A federal court allowed a plaintiff 401(k) plan with a 28% percent ownership interest in an Arizona real estate company to proceed to trial against that company and its affiliated lender and manager (joint defendants in the case) on allegations of fiduciary breach under ERISA (Employee Retirement Income Security Act of 1974). Hart Interior Design LLC 401k Profit Sharing Plan v. Recorp Invs. Inc., 2018 BL 147891, D. Ariz., CV-16-02347-PHX-GMS, 4/26/18.
Under ERISA, because the 401(k) plan owned a "significant interest" in the Arizona real estate company, its manager indeed owed plaintiff ERISA fiduciary duties (which impose requisite skill, care, and prudence and prohibits self-dealing and other conflicts of interest) when managing that company. To avoid ERISA liability completely, the defendants had hoped to rely on a REOC (real estate operating company) exception under ERISA's “plan asset” regulations at 29 C.F.R. § 2510.3-101.
The court found that the real estate company and its manager were merely holdingreal property. Even with operating agreements that indicated that the entity in which the Hart 401(k) plan invested would "engage in purchasing, financing, refinancing, developing, managing, operating, selling, exchanging or otherwise disposing of real property," the court determined that the company had not exhibited any real REOC-required activity:
As a matter of law, [the real estate company] has not demonstrated a substantial ongoing commitment to managing and developing real estate.
A company often hopes to get funded with the trillions of dollars that 401(k) and other similar plans could invest. To seek and garner that type of investment and capital raise, a company might want to avail itself of the REOC exception. Note though that simply saying a company is a REOC (and not adhering to a REOC's technical requirements, as the Hart case points out) or simply having lawyers insert boilerplate REOC representations in deal documents will just not be enough to avoid the imposition of ERISA fiduciary obligations.