Non-ESOP plans borrowing money for investments?

[Guest 0HBR2]

Greetings,

I'm curious - can an ERISA-covered qualified retirement plan that is not an ESOP borrow money (e.g., take out a loan from a bank) in order to make plan investments? Is this a prohibited transaction?

Does anyone have experience here? Thanks so much!

[J Simmons]

You will have a problem from unrelated business taxable income (UBTI) from so debt-financing the investments. IRC secs 512-514.

[Guest 0HBR2]

From the lenders' perspective, they would clearly be parties in interest under 29 U.S.C. 1002(14)(B), correct?

[J Simmons]

The bank would be a person providing services to the plan merely by reason of the fact the bank is making the loan to the plan? Is that what you are thinking? Is the bank providing any other services with regards to the plan?

[wsp]

Wouldn't you also want to know if there are any related parties involved with the employees of the bank and the plan sponsor?

[Guest 0HBR2]

The bank would be a person providing services to the plan merely by reason of the fact the bank is making the loan to the plan? Is that what you are thinking?

Yes, that is what I am thinking. Do you think a preexisting relationship (e.g., a bank providing additional services previous to the loan) is necessary for the lender to become a "person" providing services?

[namealreadyinuse]

IRAs do it right-and-left. Does 4975 not have the service provider language?

[J Simmons]

IRC sec 4975(e)(2)(B) has the service provider language.

If the bank does not provide services to the plan, apart from the fact it is lending to the plan, I don't think that would be a prohibited transaction. I think there needs to be another relationship. Otherwise, the interpretation would leave part of the prohibition statutes as mere surplus. IRC sec 4975©(1)(B) prohibits "lending of money or other extension of credit between a plan and a disqualified person"; ERISA 406(a)(1)(B) "lending of money or other extension of credit between the plan and a party in interest". If the transaction in question of possibly being prohibited could itself serve as the nexus that makes the other party a disqualified person or party in interest, then the statutory language could simply be "lending of money or other extension of credit by or to the plan". There'd be no need for mention of and definition of disqualified person or party in interest. An interpretation that gives effect to all of the verbiage is preferred to an interpretation nullifies part of the statutory language.

The other nexus that could make the bank in your situation a disqualified person and/or party in interest, and thus the loan a prohibited transaction, could arise from a number of different existing relationships, including that alluded to by the question in wsp's post.

[Guest 0HBR2]

IRC sec 4975(e)(2)(B) has the service provider language.

If the bank does not provide services to the plan, apart from the fact it is lending to the plan, I don't think that would be a prohibited transaction. I think there needs to be another relationship. Otherwise, the interpretation would leave part of the prohibition statutes as mere surplus. IRC sec 4975©(1)(B) prohibits "lending of money or other extension of credit between a plan and a disqualified person"; ERISA 406(a)(1)(B) "lending of money or other extension of credit between the plan and a party in interest". If the transaction in question of possibly being prohibited could itself serve as the nexus that makes the other party a disqualified person or party in interest, then the statutory language could simply be "lending of money or other extension of credit by or to the plan". There'd be no need for mention of and definition of disqualified person or party in interest. An interpretation that gives effect to all of the verbiage is preferred to an interpretation nullifies part of the statutory language.

The other nexus that could make the bank in your situation a disqualified person and/or party in interest, and thus the loan a prohibited transaction, could arise from a number of different existing relationships, including that alluded to by the question in wsp's post.

Thank you for the response (and my apologies for taking my time to respond).

However, all of the prohibited transactions have the "party in interest" language. If you take a look at ERISA 406(a)(1)©, for example (furnishing of goods or services), by definition, if you are providing those "services," you are a service provider and a party in interest. Yet the statute still adds the "party in interest" language there - so I am not sure how it is any different.

Also, say you have a 401(k) plan that hires a recordkeeper for the first time (assume no prior relationship). Also assume that plan assets are used to pay this recordkeeper. Would you say that the initial contract would not be subject to the prohibited transaction rules? Granted, there would be an exemption, but I think you would agree that, even though there was no prior relationship, the initial contract with the service provider would be subject to the prohibited transaction rules.

Any thoughts?

[masteff]

However, all of the prohibited transactions have the "party in interest" language. If you take a look at ERISA 406(a)(1)©, for example (furnishing of goods or services), by definition, if you are providing those "services," you are a service provider and a party in interest. Yet the statute still adds the "party in interest" language there - so I am not sure how it is any different.

Granted, there would be an exemption

I've not re-read the "party in interest" and "prohibited transaction" language so I'm not commenting in that regard. HOWEVER, don't let circular logic (ie a Catch-22) take over your analysis. "We'll pay to provide this service to the plan but then you're a party in interest and we can't pay so then you don't provide the service so then you're not a party in interest so then we'll pay you to provide this service to the plan (repeat)" Part of your analysis needs to look at the relationship absent of the transaction in question. Aside from the loan, what is the relationship of the lender otherwise to the plan?

And on the later, the exemption short circuits the logic (ie end of analysis). And, see the preceeding. Aside from the initial contract, what is the relationship of the service provider otherwise to the plan?

[Guest 0HBR2]

And on the later, the exemption short circuits the logic (ie end of analysis). And, see the preceeding. Aside from the initial contract, what is the relationship of the service provider otherwise to the plan?

No previous relationship.

Does anyone know of a case that explicitly notes the fact that service-providing parties in interest must have a preexisting relationship? I only know of one where it has come up--UFCW Local No. 56 v. Brandywine Operating Partnership, Civ. No. 05-2435 (D.N.J. 2005). The court said that a preexisting relationship was required ("to interpret . . . otherwise would render every party who contracts with the Fund a party in interest.").

Nevertheless, it doesn't seem to be something that has come up otherwise. And that is a pretty off-the-beaten path opinion (unpublished).

I don't know - I'm unconvinced that a preexisting relationship is necessary (as of yet), given how liberal courts seem to be with labeling people/entities "parties in interest."

Anyone?