Negative Assets?

[415 Limit]

We administer a calendar year 401(k) profit sharing plan that has a pooled account consisting of various investments, including cash, mutual funds, etc. and a parcel of undeveloped land. The appraised value of the property as of 12/31/09 has decreased substantially from the appraised value as of 12/31/08. As of 12/31/09 the property is worth less than what is owed on the note, so when we calculate what each participant's account balance, the values are negative. There are HCE's and NHCE's participating in the plan. Any suggestions or input on what to do? Is this right?

Thanks!

[Ron Snyder]

Assess the participants the shortfall, and if they don't pay, kick them out of the plan!

The facts you have recited make a prima facie case for a violation of the ERISA prudence requirements by the fiduciaries, and, ergo, the liability of the fiduciaries to make up the losses to the plan.

The participants should sue. If you are working for the trustees, resign!

[TLGeer]

I agree as to fiduciary duties. However, I see no basis for assessing participants. Also, you have issues as to whether the plan is going to have unrelated debt-financed income on sale and it is possible that the trust instrument prohibits plan borrowing.

If the mortgage allows recourse against the plan, as an accounting matter you would subtract the underwater amount from the other plan assets. If the liability is nonrecourse, the land, net of the mortgage would be a zero.

The fact that there are fiduciary duty issues may be a good thing, depending on the employer's general attitude to the plan. Payments to a plan resulting from breaches of fiduciary duty are not considered to be contributions subject to testing or annual additions subject to limitations. This allows a de facto contribution that is "allocated" based on account balances.

Last, you should evaluate whether a transfer of the property is viable, to reduce the risk of future fluctuations and eliminate the risk of debt-financed income. Is a distribution of the property viable? Is a transfer subject the the mortgage (with a release of the plan) a "cure" and a net payment that is not tested or limited? These issues are too complex to deal with here.

Tom Geer

[Mike Preston]

I don't see an answer to the question as posted. Sure, the question itself goes away if the fiduciaries can be convinced to pony up in some manner. But, assuming you can't, or that you can't in a timely manner with respect to the next reporting cycle, I see nothing wrong with showing the value of a participant's account as negative. It is what it is. If it encourages someone to file suit, well that is the purpose of these disclosures, isn't it?

Note that I challenge how a single debt instrument could overwhelm the other assets to the point of creating an overall negative net worth. I'd like to see how that came about. As others have stated, on its face, that sure does argue for some sort of fiduciary violation. But it might also argue for the fact that the OP is just confused about the overall value.

[Guest jims]

Sorry to add a question not an answer; but I'm trying to understand the concept. How does a plan get to borrow money to buy land? I assume the mortgage note requires some periodic repayment. That comes from plan assets, right? Does that mean employee and employer contributions go in as cash and go out as cash to service the mortgage. What if there aren't enough contributions?

[K2retire]

Note that I challenge how a single debt instrument could overwhelm the other assets to the point of creating an overall negative net worth. I'd like to see how that came about. As others have stated, on its face, that sure does argue for some sort of fiduciary violation. But it might also argue for the fact that the OP is just confused about the overall value.

It is certainly possible that there is confusion. But it's not beyond belief that a million dollar plan might have (foolishly) bought an $800,000 property with an 80% mortgage ($640,000) that is now worth only $400,000 -- leaving the plan with a negative net worth of $40,000. Especially if said property was in California or Florida.

[Bird]

If push comes to shove, is the plan going to sell other assets to pay off the mortgage? That seems unlikely, and I doubt that the other assets are collateral, so I doubt that the lender is ever going to get more than the value of the land in the event of foreclosure.

Since the asset (land) has been (properly) re-appraised, I wonder if the liability (note) should be re-appraised as well?

Just a thought...

[Ron Snyder]

Of course, jims has hit on a potentially serious question.

Question: What lender would loan to a trust that apparently doesn't have other assets (hence the reference to negative assets)?

Answer: One that has a personal guarantee from someone with deep pockets and a good credit rating.

Question: How can an individual provide a guarantee with respect to such a loan? Wouldn't such a guarantee be considered a "sale or exchange of property between the plan and a party in interest"?

Answer: Absolutely.

Of course my original response was flippant. Sorry if it wasn't obvious. There are procedures for reducing mortgages to the value of the property either with or without the lender's cooperation. Most lenders don't really want the real estate unless there is equity in it. The trustee should look around for an attorney who is familiar with the new real estate debt remedies.