The structure and the language used by the drafters of the CARES Act in their crafting of the new participant loan repayment suspension rules seem to be both rare and stunningly broad: they appear to actually mandate, as a matter of federal law, that each loan repayment due through December 31, 2020  by COVID qualifying participants be suspended for one year. Interestingly enough, the language does not appear to prevent  ongoing loan repayments from being made should the participant choose to do so-the plan just may not be able to impose a due date on those payments from COVID participants. And, as a practical matter, the need for the COVID participant to self certify status as such  may actually turn this into an elective exercise on the participants behalf.  A challenge for administrators is how you accommodate the suspension with the desire to permit repayments at the same time?

The suspension is actually a big deal. Section 2202(b)(2) of the CARES act, which mandates the suspension, did not fool with the amortization schedules, or the timing and taxation of defaults under  Section 72(p) of the Tax Code, which is the section which governs the tax aspects of loans. In fact, it did not even amend Section 72(p) at all.  Nor did it amend any part of ERISA Section 408(b)(1), which hold the ERISA rules governing loans.

No, it avoided technical changes to either of these statutes and went instead went to the heart of things: it actually appears to legally modify the loan agreement between COVID participants and the plan.

Remember the actual legal structure of the participant loan: it must be a legally enforceable agreement between the plan and the participant, on commercially reasonable terms. When a participant signs a loan application (electronically or otherwise), that person agrees to the terms of that loan contract (which is reflected in the plan’s loan policy). To do what CARES did, that is to actually change the “pay date” of the loan under that legally enforceable agreement, that agreement must somehow be changed. This change can be accomplished in one of 3 ways: mutual agreement by the participant and the plan to amend the terms of the agreement (which would take forever to do); (2) unilateral action by the plan, if it so had the right to do so under its loan documents (which is highly unlikely); or (3) a law mandated change.

This suspension of payments is a law- mandated change. But here’s the very curious thing about the change: these particular contracts are enforceable under state law, not federal law, and those contracts can clearly be changed as a matter of state law. But how does federal law now step in to mandate this change otherwise reserved to the states?

One way it seems to works is by way of the ERISA preemption clause, ERISA Section 514.  ERISA will preempt state laws insofar as they “relate to” any ERISA-covered employee benefit plan. One of the three elements that the Courts have recognized as fulfilling the “relates to” preemption standard is any law which  “binds employers or plan administrators to particular choices or precludes uniform administrative practice, thereby functioning as a regulation of an ERISA plan itself.” (See New York State Conference of Blue Cross & Blue Shield Plans v. Travelers Ins. Co., 514 U.S. 645, 658-660 (1995)). This type of change seems to fall well within this rule, giving Congress the right to change a participant loan agreement.

So keep all this in mind when detailing your approach to the loan suspension: your underlying loan policy contract appears to have been changed by federal law. Yes, the payment section of the loan policy will need to now be eventually changed, pursuant to the plan amendment clause of that section of CARES,  but note that the amortization schedules in the Code did not actually change (note also that, interestingly,  CARES did not actually change  the language of 72(p) or 408(b)(1) when dealing with the $100,000 limit and the 50% rule). You will also need to discover a way to handle volitional payments, I would think, as well. But this analysis does leave open the question on how a non-ERISA loan can be modified by federal law. I would hope that the general clauses in those loan agreements  may well be able to be read broad enough to reasonably being able to incorporate this change…..

A side note on 403(b) plans: though this rule change is going to be a nightmare to administer for payroll based 401(k) and 403(b) loan programs, the legacy 403(b) “policy”loan program will be served nicely by this rule-it almost makes me think that the drafters of these rules had these participants in mind when drafting the law. The typical 403(b) policy loan is “self-billed,” that is, the participant actually mails in (or has deducted from their bank account) every month or every quarter  their loan payment. The participant just needs to stop making those payments, and the insurer just needs to prevent the loan’s default (and then figure out how to deal with the new re-amort schedule adding in the interest accrued during the suspension).

A Note of Caution: These thoughts are only applicable to the  repayment delay rules, not to the increase of loan limits. Though I may cover that in another blog, it appears that the increase in loan limit is volitional on behalf of the sponsor, IMHO.