Loan Issuance During Divorce

[Guest Mauiorbust]

The 401(k) does not require spousal consent to issue a loan. The plan administrator knows the participant is going through a divorce but has not been presented with a DRO. The written loan policy is silent on the matter. Should the plan administrator grant the loan without spousal consent or request in this case because of the divorce?

[jpod]

If there is no QDRO, and if you have not seen a court order directing the participant not to borrow from the plan, there really is only one answer: You have to follow the Plan rules and the existing loan guidelines in effect at the time the participant applies for the loan.

[GMK]

I second jpod's post.

Until the plan receives a DRO that claims to be qualified, the account is the participant's, and the plan cannot be giving anyone else any say in the matter beyond what is required in the plan document.

Your QDRO Procedures may specify some things that the plan will do when the plan is informed that it may be receiving a DRO, such as, sending the QDRO Procedures, etc.

Absent a DRO, I would have to check with our lawyer to find out if a court order can take away the participant's right under the plan document to borrow from the plan. Maybe so. I don't know.

[Guest Mauiorbust]

Thanks for your help. Much appreciated!

[mbozek]

I second jpod's post.

Until the plan receives a DRO that claims to be qualified, the account is the participant's, and the plan cannot be giving anyone else any say in the matter beyond what is required in the plan document.

Your QDRO Procedures may specify some things that the plan will do when the plan is informed that it may be receiving a DRO, such as, sending the QDRO Procedures, etc.

Absent a DRO, I would have to check with our lawyer to find out if a court order can take away the participant's right under the plan document to borrow from the plan. Maybe so. I don't know.

How can a state court order a plan administrator to deny a loan? Under the preemption provisions of ERISA state courts cannot control plan administration. The state court could order the plan participant not to borrow as a matter of having jurisdiction over the participant in the divorce action.

[jpod]

I was referring to an order aimed at the participant, ordering him/her not to take a loan, and I was assuming that the order is not directed at the Plan. In view of the ERISA preemption, if the Plan Administrator has knowledge of the order should it go ahead and process the loan anyway? Absolutely not. While it may be an interesting academic issue, it is a silly one. There is absolutely no risk that the IRS would disqualify the plan over something like this. Could the participant file a lawsuit for a remedy under ERISA? Lot's of luck with that one.

[mbozek]

I was referring to an order aimed at the participant, ordering him/her not to take a loan, and I was assuming that the order is not directed at the Plan. In view of the ERISA preemption, if the Plan Administrator has knowledge of the order should it go ahead and process the loan anyway? Absolutely not. While it may be an interesting academic issue, it is a silly one. There is absolutely no risk that the IRS would disqualify the plan over something like this. Could the participant file a lawsuit for a remedy under ERISA? Lot's of luck with that one.

A plan administrator has to follow the terms of the plan not state ct orders. I dont understand why you are saying that the PA should violate the terms of the plan and deny the loan request even though there is no adverse consequences to the plan for issuing the loan.

[jpod]

How about being summoned to appear before a very angry judge for enabling a participant to violate a court order? What is the compelling reason for an employer/plan adminstrator to suffer that aggravation? The "sanctity" of ERISA preemption? Give me a break.

[GMK]

What is the compelling reason for an employer/plan adminstrator to suffer that aggravation?

Plan qualification maybe?

[BG5150]

And the loan is still an asset of the plan. If the guy had a $100,000 account and took a $50,000 loan, the account is still valued at $100,000.

[jpod]

GMK: If I felt that there was any risk of disqualification, I would agree that would be a compelling reason, but as I said I believe there is no such risk.

BG5150: Try giving that explanation to the angry judge after the participant has blown the $50,000 in Vegas or used it to pay off a credit card debt (or whatever).

[mbozek]

How about being summoned to appear before a very angry judge for enabling a participant to violate a court order? What is the compelling reason for an employer/plan adminstrator to suffer that aggravation? The "sanctity" of ERISA preemption? Give me a break.

How is that possible when (except in CA, maybe) the PA is not a party to suit or subject to the state court's jurisdiction when there is a valid remedy under state law. As noted in the Legislative history of REA "Of course the provisions of the bill (REA) do not affect any cause of action that an alternate payee may have against the participant. For example, if an order is determined to be qualified after the 18 month period, the alternate payee may have a cause of action under state law against the participant for amounts paid to the participant that should have been paid to the alternate payee."

I thought the question of a whether a PA can violate a state court order designating who was entitled to benefits under a plan was settled in the Kennedy Case where the Supremes held that notwithstanding any contrary valid legal right of another person to plan benefits under state law/court decree or contractual agreement, the Plan Administrator was only obligated to follow the terms of the plan in paying out benefits to the party designated under the plan. The Kennedy case cited the above language in REA's legislative history by noting that the rightful claimant under state law could always pursue the payee who received benefits under the plan in state court to recover amounts paid.

[david rigby]

I thought the question of a whether a PA can violate a state court order designating who was entitled to benefits under a plan was settled in the Kennedy Case where the Supremes held that notwithstanding any contrary valid legal right of another person to plan benefits under state law/court decree or contractual agreement, the Plan Administrator was only obligated to follow the terms of the plan in paying out benefits to the party designated under the plan.

Has it been your experience that state courts always know, understand and follow such precedent?

[mbozek]

I thought the question of a whether a PA can violate a state court order designating who was entitled to benefits under a plan was settled in the Kennedy Case where the Supremes held that notwithstanding any contrary valid legal right of another person to plan benefits under state law/court decree or contractual agreement, the Plan Administrator was only obligated to follow the terms of the plan in paying out benefits to the party designated under the plan.

