Highlights
- The U.S. Supreme Court on April 17, 2025, issued a greatly anticipated decision in which the justices unanimously held that plaintiffs alleging a prohibited transaction under Section 1106(a)(1)(C) of the Employee Retirement Income Security Act of 1974 (ERISA) need only plead the basic elements of a prohibited transaction claim without having to reference the exemptions to the prohibited transaction rules in their complaint because the exemptions are properly considered to be affirmative defenses that defendants must prove.
- The decision, which resolves a three-way split among the U.S. Circuit Courts of appeal, will likely make it easier for plaintiffs to survive motions to dismiss in ERISA litigation filed against plan fiduciaries, including disputes over plan service provider agreements.
- Acknowledging the "serious concerns" of plan fiduciaries that its ruling could open the floodgates to "meritless litigation," the Supreme Court discussed various tools that could be used "to screen out meritless claims before discovery."
The U.S. Supreme Court on April 17, 2025, issued a much-anticipated decision, unanimously holding that plaintiffs alleging prohibited transaction claims under Section 1106(a)(1)(C) of the Employee Retirement Income Security Act of 1974 (ERISA) need only plead the basic elements of a prohibited transaction claim without having to address potential exemptions under Section 1108 in their complaint, including the exemption allowing parties in interest to enter into plan service provider agreements. The issues facing the Supreme Court when it agreed to grant a petition for certiorari to review the U.S. Court of Appeals for the Second Circuit's decision in Cunningham v. Cornell University were detailed in a previous Holland & Knight alert.
At its core, the case involved Cornell University employees who alleged that the university violated ERISA by causing the two retirement plans to engage in prohibited transactions with third-party service providers that delivered retirement plan investment options, platform access and recordkeeping services by paying allegedly excessive fees. The district court dismissed the Section 1106(a) claim. Although the district court recognized that the participants had alleged that the fees the plans had paid to the recordkeepers were not reasonable, they did not allege that the fiduciaries' conduct in effectuating the transactions was disloyal or constituted self-dealing. The district court found that the omission of these allegations rendered the claim defective.
The Second Circuit affirmed the dismissal, although for different reasons. The Second Circuit held that a plaintiff may state a claim under Section 1106(a) only by sufficiently alleging the absence of any applicable exemption to Section 1106(a)'s prohibitions as set forth in Section 1108. The Second Circuit found that the participants had not alleged that the transactions they were challenging fell outside of Section 1108's exemptions and affirmed dismissal of the prohibited transaction claim.
The Supreme Court reversed the Second Circuit and found that Section 1108 exemptions are affirmative defenses that defendants must raise and prove and not elements that plaintiffs must affirmatively negate in their complaints. According to the Supreme Court, because "Section 1106(a), by its terms, sets outper seprohibitions, it would make little sense to put the onus on plaintiffs to plead and disprove any potentially relevant separate ยง1108 exemptions."
This ruling not only reverses the Second Circuit's approach, but it resolves the outstanding three-way split among the U.S. Circuit Courts of Appeal regarding the relationship between ERISA Sections 1106 and 1108 and whether plaintiffs are required to plead only the mere existence of a contract involving the "furnishing of goods, services or facilities between the plan and a party in interest" to survive a motion to dismiss or if additional allegations are required to avoid dismissal.
Practical Implications for Plan Sponsors and Fiduciaries
The high court's decision means that plaintiffs can state a viable prohibited transaction claim by simply alleging that 1) a fiduciary caused a plan to engage in a transaction, 2) the fiduciary knew or should have known the transaction involved furnishing goods or services, and 3) the transaction was between the plan and a party in interest.
This low-pleading burden creates significant concerns for plan fiduciaries because plan service providers are parties in interest under Section 1002(14)(B) and, thus, every service provider contract constitutes a per se violation of Section 1106. Under the Supreme Court's ruling, any plan service provider contract could form the basis of a complaint that survives dismissal at the pleadings stage as long as the plaintiff alleges that he or she was harmed as a result of the contract.
Defensive Tools Highlighted by the Court
The Supreme Court recognized that the "serious concerns" raised by the plans' fiduciaries and in various amicus briefs that simply requiring that plaintiffs plead that a transaction is barred by Section 1106(a)(1)(C) could allow plaintiffs to easily get past the motion-to-dismiss stage and subject defendants to costly and time-intensive discovery. However, the Supreme Court held that these concerns cannot overcome the statutory text and structure of Sections 1106 and 1108. The Supreme Court, however, did highlight that district courts can use existing tools at their disposal to screen out meritless claims before discovery. These tools include the following:
- Requiring a Reply to a Defendant's Answer. The Supreme Court suggested that district courts could order plaintiffs to file a reply to a defendant's answer that raises Section 1108 exemptions under Rule 7(a)(7) of the Federal Rules of Civil Procedure. As the Court explained: "Federal Rule of Civil Procedure 7 empowers district courts to 'insist that the plaintiff' file a reply 'putting forth specific, nonconclusory factual allegations' showing the exemption does not apply." Justice Samuel Alito, joined by Justices Clarence Thomas and Brett Kavanaugh, emphasized this option in the Concurrence and encouraged district courts to "strongly consider" utilizing it.
- Article III Standing. Courts must dismiss claims that fail to identify a concrete injury to plaintiffs, even if a technical violation is alleged.
- Limited Discovery. District courts retain authority to expedite or limit discovery to mitigate unnecessary costs.
- Rule 11 Sanctions. Where exemptions obviously apply and plaintiffs lack a good-faith basis to argue otherwise, courts may impose sanctions.
- Cost Shifting.E RISA Section 1132(g)(1) allows courts to shift attorneys' fees and costs to either party, providing a deterrent to frivolous litigation.
Next Steps for Plan Fiduciaries
This decision highlights the importance to plan sponsors and fiduciaries of having a process in place to review service provider agreements. The Supreme Court's decision may result in cases getting into discovery on these issues with more frequency, which will put a focus on compliance with the exemptions. When faced with litigation, plan sponsors and fiduciaries should be prepared to assert applicable exemptions as affirmative defenses and work with counsel to develop strategic approaches that leverage the defensive tools identified by the Court, such as requesting that courts order plaintiffs to file replies addressing these exemptions. Though Rule 7(a) is not a traditional pleading tool that is commonly used, the Supreme Court's opinion and concurrence suggest that district courts should start using it more frequently to scrutinize pleadings as a gatekeeping function.
The Court's order may also open the door to more fee petitions being filed by successful defendants under Section 1132(g)(1). Ongoing monitoring of how lower courts apply theCunninghamdecision will also be valuable in refining litigation defense strategies as this area of law continues to evolve.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
