The High Court decision in Independent Trustee Services Ltd v. Hope [2009] EWHC 2818 Ch was handed down yesterday. It has laid down new principles relevant to pension scheme trustees where the pension scheme may be at risk of entering the PPF assessment period.

The facts of the case

Ilford Limited (the Company) went into administrative receivership in August 2004. Its pension scheme had about 3,000 members. As the receivership was pre-6 April 2005 the Scheme did not qualify for PPF entry. The receivers sold the Company’s business assets but no funds were available for unsecured creditors such as the Scheme. As the major unsecured creditor, the Scheme is able to have the Company placed in liquidation after 6 April 2005 and if this happens the Scheme will qualify for PPF entry.

As at January 2007 the Scheme had a buy-out deficit of £45 million and a deficit of £15 million on the PPF compensation levels. It was clear that most of the members would be better off if the Scheme entered the PPF rather than if it wound up outside the PPF. However, some members would be worse off if the Scheme entered the PPF. These members were high-earning employees who took early retirement in 2000 and 2001. They had pensions of over £40,000 a year. Under the PPF compensation rules their entitlements would reduce to 90 per cent of a cap of £28,742.69 at age 65. Some of their pensions would be reduced by over 50 per cent. They asked the Trustee to buy annuities to secure their benefits outside the Scheme before triggering the entry of the Scheme into the PPF. The effect of this would be that they got 100 per cent of their pensions but this would result in the assets the PPF would receive being disproportionately reduced to meet the cost of the annuities. The Trustees were sympathetic provided this was lawful but the PPF and the Pensions Regulator objected.

The decision

Henderson J held that the exercise of the power to buy annuities was subject to an implicit limitation that the amount applied in buying them should be the members’ “fair share” of the Scheme assets. To apply a disproportionately large share would prejudice the remaining members who were not bought out. This raised the question whether it is proper for the Trustees to take account of PPF compensation in deciding what is a “fair share” of the assets to apply in buying a buy-out policy. The right to compensation under the PPF was not an asset of the Scheme and could not be considered in exercising the power to buy annuities.

A wider issue – is the existence of the PPF a factor a trustee may consider?

Henderson J went on to deal with a wider issue even though it was not necessary to decide the case. This was whether an amendment to the Scheme to permit the Trustee to take account of PPF compensation and treat it as an asset of the Scheme would be permissible. He concluded that it would “be a blatant attempt to undermine or circumvent the policy of the PPF legislation” for two reasons:  

1 the aim would be to minimise or eliminate the Scheme assets, which would vest in the PPF when the Scheme was seriously underfunded;

2 it would treat PPF compensation as though it were an advantage to be exploited for the Scheme’s benefit whereas Parliament intended the PPF to be a funder of last resort, which would step in where the Scheme was unable to fund PPF level benefits.

Commentary

This decision rests on the assumption that trustees can only take account of the “fair share” of the scheme assets attributable to a member when buying an annuity and the assets do not include the possibility of PPF compensation. This is prudent as a trustee who allocates more than a member’s “fair share” of the assets runs the risk that the scheme might not qualify for the PPF after all and a decision to allocate more than the “fair share” could then be regarded as a breach of trust. The same would also apply to requests for transfers out prior to the scheme entering the PPF. One issue that will need careful thought is how far before entering the PPF this will apply. What if the employer is in financial difficulty and the scheme is below PPF compensation levels? Should it apply from the point both these conditions are met? If so, it poses a problem for many trustees right now.

This decision is limited in its scope. It is concerned with cases where the exercise of the power that would otherwise be unlawful is justified by taking account of PPF compensation. Henderson J would not go further and lay down general principles about other situations that might come before the court. It is possible to think of other situations where the answer could be different. For example, a sectionalised scheme in deficit where the trustees must exercise their discretion and they decide to allocate assets to wind up different sections where some sections could be eligible for the PPF but others will not. The power to buy annuities is a mere power that may be exercised by the trustees. However, the exercise of a discretion to divide property is a trust power the trustee must exercise. The conclusion in the latter may well lead to different considerations being applied. It was noted in this decision that it is not improper to take account of the PPF when deciding whether to bring about a qualifying insolvency event to get a pension scheme into the PPF. Why should the position differ in relation to the allocation of assets in sectionalised schemes?