Pension scheme trustees may be forgiven for thinking that Parliament enjoys keeping them on their toes. As well as having to keep up with a seemingly endless stream of specific pensions legislation, the prudent trustee (or director of a corporate trustee) must also be aware of the implications of more general legislation which may have an impact upon his or her role. Certain provisions of the Companies Act 2006 will come into force on 1 October 2008 and fall into the latter category. This information is essential reading for trustees of pension schemes to avoid the risk of a breach of duty.
Conflicts of interest – common problems
There has long been a common law duty requiring company directors to avoid putting themselves in a situation of conflict of interest. The most obvious example is where the director’s personal interest conflicts with his or her duty to act in the best interests of the company. Another example, which is particularly relevant in the context of pensions, is where the director also owes a duty to act in someone else’s best interests and those interests conflict with the best interests of the company.
A common illustration of this problem is where a director of the sponsoring employer of a pension scheme is also a trustee of that scheme. As a trustee, his or her duty is to act in the best interests of the scheme’s members; but as a director of the sponsoring employer, he or she has a duty to the company to act in its best interests as well.
This often gives rise to difficulties where the pension scheme is a final salary scheme which is underfunded (as many of them are); particularly with regard to the setting of employer contribution rates and decisions concerning investment strategy. Problems can also arise in the context of possible corporate mergers or acquisitions, where the director may have received (in his capacity as director) information which is of significance to the pension scheme, but is also highly confidential.
The situation is not necessarily any easier where the scheme has a corporate pension trustee: if one or more directors of the trustee company are also directors of the sponsoring employer, the same issues of conflict arise. Indeed, the situation may be even more complex, as the director in question will owe the duty to avoid conflicts of interest to not one but two companies: the trustee company itself and the sponsoring employer.
Companies Act 2006 – A new statutory duty
This common law duty has now been codified in the Companies Act 2006. One of the key provisions of that Act (which will come into force on 1 October 2008) says that “a director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company” (section 175(1). The possible penalties for breach of this duty are the same as currently apply for breach of the equivalent common law duty. Therefore, the real interest in the Companies Act provisions lies in the various ways in which a director may be able to avoid a breach of the duty in the first place
The Pensions Regulator has issued draft guidance on how pension trustees should manage conflicts of interest. As one would expect, this guidance primarily focuses on the risk of breach of the duties which the trustee owes to scheme members. The methods for handling potential conflicts suggested in the draft guidance would often avoid the risk of breach of duty to the company as well (for example, the resignation of the director-trustee); however this is not guaranteed in all cases.
The Companies Act also provides that there will not be a breach of the duty in circumstances where “the situation cannot reasonably be regarded as likely to give rise to a conflict of interest” or where the conflict arises “in relation to a transaction or arrangement with the company”. However, neither of these provisions is likely to be of much assistance to a director-trustee in the kinds of scenarios described above. As regards the first provision, few directors will want to second guess how a court would view the reasonable foreseeability of the conflict. As regards the second, the general view is that a “transaction or arrangement” will only fall outside the duty where the transaction or arrangement is between the director personally and the company - the Companies Act contains specific and detailed provisions in relation to this scenario.
Because of these factors, director-trustees should consider carefully whether any of the Companies Act provisions for authorising a possible conflict of interests can and should be adopted. There are three such methods, which are as follows:
Authorisation by the board of directors of the company
This is likely to be effective only in relation to a specific conflict; it is unlikely it will be able to be used to give the director a general “all-clear”. The matter needs to be formally proposed to the directors and authorised by them (the conflicted director cannot vote or be counted in the quorum). In addition, for any private company which is already in existence, the shareholders must have resolved to allow authorisation by the directors in this way.
Plus, for any public company, its articles of association must include provisions specifically permitting such authorisation. In relation to a private company which is first registered after 1 October 2008, there is no need for shareholder approval, but there must be nothing in the articles of association which prevents board authorisation.
Authorisation by the shareholders
This can be in relation to a specific matter or in relation to potential conflicts in general. Only an ordinary resolution will be required.
Authorisation may be given in advance (preferable) or, in relation to specific actions, after the event (by way of ratification of the director’s actions).
