ERISA Creditor Protection for Owner/Employees:

By: George M. Morrison, Esq., email gmorrison@cbginc.com

The United States Supreme Court has agreed to hear a case from the Sixth Circuit stemming from the bankruptcy of the owner of a corporation sponsoring a plan in which the owner participates. In re Raymond B. Yates. The issue is whether the owner’s interest in the plan is excluded from his bankruptcy estate. Interests excluded from the bankruptcy estate cannot be claimed by creditors. This issue is of great importance to business owners, especially doctors and other professionals who may find themselves at risk of catastrophic malpractice claims.

In a previous case, the Supreme Court held that a participant's interest in an ERISA qualified plan is excluded from the bankruptcy estate. See Patterson v. Shumate. In that case, however, the Court did not define the phrase “ERISA qualified plan.” Courts have found that in order to fall within the protection of Shumate, a plan must be subject to Title I of ERISA. Department of Labor (“DOL”) regulations provide that a plan is not subject to Title I if the plan benefits no employees. Employees is defined by the regulation to not include an individual and his or her spouse with respect to a wholly-owned business, incorporated or unincorporated. Based on this DOL regulation, courts have held that the protection of Shumate did not protect owners’ interest in plans.

In Yates’ case, the bankrupt debtor was the owner of a corporation that maintained a profit sharing plan. The debtor, his wife, and employees participated in the plan. Yates claimed his entire interest in the profit sharing plan as exempt property. The Bankruptcy court ruled that Yates was not an “employee” as defined for purposes of ERISA, and the district court ruled that while the plan may be an ERISA qualified plan as to other participants, it was not as to Yates. The Sixth Circuit affirmed the decisions of the lower courts. The Supreme Court has agreed to hear Yates’ appeal.

The legal issue raised in Yates’ appeal to the Supreme Court is whether the protections of Shumate extend to a plan that benefits the shareholder of an incorporated business. On this issue, the DOL regulations appear to be in conflict with the Supreme Court's decision in Nationwide Mutual Ins. Co. v. Darden in which the Court held that the term “employee” for purposes of ERISA is to be determined under common law definitions. Under this approach, an employee of an incorporated entity is treated as a common law employee even if he or she wholly owns the corporation. Under this interpretation, the owners of a corporation would nevertheless be entitled to the protections of Shumate.

Owners’ interest in plans which are not subject to the protection of Shumate are part of the bankruptcy estate and thus subject to the claims of creditors unless exempted under State law (similar to the treatment of individual retirement accounts). The laws of the various States and Commonwealths vary considerably and are beyond the scope of this article. Individuals are encourage to seek individual advice regarding their situation.

Published: 10/24/2003