This latest update to PTE 80-26, which is effective as of December 15, 2004, is permanent.

Updated PTE 80-26

The updated PTE 80-26 makes several changes to the original version. As noted, the updated PTE eliminates the three business day limit on loans used for purposes "incidental to the ordinary operation of the plan." Also, if the term of any loan is 60 days or longer there must be a written loan agreement that contains all of the loan's material terms. The effective date of this written loan agreement requirement is different for loans used to pay ordinary operating expenses and for loans used for purposes incidental to ordinary operations. Specifically, the requirement applies to loans entered into on or after April 7, 2006, for loans used to pay ordinary operating expenses, and to loans entered into on or after December 15, 2004 for incidental purpose loans.

Additionally, the updated PTE 80-26 includes a provision to clarify the exemption is not available for loans enabling employee stock ownership plans (ESOPs) to acquire qualifying employer securities. These loans are covered by a special statutory and regulatory exemption. See ERISA § 408(b)(3) and DOL Reg. § 2550.408b-3, and IRC § 4975(d)(3) and Treas. Reg. § 54.4975-7(b). However, other loans to ESOPs may be covered by PTE 80-26.

Limitations of PTE 80-26

As with the original PTE 80-26, the updated exemption applies only with respect to ERISA §§ 406(a)(1)(B), (D) and 406(b)(2), and IRC § 4975(c)(1)(B), (D). Before making a loan or extending a line of credit to a plan, the plan sponsor or other party in interest and plan fiduciaries should be certain the transaction does not run afoul of other prohibitions. For example, ERISA § 406(b)(1) prohibits fiduciaries from dealing with plan assets in their own interest or for their own account, and ERISA § 406(b)(3) prohibits fiduciaries from receiving any consideration for their own personal account from any party dealing with the plan in connection with a transaction involving the plan's assets. Additionally, PTE 80-26 does not provide relief from ERISA's fiduciary requirements.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2006, Deloitte.