Small Business Owners and ERISA Protection: A Working Business Owner's Benefits in an Employment Retirement Income Security Act Plan Are Protected from Creditors If the Plan Also Covers Other Business Employees, the Supreme Court Rules

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The U.S. Supreme Court recently decided a case arising from the bankruptcy of the owner-employee of a corporation that sponsored an employee retirement plan in which the owner participated. The court was asked to decide whether the working owner of a business (here, the sole shareholder of the corporate employer) is precluded from being a plan "participant" under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA) in a retirement plan that is established in accordance with ERISA.

This case presents the question of whether a working owner (such as a sole shareholder, sole proprietor, or partner who renders services to a business) may be a participant in an ERISA plan and enjoy the same protections that other plan participants enjoy. A lower court, the U.S. Court of Appeals for the Sixth Circuit, had ruled that working owners could not be ERISA-plan participants.

The facts of this case are fairly straightforward. Dr. Raymond B. Yates was a practicing physician and the sole shareholder and president of a professional corporation known as Raymond B. Yates, M.D., and P.C. The corporation maintained the Raymond B. Yates, M.D., P.C. Profit Sharing Plan (the plan), for which Dr. Yates was the plan administrator and trustee. As of June 30, 1996, four persons were designated as plan participants, including Dr. Yates, his wife, and two employees. From its inception, the plan always had at least one participant other than Dr. Yates or his wife.

The plan was established in accordance with Section 401 of the Internal Revenue Code and contained an "Anti-alienation" provision as required by the Internal Revenue Code and ERISA. That provision, known as the "Spendthrift Clause," provided that: Except for plan loans to participants (as permitted by Article 12 of the plan document) and the assignments provided therefore, no benefit or interest available hereunder would be subject to assignment or alienation, either voluntarily or involuntarily. This provision is intended to protect plan assets from the claims of creditors and is a very important provision in the eyes of an owner-employee. It ensures the owner-employee that no matter what good or bad luck the business may encounter, at least money deposited into the company pension plan is "safe."

In an earlier case, Patterson v. Shumate [504 US 753 (1992)], the Supreme Court held that retirement benefits of a plan participant (who has filed for bankruptcy protection) in an "ERISA-qualified" plan are protected from that debtor's creditors. The Supreme Court, however, didn't define "ERISA-qualified" in its decision. Defining the term has been left up to the lower courts, and the definition has continued to be refined.

Many federal circuit courts of appeal have previously ruled that a plan in which the only participant is and always has been the sole owner of the business that sponsors the plan (or only the owner and his or her spouse) is not ERISA-qualified. The basis for this position is that, under the Department of Labor (DOL) regulations that govern ERISA plans, the owner and spouse aren't employees, and if they are the only participants, then the plan isn't an "employee benefits plan" for purposes of Title I of ERISA because it covers no employees. Further, since it isn't an "employee benefits plan" under ERISA, the plan isn't subject to the anti-alienation provision that is part of Title I.

A plan's status as an "employee benefit plan" under ERISA Title I has been crucial in these cases because the ability to enforce the anti-alienation provision is required in order for the benefits to be protected from creditors under the Supreme Court holding in Patterson v. Shumate. That's because Bankruptcy Code Section 541(c)(2) provides that the retirement benefits are excluded from the debtor's bankruptcy estate only if they are subject to a "restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non-bankruptcy law. …