Plan loans and payroll deductions

[R. Butler]

I know that this topic has been discussed extensively, but there does not seem to be a consensus. We have a plan that allows loans, requires repayment via payroll deduction. Participant wants to stop payroll deductions and default on the loan. Can the employer allow the particicpant to rescind the payroll deduction and default on the loan?

In prior threads, the main concern was state law. Many threads suggested that state law required the payroll deductions to stop at the participant's request. In Advisory Opinion 96-01A, doesn't the DOL suggest that state law is preemepted by ERISA?

[Guest hank]

Advisory Opinion 96-01A was a narrow advisory opinion dealing with a very specific provision of Puerto Rican law that was designed to regulate the administration of benefit plans otherwise regulated under ERISA. Most states, I believe, have broader statutes which permit employers to make payroll deducts only when authorized by the employee or by law.

If an employee no longer wishes to authorize a pay deduct and the result is a loan default, I would advise the employer to stop making the pay deduct (and direct the plan administrator to inform the participant in writing of the tax consequences of a plan loan default).

[R. Butler]

Although I agree that 96-01A can only be relied for the specific facts set forth in the opinion, doesn't ERISA §§514(a) and 514(B) and they do seem to state that ERISA would preempt state law in similar sitauations?

[Bob R]

One would think that there is ERISA pre-emption. But, it's not clear. A similar issue arises with negative elections. Can you withhold money out of a paycheck without written authority? A request has been sent to the DOL to rule on this because in CA you need consen. But, the DOL has not responded.

[Kirk Maldonado]

What about Advisory Opinion 94-27A?

[MoJo]

Perhaps I'm being dense here, but why would ERISA preempt state withholding laws? The ability to get a loan from a plan may be an ERISA/Code preemption issue, but the form of repayment is not - and under the doctrine of preemption as implemented in ERISA, ERISA only preempts state law only to the extent it relates to an ERISA covered plan. Payroll deduction for repayment of a loan does not, in my humble opinion, "relate to" a benefit plan - it relates to the source of funds for purposes of repaying a loan. It appears that the fact that the loan is from ERISA plan is only incidental.

Consider this - a DB plan makes a loan to a contractor as an investment (prudent? maybe not, but certainly legit...). If the contractor defaults on loan, is the resultant action to enforce it now an ERISA based action, with jurisdiction vested in federal courts, merely because the loan was from an ERISA plan? I think not.

My policy has always been to allow the participant to stop payment through payroll deduction, then to default the loan. Of course, as a good fiduciary, one should *still* attempt to collect the loan..., but that would be a different thread....

[R. Butler]

It seems to me that 94-27A also indicates ERISA §514 would preempt state withholding laws. I spent alot of time researching this issue and it seems to me that employee should not be able to rescind the payroll deductions. However, most of the people I spoke with (and they are much more knowledgeable than I am) disagree. They cite state withholding laws, but they don't seem to be able explain to me why ERISA §514 does not apply. I have difficulty with the arguement of ERISA not dictating the form of repayment because how do you explain the advisory opinions (or negative elections for that matter)?

Even though I don't necessarily agree, for right now I acquiesed to the majority and advised the employer to stop payroll deductions.

[Guest hank]

There may be a practical aspect to disregarding the ERISA preemption element and abiding by state wage payment laws as to employee consent for deductions from pay. Many such laws (e.g., Pennsylvania) provide for criminal penalties as well as multipliers for economic damages (not to mention attorneys' fees!) for "knowing" violations by employers. Faced with the prospect of state court actions to enforce state laws with those risks, many employers may opt to take the "safe" course and comply with the state wage payment law rather than undertake to litigate (again, in state court) the ERISA preemption defense to not complying.

That's not to suggest that the preemption argument fails to hold intellectual water. It's only to indicate that employers may evaluate these risks in a conservative way and comply when maybe they don't really have to.

For what it's worth!

[MoJo]

Ah, R. Butler.... I have been fortunate to have once worked with Dean Hopkins, an attorney in Cleveland who fought the IRS in the case of O'Neill v. Secretary (IRS), (1969, I think).... The case basically forced the IRS to recognize partnerships as employers of the partners for purposes of providing qualified plan benefits. Up till that point, the IRS had issued regulatory guidance indicating that partners in partnerships were not employees for purposes of receiving benefits (I realize this is a huge oversimplification of the issues in this case)....

Nonetheless, Dean's trademark line was that "the IRS' opinion in its regulations are but one interpretation of the law, and not necessarily a correct one."

The same may hold true for the DOL and its advisory opinions....

I wouldn't advocate a wholesale disregard for agency pronouncements, but alas, I feel compelled to always ask "why?" Explain to me how the method of repayment of a participant loan "relates" to an employee benefit plan. The method of repayment has nothing to do with the provision of benefits, nor with purpose of the loan feature. It generally is dictated as a matter of administrative convenience, and *arguably* as an easy means for the fiduciaries to fulfill their obligation as fiduciaires to seek repayment. It is by no means the *only* way in which to accomplish these goals, and while deference must be given to the fiduciaries in selecting how to implement such a feature, these policies surrounding the implementation are not part of the statutory and regulatory framework that surround such a feature (ie, the PT exception language in ERISA, and the Section 72 requirements in the Code)....

Far too often we assume that something that "touches" a plan, "relates" to it for purposes of preemption. In our federalist-republic form of government, that is not (always) the case. If in fact it were, then virtually every activity I do (as an attorney and consultant with respect to qualified plans) would be regulated by ERISA - as what I do affects the benefits that participants ultimately receive (including plan design, interpretation, negotiations, etc.). I thank God that such is not the case....