Authorisation under the articles of association
Another alternative is that the company’s articles can contain provisions for dealing with conflicts of interest. Provided that these provisions are adhered to, there will be no breach of duty. The statutory wording appears to envisage that some particular procedure will be specified in the articles; such as assessment and authorisation by a particular officer or sub-committee of the board. Each of the above methods will require action to be taken by the company to whom the director-trustee owes the new statutory duty (under section 175 of the Act). Companies should ensure that the necessary steps are taken in good time so that their directors are suitably protected before the first situation of conflict arises after 1 October 2008. The Companies Act 2006 envisages that some such steps (such as shareholder resolutions allowing board authorisation) may take place before the new duty comes into force.
Disclosure of conflicts
Disclosure of a potential conflict by the director-trustee is both expected by the Pensions Regulator and in some cases required by the Companies Act 2006. However, disclosure is unlikely in itself to be adequate to resolve any serious conflict of interests.
Nevertheless, it represents best practice, and it would be advisable for both board and trustee meeting agendas to include the making of any such declarations as a standing item (even where the conflict has been authorised by one of the methods already described). At the very least, this practice may help to ensure that all parties present are reminded of known conflicts.
It also provides an opportunity for reviewing the effectiveness of any particular strategy adopted to manage such conflicts in the context of the specific business to be discussed at that meeting.
Protection for director-trustees
The Companies Act 2006 also includes updated provisions regarding indemnities provided by a company (or a company within the same corporate group) to a director. These provisions cover indemnities in respect of any liability for negligence, default, breach of duty or breach of trust. They replace the old Companies Act 1985 provisions, which have until now been something of a problem area for corporate pension trustees.
Under the 2006 Act provisions, which came into force on 1 October 2007, the general position is that any such indemnity is void where it relates to a director’s liability to the company. However, there are three main exceptions:
The company can pay for insurance covering the director against such liabilities.
Qualifying Third Party Indemnity Provision (a “QTPIP”)
Since the prohibition is on indemnifying the director against liabilities to the company itself, it is acceptable for the company to indemnify the director against liabilities to third parties arising from his actions as director. A QTPIP may therefore be given to protect an individual director-trustee from liability to the members of the scheme. Note, however, that there are various kinds of liability which may not be covered by a QTPIP; key amongst these are any criminal or regulatory fines and the director’s costs in unsuccessfully defending himself against criminal proceedings or against any civil proceedings brought by the company itself or an associated company. The QTPIP provisions are a reenactment of an existing provision which first came into force on 29 October 2004.
Qualifying Pension Scheme Indemnity Provision (a ”QPSIP”)
This is any provision indemnifying a director of a company that is a trustee of an occupational pension scheme against liability incurred in connection with the company's activities as trustee of the scheme. Again, there are liabilities which cannot be covered by a QPSIP: these are criminal or regulatory fines, and the director’s costs in unsuccessfully defending himself against criminal proceedings. This is a particularly useful change where the sponsoring employer sets up an “in-house” corporate pension trustee for its scheme and such trustee company is an associate of the sponsoring employer. This is because such an indemnity can be given either by the trustee company or by the sponsoring employer.
A QTPIP or a QPSIP must be disclosed in the company’s annual report and (where the indemnity is given by an associated company) by the indemnifying company. A copy must also be available for inspection at its/their registered office and must be retained for at least 1 year after it expires.
An indemnity may be contained in the company’s articles, or in the director’s appointment letter or service contract, or it may be in the scheme’s rules.
The wording of the statutory provisions is wide enough to cover (and so render void) all of these possible forms of indemnity. Therefore director-trustees should make sure that the statutory requirements for the indemnity to fall within the definition of QTPIP or QPSIP (as appropriate) are met.
One particularly knotty problem is whether existing indemnities in (say) the scheme rules which would otherwise meet the requirements for a QTPIP or QPSIP and which were already in place on 1 October 2007 (or 29 October 2004 for a QTPIP) will be caught by the legislation, or whether they will already have been rendered void by the old law. For safety’s sake, directortrustees may wish to ensure that insurance cover is obtained, or that the indemnities are expressly given afresh now that the new provisions are in force.
One final word of warning: it is important to distinguish between indemnities and exoneration clauses. Any provision which attempts to exclude altogether the director’s liability to his company for negligence, default, breach of duty or breach of trust is void – there are no exceptions. However, this does not affect the provisions already discussed in relation to authorisation of conflicts of interest.
Director-trustees continue to face difficult conflicts of interest. Therefore it is not surprising that schemes are increasingly opting to appoint an independent professional trustee instead of struggling with such conflicts. However, where schemes do not wish to do this, it is important for the trustees and the company/ companies involved to take account of the Companies Act provisions and to put in place appropriate provision to protect director-trustees against the consequences of a potential breach of duty.