“Bad boy” clauses aren’t passe after all – but sometimes it takes a judge to do the right thing

Back in the day – before ERISA – retirement plans had ‘bad boy” clauses. These were plan provisions under which a participant would forfeit his vested account balance if the participant was a “bad boy” for such actions as violating a non-compete clause or committing a criminal act. But ERISA did away with “bad boy” clauses. (See Susan Wynn’s post in her Pension Protection Act Blog, Bad Boy Clauses in Plan Documents).

ERISA’s prohibition against bad boy clauses generally precluded a court being able to order the retirement plan to pay out a participant’s benefits to a third party as restitution, even for a crime committed against the employer. But what if a crime was committed against the plan? Under these circumstances the Department of Labor or a Federal court could order the Plan Administrator to offset the plan’s losses against the participant’s account.

And now a recent case decided by the U.S. District Court for the Northern District of Alabama extended the circumstances under which a participant in an ERISA retirement plan could forfeit benefits because of his conduct. The case is Pension and Employee Stock Ownership Plan Administrative Committee of Community Bancshares Inc. v. Patterson, N.D. Ala., No. CV-04-BE-00531-S, 3/31/08. The Court allowed a bank ESOP committee to offset a participant’s account balance to repay damages to the ESOP.

The Court held that Kennon Patterson, former President and Chief Executive Officer of Community Bancshares, Inc. and Community Bank, breached his fiduciary duty to the bank’s ESOP by not disclosing his criminal acts against the bank to the ESOP committee of which he was a member  before the purchase of more company stock for the plan. Mr. Patterson used bank money to pay for building a 17,000 square foot home. The court said that Patterson not only committed fraudulent acts but also

knowing the Plan’s investment had been impaired by [his] own fraudulent acts, . . . failed to take any steps to protect the Plan’s assets. . . .

The case was reported by PlanSponsor (free registration required) by way of BenefitsLink.

Note: For an excellent discussion of qualified plan protection from creditors, see McKay Hochman’s commentary on the subject with a click through to an update for the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.