Employee Stock Ownership Plans (“ESOPs”) are powerful vehicles for business succession and employee ownership, but they operate under a tightly regulated framework. Because ESOPs are governed by the Employee Retirement Income Security Act of 1974 (“ERISA”), they cannot function like typical corporate buyers or sellers. A commonly misunderstood limitation is the ability of an ESOP to indemnify a party in connection with a transaction. The short answer is “NO” and understanding why is essential for properly structuring deals and avoiding fiduciary missteps.
The fiduciary duty owed to participants is the foundation of ERISA. This duty is called the exclusive benefit rule, and it requires every plan asset be used solely to provide retirement benefits to plan participants and beneficiaries. Indemnifying selling shareholders, buyers, company officers, trustees, or advisors would violate this principle. If an ESOP had to use plan assets to indemnify someone, those payments offer no corresponding retirement benefit to employees. Any indemnification obligation would instead divert plan assets to protect third parties, reducing the economic value available to participants and therefore conflicting with the legal purpose of the ESOP.
In addition to violating the exclusive benefit rule, an indemnification commitment would place the ESOP trustee in an untenable fiduciary position. ERISA requires a trustee to act solely in the interest of participants and with the care, skill, prudence, and diligence of an expert. Agreeing to indemnify others in a transaction would impose additional liabilities and financial risks on the ESOP without providing any participant benefit. That kind of risk assumption would be inconsistent with the trustee’s fiduciary duties and would almost certainly constitute a breach under ERISA.
ESOP indemnification would also trigger ERISA’s prohibited transaction rules. These rules bar transactions between a plan and “parties in interest,” including the company, selling shareholders, officers, directors, and certain service providers. If an ESOP attempted to indemnify any of those parties, the plan would effectively be transferring value to them, a transfer that ERISA views as inherently conflicted and therefore prohibited. Violating these provisions exposes fiduciaries to excise taxes, civil penalties, and personal liability.
Importantly, even the ESOP trustee cannot be indemnified by the plan. Although the trustee acts on behalf of the ESOP, ERISA prohibits fiduciaries from being indemnified by plan assets for their own errors or breaches. While the company itself may indemnify the trustee for certain non‑fiduciary matters, the ESOP itself cannot do so under any circumstances. This maintains strict accountability for fiduciaries and ensures that plan assets are used only for participants.
Because of these restrictions, ESOP transactions rely on alternative risk‑allocation tools that do not involve plan assets. Typically, companies indemnify selling shareholders or officers instead of the plan doing so. Deals may also incorporate representation and warranty insurance, escrow arrangements funded by seller proceeds rather than by the ESOP, or purchase price adjustment mechanisms built into seller notes. These structures allow the transaction to move forward while preserving compliance with ERISA and safeguarding participant benefits.
Ultimately, the reason an ESOP cannot indemnify anyone is simple: the ESOP exists to protect employees’ retirement interests, not to protect sellers or corporate insiders from risk. Each aspect of the ESOP rules, including the exclusive benefit requirement, fiduciary obligations, and the prohibited transaction provisions, is designed to keep employee retirement assets insulated and secure. Understanding these limitations allows all parties involved in an ESOP transaction to structure the deal properly and avoid serious compliance problems.
If you have any questions about how to work with an ESOP in a transaction or any other ESOP administration questions, please contact any of Bricker Graydon Wyatt’s employee benefits team.
