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Trust Examination Manual
August 20, 2002
Michael A. Crabtree, Esq.
Central Pension Fund of the International Union of
Operating Engineers and Participating Employers
4115 Chesapeake Street, NW
Washington, DC 20016-4665
ERISA Sec. 404(a) & 408(b)(2)
Dear Mr. Crabtree:
This is in response to your request for an advisory opinion on behalf of the Central Pension Fund of the International Union of Operating Engineers and Participating Employers (the “Fund”) concerning the application of the provisions of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Specifically, you have requested the views of the Department as to whether inclusion of certain indemnification and hold-harmless provisions in a plan’s service provider contract would violate the fiduciary provisions of ERISA.
You represent that an actuarial firm, in connection with discussions relating to the renewal of its contract to provide actuarial services to the Fund, advised that it was requiring all new engagement letters to contain, among other things, “limitation of liability” and “indemnification” provisions. These provisions, in effect, would require the Fund to agree not to recover from the actuarial firm an amount in excess of the greater of $250,000 or one year’s fee for any damage caused to the Fund “regardless of the cause of action,” and to indemnify and hold the actuarial firm harmless for any amount exceeding the same limits “from any third party claim or liability” arising from, or in connection with, the firm’s services to the Fund. The Fund’s insurer has informed the Fund that its fiduciary liability policy would not cover the Fund’s losses if the Fund suffered losses in excess of $250,000 as a result of the actuarial firm’s actions that were not recovered because of the proposed limitation of liability and indemnification provisions. The insurer explained that the policy is not designed to cover professional liability exposures normally associated with Actuarial Errors and Omissions coverage.
Although the Fund has decided not to retain the actuarial firm, opting instead for a firm that required no specific limitation of liability or indemnification provision, limitation of liability and indemnification provisions may be becoming increasingly popular with actuarial firms according to press and other reports. Given the current and future issues presented to fiduciaries with respect to the engagement of service providers with contractual limitations of liability or indemnification provisions, you have requested guidance from the Department concerning the permissibility of such provisions under ERISA.
Section 404(a)(1) of ERISA requires, among other things, that a fiduciary discharge his or her duties with respect to a plan solely in the interest of the participants and beneficiaries and with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character with like aims. The prohibited transaction provisions state, in section 406(a)(1)(C) and (D) of ERISA, that a fiduciary with respect to an employee benefit plan shall not cause the plan to engage in a transaction if he or she knows or should know that such transaction constitutes a direct or indirect furnishing of services between the plan and a party in interest with respect to the plan, or transfer to, or use by or for the benefit of, a party in interest, of any assets of the plan. Section 408(b)(2) of ERISA provides a statutory exemption from the prohibitions of section 406(a) for contracting or making reasonable arrangements with a party in interest, including a fiduciary, for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid for such services.
With regard to the selection of service providers under ERISA, the Department has previously indicated that the responsible plan fiduciary must engage in an objective process designed to elicit information necessary to assess the qualifications of the provider, the quality of services offered, and the reasonableness of the fees charged in light of the services provided. In addition, such process should be designed to avoid self-dealing, conflicts of interest or other improper influence. What constitutes an appropriate method of selecting a service provider, however, will depend upon the particular facts and circumstances. Soliciting bids among service providers is a means by which a fiduciary can obtain the necessary information relevant to the decision-making process, including information about contractual provisions such as those identified in your letter relating to limitations of liability and indemnification.
The Department does not believe that, in and of themselves, most limitation of liability and indemnification provisions in a service provider contract are either per se imprudent under ERISA section 404(a)(1)(B) or per se unreasonable under ERISA section 408(b)(2). The Department believes, however, that provisions that purport to apply to fraud or willful misconduct by the service provider are void as against public policy and that it would not be prudent or reasonable to agree to such provisions. Other limitations of liability and indemnification provisions, applying to negligence and unintentional malpractice, may be consistent with sections 404(a)(1) and 408(b)(2) of ERISA when considered in connection with the reasonableness of the arrangement as a whole and the potential risks to participants and beneficiaries. At a minimum, compliance with these standards would require that a fiduciary assess the plan’s ability to obtain comparable services at comparable costs either from service providers without having to agree to such provisions, or from service providers who have provisions that provide greater protection to the plan.
In the Department’s view, compliance with ERISA’s fiduciary provisions, including section 408(b)(2), also would require that a fiduciary assess the potential risk of loss and costs to the plan that might result from a service provider’s act or omission subject to a proposed limitation of liability or indemnification provision. In making such an assessment, a fiduciary should consider the potential for, and outside limits of, such a loss, as well as any additional actions that may be available to the plan to minimize such a loss.
This letter constitutes an advisory opinion under ERISA Procedure 76-1. Accordingly, this letter is issued subject to the provisions of the procedure, including section 10 relating to the effect of advisory opinions.
Chief, Division of Fiduciary Interpretations
Office of Regulations and Interpretations