A new bill moving through Congress could make it easier to sue your retirement plan if something goes wrong. Although opposed by lobbyist groups such as the American Retirement Association this bill, known as the Employee and Retiree Access to Justice Act of 2022, could help individuals protect themselves and their money.
It will do so by eliminating binding arbitration clauses from your employer-sponsored retirement plan.
Binding Arbitration Clauses and Retirement
During the mid-2010s, the Supreme Court embraced an area of the law called “binding arbitration clauses.” These are sections in a contract which require that, in the event of a dispute, the parties will take their case to a mediator rather than to court.
While binding arbitration is nothing new, its application was. Previously, this had been a relatively niche area of the law. Binding arbitration clauses had been restricted to sophisticated parties, meaning people who had actively negotiated their contracts and could reasonably understand what they’d agreed to.
The Supreme Court changed those rules. It held that businesses could include binding arbitration clauses in virtually any document, ranging from employment contracts to end user license agreements. Virtually overnight these clauses exploded in popularity. If you have purchased a cell phone, opened a box of cereal or even liked a Facebook page, you’ve probably agreed to arbitration without knowing it.
It’s this last element that the Supreme Court changed. You no longer need to prefer arbitration, or even know you’ve agreed to it, for someone to enforce it.
Proponents of binding arbitration argue that it exists to streamline litigation. The process of managing a lawsuit has become so expensive, they argue, and the number of cases so excessive that companies need a way to manage the caseload. Handling disputes in front of a mediator can cut down those costs dramatically and speeds up resolution. Instead of spending hundreds of thousands of dollars and years of time, the parties can get an answer with just one hearing.
This is true, as far as it goes. Arbitration is, indeed, cheaper and faster than taking a case to trial. This is because arbitration skips a process known as “discovery,” the lengthy and expensive part of a case where parties produce documents and testimony.
Skipping discovery heavily advantages the defendant in any matter. Someone who has been harmed doesn’t come into a lawsuit armed with the proof they need to make their case. They need a court, with its power to subpoena documents and compel testimony, to produce the actual evidence of negligence and wrongdoing. By eliminating this step arbitration produces consistently better results for defendants, which are usually the businesses that wrote the contract.
Binding arbitration also requires that parties handle their disputes one-on-one.
This is the most important part of the arbitration revolution, because it eliminates the class action lawsuit altogether. If a company harms 1,000 people, ordinarily they can band together and sue as a group. Given the time and expense involved with a lawsuit, often this is the only way that individuals can afford sue at all.
Arbitration bans this process. Instead, each individual must file a claim on his own. Each person must show up at a place selected by the defendant, in front of a mediator selected by the defendant, and negotiate his claim personally. Difficult enough for large claims, this is effectively impossible for claims worth only a few hundred, or even a few thousand, dollars.
Companies have leapt on the opportunity. By now almost every consumer-facing contract includes binding arbitration language, and that very much includes contracts for retirement plans. Today most tax-advantaged retirement plans require you to settle any disputes through this process. They also include a longstanding practice known as “discretionary clauses,” language that gives the plan administrator authority to interpret the terms of the retirement plan as they see fit.
What’s Changing With Arbitration Clauses?
The new bill in front of Congress, formally H.R. 7740, would ban both of these clauses. Under this law, arbitration and discretionary clauses would be unenforceable in any retirement plan governed by the ERISA statute. This includes employer-sponsored retirement plans such as 401(k)s, profit-sharing plans, HMOs and flex accounts. It does not include non-employer retirement plans such as IRAs and Roth IRAs, as those are not covered by the ERISA statute.
This would have two main effects.
First, individuals who feel that they have been harmed by an ERISA-governed retirement plan could sue the plan or its administrator in court. They could not be required to go through arbitration. For widespread harm they could band together and file a class action lawsuit. This would be particularly valuable to plaintiffs with claims of mismanagement or breach of fiduciary duty, which can often involve significant sums overall but relatively small amounts per-person.
Second, courts would no longer defer to a plan administrator’s decisions when participants challenge them. This comes up most often in denial of benefits claims. Under current law, a court will only intervene if a plan administrator has abused their discretion and can show no good faith reason for their decisions. The new bill would eliminate that requirement, allowing courts to review the matter with no deference toward either party.
This second change would not apply to multiemployer benefits plans such as those commonly negotiated by industry organizations or labor unions.
Lobbyist groups such as the American Retirement Association have come out strongly against H.R. 7740. In an open letter, the ARA wrote that the bill “will increase costs for a small business to operate a retirement plan and will lead to more frivolous lawsuits against plan sponsors… This change will simply result in more retirement plan administrative costs and litigation that will benefit the plaintiffs’ bar but not every day working Americans who are saving for a secure retirement. This legislation only offers more deterrents to maintaining retirement plans and should be opposed.”
Despite this opposition, the ARA’s open letter provided no evidence for these claims. The U.S. Chamber of Commerce has also filed an open letter opposing this bill. It, too, argues that binding arbitration clauses are necessary “in reaction to the onslaught of class action lawsuits aimed at attorney fee recovery rather than protecting participants’ rights” citing evidence of increased litigation and soaring expenses related to class action lawsuits.
While a plaintiff’s attorney would argue that more lawsuits suggest more wrongdoing, the Chamber of Commerce also argued that individual employees should prefer binding arbitration clauses. It claims that individual plaintiffs are three times more likely to win an arbitration than a lawsuit and tend to collect almost $40,000 more per case.
Employee-oriented arguments are at odds with most third party research, however, which finds that arbitration clauses overwhelmingly advantage the businesses drafting those contracts. These arguments are also somewhat counterintuitive, suggesting that retirement plans sweepingly require an arbitration process that produces worse results for them. While defense attorneys would argue that a retirement plan may embrace worse outcomes in exchange for reduced costs of litigation, it’s important to note that nothing in this bill would bar retirement plans from offering arbitration. It would simply stop them from requiring that process over an employee’s objections.
If it passes, H.R. 7740 would allow individuals to sue their retirement plan and its managers for misconduct, mismanagement, breach of fiduciary duty or other forms of wrongdoing. This is one of the most contentious issues in modern civil procedure.
Industry organizations argue that banning arbitration clauses will lead to higher fees and exploding costs. While this is possible, virtually all third party analysis has found that abuse increases, products get worse and costs go up once consumers lose their right to sue.
Bottom Line
A new bill in front of Congress could eliminate binding arbitration clauses from ERISA-sponsored retirement plans. While strongly opposed by industry groups, research into this area suggests that it could be very good for individual savers.
