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Service Provider Fee Disclosure Regulations: Contract Termination – Part XII 11/3/2010
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This is the twelfth in a series of Technical Updates relating to the DOL’s July 2010 service provider fee disclosure regulations. The prohibited transaction exemption for necessary services has specific rules for termination of a service provider contract that must apply in order to have a “reasonable" contract. This Technical Update discusses the termination requirements.

Q-1: Do the provisions for termination of a service provider contract impact whether the contract is reasonable?

Yes. The “408(b)(2) regulations" (referring to the statutory prohibited transaction exemption for a “reasonable" contract for necessary services that is the statutory basis for the fee disclosure regulations) include specific limitations on provisions for termination of a service provider contract.

Q-2: Are the contract termination provisions in addition to the fee disclosure regulations?

Yes. In fact, until the addition of the fee disclosure regulations, the regulations relating to a reasonable service provider contract consisted of the single paragraph dealing with the issue of contract termination. The DOL chose to retain the prior termination regulation, and simply changed the paragraph number to place the paragraph at the end of the new regulations. So while the termination regulations are not new, we review them in this Technical Update to complete the discussion of the service provider contract rules.

Q-3: What is the basic limitation on contract termination?

Under the regulations, a service provider contract is not reasonable (and therefore is a prohibited transaction) if it does not permit termination by the plan “without penalty" to the plan on “reasonably short notice." What is reasonably short notice depends upon the circumstances, but the purpose of the regulation is to prevent a plan from bound to continue an arrangement that has become disadvantageous.

Q-4: May a service provider contract include a provision that “reasonably" compensates the service provider for loss upon early contract termination?

Yes. A contract that “reasonably" compensates the service provider for loss upon early termination is not considered a penalty. The regulations use the example that a “minimal" fee in a service contract which the service provider charges to allow recoupment of start-up costs is not a penalty. Of course, “reasonable" and “minimal" fee are not defined, and depend on the facts and circumstances.

Q-5: Do the regulations prohibit a long-term lease?

No. A lease is not unreasonable merely because it is long-term, provided the plan may terminate the lease, without penalty, upon reasonably short notice (under the circumstances). Consistent with the previous Q&A, a lease provision which reasonably compensates the lessor for loss upon early termination is not a penalty. Similarly, the regulations provide that a lease provision for a termination fee that covers reasonably foreseeable expenses related to the vacancy and reletting of the office space upon early termination is not a penalty. However, to be reasonable, the provision may not provide for payment in excess of actual loss, and must require mitigation of damages.

ERISA Workshop 2010 to Focus on New Service Provider Regulations
The focus of this year’s ERISA Workshop is indeed on ERISA, as the workshop will look in-depth at the new regulations mandating disclosure from service providers to plan administrators. We’ll show you how to know if you are subject to the new rules and what you must do to comply (and what happens if you don’t). We’ll also analyze the rules in terms of modern business practices and revenue models. Of course, this seminar will also keep you up-to-date on all other recent changes in tax rules, and important developments affecting qualified plans. With the new service provider regulations, this seminar is a “must attend" for all those servicing retirement plans. Register for the workshop on our Web site.

Don’t miss our upcoming Web seminars on these timely topics:
Participant Fee Disclosure - The Third Time Is the Charm - Tuesday, November 16, 2:00 p.m. ET
NEW! PTIN and Me: New Rules; New Duties; New Questions – Encore presentation, Tuesday, November 23, 1:00 p.m. ET
DOL and IRS Compliant Participant Notices – Tuesday, November 30, 2:00 p.m. ET
To view more information about these Web seminars and to register, go to our Web site.