On April 17, the U.S. Supreme Court issued its unanimous decision in Cunningham v. Cornell University. The decision, closely watched by the ERISA crowd, is not good news for plan sponsors or fiduciaries. 

The issue addressed by the Court is what claims must be alleged for a fiduciary suit to be viable. Under Section 406 of ERISA, a prohibited transaction occurs if a fiduciary causes a plan:

(i) “to engage in a transaction.” 

(ii) that the fiduciary “knows or should know…constitutes a direct or indirect… furnishing of goods, services, or facilities.” 

(iii) “between the plan and a party in interest.”

Elsewhere in ERISA (Section 408), the law backtracks a bit and states that a prohibited transaction under Section 406 becomes permitted if only reasonable fees are paid.

The core question was whether a plaintiff need only (plausibly) allege (i)-(iii) above for the case to proceed (and, once filed, the defendant can use the reasonableness of the fees as a defense) or whether a valid claim is only stated if the plaintiff also makes a plausible allegation that the fees paid were not reasonable. In Cunningham, the court ruled that (i)-(iii) are enough to state a cause of action, and the fiduciary can then use reasonableness as a defense. 

The problem is that once a viable claim (as now defined in Cunningham) is filed, plan fiduciaries must engage in the costly process of defending their actions by demonstrating the reasonableness of the fees. And, once fiduciaries have the burden of defending the fees, the more likely it is that plaintiffs extract a settlement (regardless of the merits of the claim). Since the plaintiffs’ game is to sue to settle, this case gives plaintiffs a better hand in settling cases (because the cases are now harder to dismiss).

Note: This case affects all ERISA plans and ERISA fiduciaries. This litigant (Cornell) is a university, so some discussions frame this as a university matter. However, it affects every ERISA fiduciary.

The Rationale 

The Court’s rationale was based on some fundamental rules of civil procedure and statutory interpretation, and had nothing to do with the adverse impact on plans. Hence, the unanimous decision.

The Court focused on the structure of Sections 406 and 408. Under Section 406, a prohibited transaction occurs when the three elements specified in Section 406 occur: a transaction…for goods or services…between a plan and a party in interest. Looking at Section 406, those are the only things that need to be alleged for a case to proceed. The fact that Congress then stated, in Section 408, that such a transaction is exempt from the prohibition on prohibited transactions means that the reasonableness of the fees is an affirmative defense—a defense that must be raised and ultimately proven by the defendants (i.e., the plan fiduciaries). As stated by the Court:

In particular, when a statute has “exemptions laid out apart from the prohibitions,” and the exemptions “expressly refe[r] to the prohibited conduct as such,” the exemptions ordinarily constitute “affirmative defense[s]” that are “entirely the responsibility of the party raising” them.

The Consequences

The Court acknowledged Cornell’s concern that, as a result of this decision:

[If plaintiffs only need to plead the three elements of Section 406]…plaintiffs could too easily get past the motion-to-dismiss stage and subject defendants to costly and time-intensive discovery. Such meritless litigation, respondents claim, would harm the administration of plans and force plan fiduciaries and sponsors to bear most of the associated costs. These are serious concerns, but they cannot overcome the statutory text and structure. Here, Congress “set the balance” in “creating [an] exemption and writing it in the orthodox format of an affirmative defense,” so the Court must “read it the way Congress wrote it.”  

Interestingly, after acknowledging these risks, the Court then suggested ways that the courts—and fiduciaries—could address “meritless” cases. For example, the Court noted that if defendants answered a complaint by showing the reasonableness of fees, Federal rules of civil procedure allowed a trial court to “insist that the plaintiff’ file a reply, “‘put[ting] forward specific, nonconclusory factual allegations’” showing the exemption does not apply… Lower courts may then dismiss the suits of those plaintiffs who cannot plausibly do so. 

The Court also noted that district courts can dismiss cases if there is no injury alleged—in effect, if fees are reasonable and take other actions, such as sanctioning attorneys or imposing costs.

Time will tell whether these suggestions are effective. But, in the meantime, we can expect the wave of fiduciary lawsuits to keep rolling in.