Most third party administrator and other service provider claims and/or lawsuits arise out of actual or alleged administrative errors. The problem is especially frustrating when the administrative error was committed by the client's previous practitioner. In this issue of The Benefits Professional Update, Joe Faucher of Reish & Luftman discusses the significant role properly drafted engagement letters and buy-sell agreements can play in both defending a preferable position and managing client expectations. We hope this issue will prompt the estimated fifty-percent of the industry operating without properly drafted agreements to reconsider the consequences and make the investment to manage foreseeable liability issues.
We all know how good it feels to land a new piece of business. Getting a whole new block of business - for instance, through a merger or acquisition - only adds to the euphoria. But the Benefits Professional Update isn't about euphoria. Rather, it's about identifying problems and taking steps to avoid them. This issue of the Update discusses some of the most common springboards to litigation against third party administrators and other service providers: takeover plans and mergers and acquisitions.
Takeover Plans
The most common thread running through lawsuits against third party administrators ("TPAs") is a lack of understanding on the part of the client as to the functions the TPA performs. The problem is especially pronounced in connection with "takeover plans" - when a client transfers the plan administration work from one firm to another. We recently represented a TPA who came on board to represent a company that was in the middle of a "breakup." The existing retirement plans were also separated, such that each of the two new entities would sponsor their own plans. The new TPA began its work while the division of assets between the two plans was in process. Ultimately, assets to fund the "break-off" plan were transferred twice. The discrepancy wasn't discovered until several months later - even the plan auditors didn't clearly identify the problem. In the meantime, participants came and went, and took distributions from the plan.
Both plan sponsors sued the TPA. Although the case ultimately settled, and it was clear that the mistake giving rise to the problem pre-dated the new TPA's involvement with the plan, the case probably could have been settled more favorably under different circumstances. Most significantly, the new TPA did not have a detailed engagement agreement describing what services the TPA would and would not provide. If an engagement letter had been in place, and indicated that the TPA would not conduct an audit of the plan or review the prior TPA's work for accuracy and completeness, it is possible that the case could have been resolved sooner, and for far less money. This is because a properly drafted engagement letter would have provided evidence that could have been presented to the court to indicate that the TPA's obligations to the plan were purely prospective.
For standard "takeover" plans, engagement letters should indicate (1) what services the TPA will provide, and the fees to be charged for those services; (2) what services the TPA will not provide; (3) services that are available for extra fees, and (4) a clear statement that the TPA does not provide services defined as "fiduciary" functions under ERISA. A detailed checklist of items to be included in TPA engagement agreements is available on the Reish & Luftman website at http://www.reish.com, under the "ERISA Litigation" heading.
Mergers, Acquisitions and Buy-Sell Agreements
Claims and litigation against plan service providers also arise with disproportionate frequency in the aftermath of mergers, acquisitions and buy-sell agreements. The good news is that there are steps that successor TPAs can take to minimize the potential of these types of claims.
First, if you are considering a merger or acquisition, remember that the value of a business is determined by the quality of its product. Not all service providers are created equal. Do your homework regarding the work product of the business you are acquiring. Find out whether the quality control practices of the company you are acquiring are similar to your own. Consider whether you should perform "due diligence" by reviewing at least a representative sampling of the plans that the prior TPA firm administered. Obvious errors in plan administration tend to be like cockroaches: if you see one, many more are likely to come out of the woodwork. If you determine that a disproportionate number of administration errors were made, you need to consider whether it makes sense to go forward with the purchase of the business. Will you be able to cost-effectively correct the problems? If the cost of correcting any one problem is significant, are you likely to get embroiled in litigation between your new client and the prior TPA? If the new client refuses to pay for the correction, does your purchase agreement give you adequate assurances that you can either (1) get paid by the prior TPA or (2) deduct the amount of the lost fees against any amounts that you owe on the purchase contract.
If you decide to go forward with the purchase of the business, you need to decide who will be liable for errors in plan administration. This should be expressly addressed in your purchase agreement. Equally important is that you determine whether the seller was and is insured, and whether the seller's insurance carrier is obligated to cover claims that relate to services provided before the sale of the business. To answer these questions, and provide you with adequate protection in the purchase agreement, you should hire an attorney who is experienced in the purchase and sale of businesses, and with experience in representing clients who work in the employee benefits industry. Most importantly, that attorney should be yours, and yours alone. You should avoid the temptation to save costs by splitting the attorneys' fees with the seller. That could very well lead to an agreement which is ambiguous or, even worse, adverse on the issue of who is responsible for prior errors in plan administration. You need to make sure that your interests are being considered.
These same considerations play a part in buy-sell agreements (in which, for instance, a sole shareholder of a TPA corporation sells his interest in the company to an employee or group of employees). We handled one case in which our client was a corporation that provided third party administration services. The corporation had previously been owned by a single shareholder who was "phasing out." The new owners had risen through the ranks as employees. Buyout negotiations took place and deal documents were drafted. The attorney who had handled routine corporate matters for the business up to that point drafted the purchase and sale documents.
The deal documents called for a purchase of the stock of the corporation, rather than the assets of the business. The former owner entered into an employment agreement with the new owners to provide consulting services on an "as needed" basis. For tax purposes, a large part of the total buyout price was allocated to the employment agreement, while a relatively small portion was allocated to the purchase price of the stock. Even though there were some tax benefits to this buyout structure (the employment agreement payments were deductible), there were problems that outweighed the benefits. Long before he sold the stock, the former owner entered into a strategic alliance with a securities broker?dealer who specialized in real estate limited partnerships and other real estate syndications. The former owner allegedly steered some of his pension clients to this broker, and consequently, into real estate partnership investments that ultimately lost money. Later, the plan sponsors and fiduciaries complained about the losses on those investments.
They sued everyone involved, including our client (the TPA corporation), for breach of fiduciary duty under ERISA. They claimed that the former owner received "kickbacks" from the broker-dealer. The new owners were aware at the time they purchased the corporate stock that some of the corporation's clients had been complaining about the investments they made, and were starting to point the finger at the former owner even before he sold his stock. If the new owners had purchased the assets of the corporation instead of the stock, and given appropriate notice to creditors, they could have formed a new corporation or other business entity. This new corporation might have avoided liability by defending itself on the grounds that it did not assume the liabilities of the old corporation. In contrast, when the new owners purchased the stock of the corporation, and therefore all of the corporation's assets and liabilities, they essentially "bought" the lawsuit.
All this is to say that, when buying a business, or even a block of business, you should do so in a businesslike manner. The cost of an experienced attorney to oversee the purchase, advise you regarding potential liabilities, and act as your advocate in the transaction is minor compared to the expense of a purchase gone bad, or liabilities that weren't considered.
Copyright 2000 by Professional Practice Insurance Brokers, Inc., a Hilb, Rogal & Hamilton Company. Reprinted with permission from The Benefits Professional Update, Second Quarter Update.