The U.S. Supreme Court has declined to hear two cases concerning the enforceability of mandatory arbitration and class action waivers in plan documents.

The decision effectively denies appeals of decisions made by judges in the 3rd and 10th Circuit Courts of Appeal, which ruled that mandatory arbitration and class action waiver clauses in plan documents are unenforceable under the Employee Retirement Income Security Act. The Supreme Court declined to hear the appeal of the 10th Circuit decision on October 10 and the 3rd Circuit decision on October 16.

Both cases alleged that private equity in employee stock ownership plans was improperly valued at the expense of the participants. In Robert Harrison v. Envision Management Holdings, the 10th Circuit ruled for Harrison, while in Marlow Henry v. Wilmington Trust, the 3rd Circuit ruled for Henry.

In both circuit court outcomes, the defendants’ moves to force individual arbitration and prevent a class action remedy were denied.

10th Circuit Complaint

Harrison initially brought his complaint in January 2021 in the U.S. District Court for the District of Colorado. The plaintiff alleged that his employer, Envision, a radiology company, violated its fiduciary duties in the management of an ESOP.

Specifically, Harrison alleged that Envision owners sold 100% of its private stock to the ESOP for approximately $160 million, $150 million of which the ESOP borrowed, since it had insufficient funds. Of that loan, $100 million came from the owners themselves and $50 million came from Envision.

The lawsuit alleges that contributions to the ESOP were first spent on paying interest on those loans, set at 12%, and that two separate prices were used to value the private stock of Envision, both of which were overpriced.

Envision argued that the plaintiff had signed an arbitration clause that required him to only claim individual damages, not plan-wide damages. The District Court refused to enforce that agreement. Envision then appealed to the 10th Circuit.

The 10th Circuit ruled that mandatory individual arbitration is invalid “because it disallows plan-wide relief,” a statutory right under ERISA. The court explained that the effective vindication exemption means that arbitration clauses cannot remove the right to pursue statutory remedies, which include plan-wide relief.

The defendants argued that the Department of Labor can still pursue enforcement action on behalf of the plan and that individual participants can seek individual relief through arbitration. The court ruled that ERISA expressly authorizes plan-wide relief in cases brought by participants, and mandatory individual arbitration cannot remove that right: “Because we agree with the district court that the remedies limitation contained in Section 21.1(b) prevents Harrison from effectively vindicating his statutory remedies, that means that the entire Arbitration Procedure outlined in Section 21 of the Plan is ’rendered null and void in all respects.’”

3rd Circuit Complaint

Henry similarly alleged the private stock of BSC Ventures was inflated and therefore hurt the ESOP’s participants, filing the initial complaint in U.S. District Court for the District of Delaware.

On appeal, the 3rd Circuit ruled that plan-wide relief—a remedy that addresses all affected members of the plan—is protected by ERISA. An individual cannot waive a statutory remedy for a plan, because it is not the individual’s right to waive, but the plan’s right.

This ruling was also effectively upheld when the Supreme Court declined to hear an appeal.

Mark Boyko, an ERISA attorney and partner in Bailey Glasser LLC, says that arbitration clauses as such are not unlawful. It is when they are paired with a class action waiver that they become unenforceable, because then a plaintiff cannot pursue the plan-wide relief protected by ERISA. Boyko says that courts have ruled that “the plan can agree to arbitration, but the plan can’t agree and limit the award to one individual” through a class waiver.

“You can waive your procedural right to go to court,” says Boyko, “but not your statutory right to plan-wide remedies,” whether awarded by a court or by an arbitrator.

The SECURE 2.0 Act of 2022 requires the DOL to issue regulations spelling out how private assets should be appraised for the purpose of creating ESOPs. A report published by Matrix Global Investors in September argued that a lack of regulatory uncertainty on ESOP valuation may be the greatest obstacle to their wider formation.