Has it been your experience that state courts always know, understand and follow such precedent?

Last time I researched it, since Marbury v. Madison (1802) US Supreme Court decisions are the law of the land which require that state courts adhere to its precedents. I thought the question of states and their courts being required to follow Supreme Court precedents was put to rest in Brown v. Board which has been around for 54 years. You know something I dont know?

[david rigby]

How 'bout the "understand" part?

[jpod]

Marbury vs. Madison aside, if the employer/plan administrator's options are (a) deny the loan and face zero risk of plan disqualification, or (b) risk having to deal with an angry judge, I think the correct choice is obvious.

Naturally, I would advise the employer/plan administrator to use all of its powers of persuasion to get the participant to change his mind about the loan, and stall for a while, and maybe even write a letter to the judge informing him/her of the situation, but in the end I would advise the employer that it faces no risk in denying the loan.

[Peter Gulia]

jpod has been describing a practical response to an unfortunate situation. Even if not required under any law, sometimes a path of least resistance is to administer an individual-account retirement plan in a way that might be less likely to invite further scrutiny. If a participant disobeys a court's order that binds him or her (even if it doesn't affect the plan), such a participant might be a little less likely to sue because he or she might be aware, or might be advised, that many judges would want to find a reason to dismiss a complaint of a person who previously abused any court's processes.

Here's another outlook on this kind of situation. An administrator of an ERISA-governed retirement plan ordinarily must administer the plan according to its documents. ERISA 404(a)(1)(D). But could there be a situation in which an administrator believes that correctly applying the plan likely would result in the plan incurring expenses to defend the plan's fiduciaries and educate a judge? And could an administrator find that those expenses would be more than "reasonable expenses of administering the plan"? See ERISA 404(a)(1)(A)(ii). A plan fiduciary must discharge its duties following all four subparagraphs of ERISA 404(a)(1). It's unclear what balancing might be required or permitted if the circumstances involve a tension between some of these goals.

Is there some point at which the duties to obey the plan documents and provide a benefit (the loan) to the participant could be outweighed by a duty to incur no more than reasonable plan-administration expenses?

If you were a participant in the hypothetical plan that jpod describes, would you want the plan's fiduciaries to charge your account for your proportionate share of the plan's expenses for defending the plan and its fiduciaries against State court proceedings? How much would you want to pay to make clear that it's proper for the plan to pay the loan that a participant was ordered not to take? I would want the plan's fiduciaries to defend their correct administration; but I suspect that others might have different views.

[GMK]

OK, I get it. Thanks, Fiduciary Guidance Counsel.

And I agree that plan expenses are an important fiduciary duty. Becomes a bit of a dilemma deciding how much doing the right thing is worth in dollars.

Just curious. Have the feds ever come in to defend a plan in a case like this?

[Peter Gulia]

GMK, to answer your curiosity, I don't remember a situation in which the Labor or Treasury department put a serious effort on helping a retirement plan's administrator resist an improper payment demand, much less an improper restraint on payment. Every now and then, a little speechifying, but not much else.

In the 1980s, many retirement plan administrators tried to get help resisting bankruptcy trustees' demands that were contrary to plans' terms, ERISA's and the tax Code's anti-alienation provisions, and even the Bankrupty Code itself. (A bankrupt participant often had no money to pay a lawyer even to file an answer to a bankruptcy trustee's turnover demand.) These efforts went so far that I know of at least one plan administrator's lawyer who petitioned the Internal Revenue Service to tax-disqualify the plan (because its frequent payments to bankruptcy trustees violated the plan's terms and IRC 401(a)(13)). These and other efforts didn't accomplish much.

Getting the words in a statute to come to life depends on people who are willing to invest in a lawyer's work. But it's not quick and easy to show how a matter involving one participant in an individual-account retirement plan affects everyone.

[GMK]

Getting the words in a statute to come to life depends on people who are willing to invest in a lawyer's work.

...willing and able... but I hear you. Several aspects of this make me as angry as jpod's judge.

But anyway, thank you very much for your response. I appreciate all your posts.

[mbozek]

GMK, to answer your curiosity, I don't remember a situation in which the Labor or Treasury department put a serious effort on helping a retirement plan's administrator resist an improper payment demand, much less an improper restraint on payment. Every now and then, a little speechifying, but not much else.

In the 1980s, many retirement plan administrators tried to get help resisting bankruptcy trustees' demands that were contrary to plans' terms, ERISA's and the tax Code's anti-alienation provisions, and even the Bankrupty Code itself. (A bankrupt participant often had no money to pay a lawyer even to file an answer to a bankruptcy trustee's turnover demand.) These efforts went so far that I know of at least one plan administrator's lawyer who petitioned the Internal Revenue Service to tax-disqualify the plan (because its frequent payments to bankruptcy trustees violated the plan's terms and IRC 401(a)(13)). These and other efforts didn't accomplish much.

Getting the words in a statute to come to life depends on people who are willing to invest in a lawyer's work. But it's not quick and easy to show how a matter involving one participant in an individual-account retirement plan affects everyone.

The reason the IRS and Labor did not intervene in the bankruptcy cases involving alienation of benefits is that ERISA does NOT preempt other federal laws such as bankruptcy and the bankthe bankruptcy courts had the authority to order a turnover. It was up to private litigants to have the Supremes review the claims of creditors tgo benefits since the Federal agencies could not challenge the validity of the federal law they administered.

[GMK]

Thank you for that clarification, mjb, and for your other posts.