• Modification of Prohibited Transaction Exemption for Certain Interest-Free Loans
  • May 31, 2006 | Authors: Richelle L. Aschenbrenner; Angela M. Miller
  • Law Firm: McGuireWoods LLP - Chicago Office
  • On April 3, 2006, the Department of Labor (“DOL”) issued an amendment to Prohibited Transaction Exemption 80-26 for certain interest-free loans to employee benefit plans (“PTE 80-26”). PTE 80-26 exempts certain loans from the prohibited transaction limitations codified in Section 406(a)(1)(B) and (D) and Section 406(b)(2) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In general, PTE 80-26 allows loans or extensions of credit from a party-in-interest to an employee benefit plan (the “plan”), and the repayment of those loans, provided that: (1) no interest is charged to the plan and no discount for payment in cash is relinquished by the plan; (2) the proceeds of the loan are used for payments of ordinary operating expenses of the plan or purposes incidental to the ordinary operation of the plan; (3) the loan is unsecured; and (4) the loan is not made directly or indirectly by an employee benefit plan.

    The DOL published notice of the proposed amendment to PTE 80-26 on December 15, 2004. The final amendment to PTE 80-26, which incorporates comments received by the DOL and is effective December 15, 2004, contains three significant changes from the original exemption. First, it clarifies that loans described in Section 408(b)(3) of ERISA and the regulations thereunder (i.e., loans involving an employee stock ownership plan (“ESOP”) to the extent that such loans relate to the acquisition by the ESOP of employer securities) are not covered by this exemption. Second, it eliminates the three-day limit on loans for purposes incidental to the ordinary operation of the plan. Third, it requires a written loan agreement when the term of the loan is 60 days or longer. The effective date for requiring a written loan agreement differs depending on the purpose of the loan. If the loan is for ordinary operating expenses, a written loan agreement is required for any loan entered into on or after April 7, 2006. If the loan is for purposes incidental to the ordinary operation of the plan, a written loan agreement is required for any loan entered into on or after December 15, 2004. The written loan agreement must contain the material terms of the loan.

    This is the third amendment to PTE 80-26 since it became effective January 1, 1975. The two previous amendments were temporary exemptions addressing specific issues, Y2K and the market disruption caused by the events of September 11, 2001, for which only a limited exemption was needed. In contrast, the most recent amendment is a prospective general exemption effective as of December 15, 2004.

    PTE 80-26 can be used by the employer sponsoring a plan to pay plan expenses and then seek reimbursement by the plan. However, if there is to be an interval of 60 days or more between the time the employer pays the expense and the time the plan reimburses the employer, a written loan agreement is needed.