In a case that will be of interest to all employers and trustees considering making changes to occupational scheme benefits, an employer has been held to be in breach of its contractual and Imperialduties in the way in which pension scheme changes were implemented. Trustees may also need to consider whether their own actions have contributed to establishing members’ reasonable expectations of certain levels of benefits.
In IBM UK Holdings and another v Dalgleish and others , the Court held that IBM’s actions as a whole amounted to a breach, although irrationality or perversity on the part of the employer was required.
The claimants sought to clarify the validity and lawfulness of changes purportedly made by IBM to two IBM pension schemes, known internally as “Project Waltz”. The major complaint of the members was that IBM was in breach of the implied duty of good faith which is owed by an employer to the members of a pension scheme when exercising its functions in relation to such a scheme. This implied duty is often known as the Imperialduty after the 1991 case in which the duty was first identified. There was also a question of whether the employer had breached its implied contractual duty of mutual trust and confidence which should exist between an employee and employer.
In the previous IBM judgment in 2012, which involved a rectification claim, the same judge as in the 2014 IBM case, Warren J, summarised the Imperial duties as follows:
- the employer's exercise of discretion requires a “genuine and rational as opposed to an empty or irrational exercise of the discretion”;
- the correct test is not one of fairness. Assessing whether a decision is irrational or perverse is not to be equated with the application of an objective standard of reasonableness;
- whatever the test is, it is a “severe” one; the employer's conduct must be such as to destroy or seriously damage the relationship; and
- the test is an objective one, although the judge acknowledged there may be circumstances when the employer's subjective purpose might be relevant.
The Court considered a number of issues, which are listed in an annex to the judgment. The issues of general interest were whether IBM had acted, or would be acting, contrary to its contractual duty of trust and confidence to its employees, and its implied duty of good faith to members of the pension scheme, as regards the exercise of its functions in relation to the various changes it sought to make to the future provision of scheme benefits. In brief, these changes included closure to future accrual, making future pay increases non-pensionable (that is, breaking the final salary link) and introducing a new early retirement policy under which IBM would largely agree to no further enhanced benefits on early retirement.
The Court held that, when its actions were viewed as a whole, the Project Waltz changes amounted to a breach by IBM of its Imperial duties and of its implied contractual duty of trust and confidence. Warren J considered that the members’ reasonable expectations had been relevant. A reasonable expectation was the members’ expectation of what would happen in future generated by the employer’s own past actions, and which gave members a positive reason to believe that things would take a certain course. Warren J found that “Conduct on the part of an employer which is contrary to a reasonable expectation is, in principle, capable of giving rise to a breach of the Imperial duty on the basis that the conduct is irrational or perverse”. He held that it was clear that the Imperial duty applied to the exercise by employers of discretionary powers under a pension scheme. On the facts of this case, IBM had breached its Imperial duty in exercising its power the way it had to close the schemes to future accrual, as the exercise of that power was contrary to the members’ reasonable expectations of future benefit accrual, and the matter was sufficiently serious to give rise to the breach of duty.
IBM had also acted in breach of its contractual duty in indicating that there would be no salary increases in future for those members who did not sign the non-pensionability agreement. However, this change was later qualified by IBM, and members were then informed that it would apply only to the period 2009 – 2011, after which it would be reviewed. Nevertheless, the original announcement to the effect “no salary increases if you don’t sign up” was the basis upon which some members made their decision. Members who made their choice prior to becoming aware of the qualification of the original announcement could have a claim for breach of duty giving rise to a damages claim.
The introduction of the new early retirement policy with effect from 6 April 2010 was a further breach of theImperial duty, as this was inconsistent with the members’ reasonable expectations that the policy would not change until 2014. This was a “very serious matter” and capable of giving rise to a breach of the Imperial duty under the “irrational or perverse” test.
Further, IBM stated during negotiations that it intended to close the scheme to future accrual in 2010 (despite always intending to effect closure in 2011) in order to strengthen its negotiating position. IBM did not inform the trustee or the members of its true intention for making the pension changes – that is, in order to satisfy earnings per share requirements, with which its US parent required it to comply. The consultation on the changes had not been carried out in a way which was open and transparent, neither had it been carried out in accordance with IBM’s implied contractual duty of trust and confidence.
The Court said that it was clear to IBM that the Project Waltz proposals would meet with a hostile reaction from members. Once the announcement had been made, IBM then knew it was being accused of betrayal and breach of trust by members and, at that point, IBM should have taken the consultation with the “utmost seriousness and [been] frank and open with members”. Warren J stated that he had not relied upon the fact that IBM had not conducted the consultation in accordance with its own philosophy, as set out in its Business Conduct Guidelines and Core Values publication, but had he done so, this would only have confirmed his decision.
Despite the above, Warren J held that his conclusion that IBM had acted in breach of its duties did not necessarily mean that the Project Waltz changes had been swept away entirely, nor did it say anything about how the employer was able to act in the future. There would be a further hearing to consider the remedies to be provided in relation to the breaches of duty which had been identified.
The members also argued that the method by which IBM closed the scheme to future accrual (by means of a rule allowing it to exclude specific members or classes of members from membership of the scheme) was invalid. They claimed that the introduction of the rule was contrary to certain restrictions in the power of amendment, particularly the restriction on breaking the link to final salary. Warren J held that IBM could use the scheme’s exclusion power to close the scheme to future accrual, but that the final salary link was protected by the relevant restriction in the power of amendment.
This case will be a concern to employers who are considering making significant changes to the benefit provisions under their pension schemes, as it is the first time that an employer has been held to be in breach of its contractual and Imperial duties. However, the judgment confirms that irrationality or perversity is required in order to breach that duty, and this case turned very much on its facts, together with some actions on the part of the employer which the court identified as ill-considered. Nevertheless, the actual nature of the scheme changes proposed under Project Waltz was not, on its own, enough to breach the duty. The manner in which the consultation was conducted by the employer and the fact that some misleading statements were made to members were key elements in concluding that breaches had occurred. However, Warren J was keen to stress, in particular, that non-pensionability agreements are not offensive in themselves, but the manner in which IBM handled the consultation left his particular agreement open to challenge.
This is a clear warning that employers must take very seriously their Imperial duties of acting in good faith and must implement these by communicating honestly and openly with members when scheme changes are proposed. In addition, they must ensure that any such exercises are conducted in a way that will not affect adversely the trust and confidence in the employer/employee relationship. The case emphasises that employers must consider consultations on pension scheme changes carefully and it is essential that they allow themselves sufficient time to provide to members accurate and thorough advance communications.
The judgment also raises issues for pension scheme trustees in relation to consultation. Trustees are already required to check the powers in their scheme’s governing documentation to see if the employer’s proposals are possible. They must also ensure that the employer has complied with the consultation requirements. In addition, it was suggested that trustees have a role in considering whether members have reasonable expectations in relation to benefits, and whether proposed changes would breach the employer’s Imperialduties.
Trustees may need to look at their own actions and statements or assurances to members to see if they have contributed to establishing a reasonable expectation. This is contrary to the accepted view that future benefit design is for the employer alone, and suggests that trustees may need to consider these issues in their negotiations with the employer.
A remedies hearing is due in the near future. Depending on the outcome, we understand that an appeal may follow.
View the judgment.