[R. Butler]

Nonetheless, Dean's trademark line...

I realize that advisory opinions only apply to the facts of the particular case. I agree that DOL opinions are but one interpretation of the law. However, in this case they are only interpretation I can find. I have looked for case law and have not found any on point.

As far as how the method of repayment relates to ERISA, again I would refer you to DOL advisory opinion 96-01A. That issue dealt with discretionary methods of loan repayments. In reaffirming a previous DOL position the opinion states, "Although the Department's previous opinions did not address the specific issue here, which concerns the discretionary methods by which to operate a loan program, we reach the same conclusion."

Most of us readily accept that negative elections are permissable. It is not the only means of enrolling participants; it is not even the most widely used method. Why does ERISA preempt state withholding laws with negative elections, but not loan repayments?

Now I do realize I am probably in the minority. For the very reasons Hank mentions in his post, I did acquiesse and advised the client to stop withholding.

[MoJo]

I think the distinction between negative elections and loan repayments is that negative elections affect a benefit contribution - a concept which is central to the idea of a qualified retirement plan containing a CODA - that of providing retirement income or income deferral. Loan repayments are in fact ancillary to the benefit - indeed, loans themselves are not part and parcel of the benefit, but rather are an INVESTMENT of the plan, which has been exempted from the PT consequences for political reasons. Loans, and their associated repayments have no relevance to the purpose of the plan, which is to provide retirement income (or at least income deferral).

Now, before you say "wait a minute - whether a loan is repaid or not does affect the ultimate benefit" consider that if ANY investment of the plan goes bad, benefits are affected. That doesn't mean ERISA preempts investment management laws, or "blue sky" regulations, or anything else. Loans are investments. they aren't central to the purpose of the plan.

The means of electing a deferral amount, being so central to the benefit to be provided, may as well be an area of exclusive federal jurisdiction, but last time I checked, the issue was still being litigated. Cases are pending in AZ, CA and NY (that I know of), and the DOL has not "officially" given an opinion on negative elections (although unofficially, they - at least PWBA - has indicated that it seems ok - it'll be interesting to see whether the other parts of the DOL - specifically those charged with enforcing worker rights - believes that negative elections are a good thing).

[R. Butler]

Points well taken. I understand your arguments, I just don't necessarily agree with the conclusion. Maybe one day case law or statute will give a definitive answer.

[Kirk Maldonado]

MoJo:

What if the plan said that it would only make a loan only if the participant agreed to repay the loan through payroll withholdings and that the participant's election to do payroll withholdings is irrevocable?

Believe me, there are plenty of plans that provide that.

[MoJo]

Well, personally, I think that provision would be inappropriate in a plan, and it highlights the issue in this thread. If ERISA preempt, then the provision is unnecessary. If ERISA doesn't preempt, then the inclusion of such a provision is superfluous, and possibly a violation of state law. Lets not assume that just because a provision is in a plan that it is an ERISA protected provision. You can put lots of things in a plan document, and as long as it isn't a violation of ERISA or the Code, it should be given effect - but if it is in violation of state law and not an ERISA related provision, it won't, despite being in an ERISA plan. Furthermore, as was pointed out above, failure to comply with the state law, absent ERISA preemption, may have dire consequences.

If this is such a concern, why does the plan have a loan provisions? WHat is the problem, if the plan allows loans, in allowing an intentional default?

[R. Butler]

I see a problem with allowing intentional defaults. There isn't a reason for this thread if we weren't concerned about intentional defaults. ERISA requires that loans be bona fide. Now I am not necessarily extremely concerned about one person revoking a payroll withholding. I am concerned about many participants using the loan and a subsequent revocation of payroll withholding to circumvent distribution provisons. Wouldn't the DOL be concerned if 30 loans were taken and then payroll deductions immediately revoked?

[MoJo]

R. Butler - intentional may have been the wrong word. Of course the loan at the time it is initiated must be a bona-fide obligation and not a sham transaction. But, after that, what's the problem with a participant electing to discontinue payments on a loan? People do that everyday with respect to other bona-fide obligations?

[RCK]

Our promissory note says " I authorize XXXX to institute continuing payroll deductions in the full amount of each installment of principal and interest on this note until the loan is repaid in full.' And that's what we do: the participant cannot elect to stop payments.

So I don't see this as an ERISA preemption issue--is MoJo saying that the note itself violates state laws?

But then again, we've been doing auto enrollment (we prefer not to use the negative election terminology) for two years, so our exposure is not on the loan issue.

[R. Butler]

Can the terms of the note prevent the employee from rescinding? My initial question didn't consider this issue, but it is an interesting thought. Our notes also provide that withholding will continue until the loan is repaid. My concern is my own lack of understanding of state withholding laws. I doubt the note itself violates state law, but can the repayment clause be enforced over state withholding laws? Would the answer vary from state to state?

[MoJo]

I concur, R. Butler. And to compound that problem. including "extraneous" terms within the note may make it non-negotiable (which isn't necessarily a problem, but may foreclose various options), and may be unenforceable. I also agree that it would be a state by state determination - the note must be legally enforceable under state law. The worst possible situation would be a provision in the note that makes in totally unenforceable - which could then render it a PT at least, and a breach of a fiduciary duty at most.

I personally don't like notes cluttered with things other than an unconditional promise to pay a sum certain at a certain time (or over time).