Is an endorsed check a legally enforceable agreement against borrower from "paperless" 401(k) plan?

[Guest oscar]

Treasury Reg 1.72(p)-1 state that a loan agreement does not need to be signed if the agreement is enforceable under applicable law w/o being signed. If a loan from a 401(k) account is disbursed, does the employee's signature on the loan check constitute a legally enforceable agreement in CA?

[Harwood]

I know a California bank - a trustee/recordkeeper for many plans - that puts the following on the back of loan [including paperless] proceeds checks:

"By endorsing or cashing this check, I agree to repay the amount of this loan, plus interest, according to the terms and conditions of the Promissory Note and Security Agreement contained on both sides of the document attached to this check and according to the Participant Loan Authorization Agreement. I agree that my employer will deduct the amount of my loan repayments from my compensation."

[Harwood]

Of course in California, if an employee says "stop my loan deductions," the employer best comply.

Loan agreements often say that an irrevocable agreement for payroll loan deductions are valid only if allowed by law. A prudent reading of California law is that such elections cannot be irrevocable. I don't think ERISA preemption applies here.

[mbozek]

H: The DOL has issued opinions preempting NY and Puerto Rico statutes requiring written employee consent to salary reduction or limiting the plans to which employee contributions can be made (Opinions 94-27 (NY), 93-05) because the state law limits, prohibits or regulates the funding of ERISA plans, including payroll deductions. The logical reason why state payroll deducton laws are preempted is that they prevent the plan from recovering plan assets from a debtor who has agreed to make payments under the terms of the plan and impair the ability of the plan to operate simultaneously in all states.

If the CA law is not preempted then employers who offer loans to CA participants risk disqualfication because there is no enforceable obligation to repay the amount borrowed as required by IRS regulation 1.72(p)-1 Q-3 (b) including the requirement of making repayments at least quarterly.

[MoJo]

I disagree with your conclusion, mbozek. There still can be an enforceable obligation sufficient for the loan to pass 72(p) muster even though the ability to collect it through payroll deduction is uncertain. Generally, the terms of the note provide that the obligation continues despite the inability to collect through payroll (i.e. layoffs, termination, etc.) and it become the fiduciary's responsibility (often ignored) to attempt collection through reasonable means....

[mbozek]

The plan admin should not be put into the position of having to determine whether the loan is uncollectible at inception or because it would not provide for repayment on a periodic basis which would invalidate the the loan as a permissible exception to the non alienation rules as well as require the plan to have different procedures for enforcing payment of loans depending on state law. The recent 9-0 US Supreme Ct decision on preemption of state liability laws on HMOs providing health benefits under ERISA plans confirms that state laws which affect the operation of ERISA plans are preempted.

[MoJo]

I don't disagree that there should be uniformity in approach - just that making repayment of the note "dependent" of payroll deduction is probably legal malpractice on the part of the one who drafted the note. Make the repayment of the note unconditional on the repayment method - which makes it legally enforceable for Section 72 purposes (and solves the problems of hourly workers who have there hours cut below that which is needed for repayment) and then make the granting of the loan conditional on payroll deduction. Then, for ERISA purposes, it is irrelevant that participant later revokes the consent to the payroll deduction (we can argue whether that is even possible, but if it is, making the note repaybale in any event makes it legally enforceable, and removes the taint on the plan).