On its face, FDR1 is a technical case concerned with the true extent of an “underpin” relevant to how pension increases are calculated under the scheme at issue. At its heart, it is much more: it is a salutary warning about the dangers of not paying attention to restrictions on scheme amendment powers.

Howsoever categorised, it was commercially important to the parties, with the outcome determining whether there would be an extra £5m added to the liabilities of the scheme, £17m, or something in between. The answer was £17m.

The facts

The scheme was established in 1972, although its first definitive trust deed and rules was not made until 1977. The 1977 rules provided for pensions coming into payment after 30 April 1974 to be increased on each anniversary of the date of commencement of pension by 3% compound.

On 20 June 1991, a deed of amendment purported to replace the existing increases rule with a rule that still provided for increases to be payable on each anniversary of the commencement of the pension, but in an amount equal to the lesser of 5% of the pension in payment and the increase in RPI over the past year. It purported to apply in relation to all pension, no matter when accrued.

The scheme’s amendment power included a restriction preventing both pensions in payment and members’ accrued rights from being affected prejudicially.

It was common ground as between the parties that the amendment made in 1991 contravened the restriction, insofar as the amendment adversely affects pension accrued before 20 June 1991 (there was no issue to the extent that it resulted in a higher increase to such pension). Nevertheless, the issue had not been spotted until a re-write of the definitive deed and rules was underway in 2012, with increases to pension accrued before 20 June 1991 having been administered on an incorrect basis in the meantime.

Key legal point

Given all parties accepted that there was an issue, the question for the court was to determine the extent of the issue. Specifically, what exact protection applies in relation to pension accrued before 20 June 1991, as a result of the restriction on the scheme’s amendment power.

The employer raised various constructions and analyses that were designed to result in the lowest possible amount of additional liability for it, but all of them involved a contortion of the language under the scheme’s governing documentation that the judge would not accept.

In particular, the employer’s arguments involved a “cumulative analysis” that could reduce the “starting point” for the calculation of future years’ increases. It would do so by, in effect, allowing a “netting off” of years where RPI increased by more than 3% against years when it did not (subject to the resulting aggregate increase being no less than 3% compound).

However, the judge said that the language of the scheme’s governing documents is clear. Both under the pre and post June 1991 increases provision, increases are applied annually on each anniversary of the date the pension commenced.

So, on each such anniversary, the trustees need to apply an increase that, in relation to pension accrued before 20 June 1991, is the better of (i) 3% and (ii) the lower of 5% and the rise in RPI over the past year. Once each such annual increase has been applied, that it is the starting point for the calculation of next year’s increase and there is no looking back over the period since retirement to see what has happened in aggregate over that time.

Watch this space

As a final thought, the case could be indicative of the type of litigation that we may see more of in the coming years.

We now have a respectable body of pensions case law from which various key principles can be gleaned. The challenge that many schemes have found, however, is how those principles should be applied.

In the recent litigation concerning IBM’s closure of its scheme to future accrual, we had a lengthy judgment about the consequences of the various breaches of duty, which followed on from a prior hearing and lengthy judgment in relation to the breaches of duty and applicable principles themselves.

As noted above, the FDR case concerned the consequences of applying accepted principles, not questions as to what those principles are.

Given that there will often be much at stake resulting from how principles are applied – like here, with the difference between £5m of extra liability and £17m – we fully expect to see more cases of this kind: so, watch this space…