Engelbert Humberdinck sang it all those years ago, and now IBM must be singing it too after the long running pensions litigation has ended with the Court of Appeal allowing IBM’s appeal against a High Court ruling in 2014. The High Court had held that IBM had breached its Imperial1 duty of good faith and its contractual duty of trust and confidence relating to a series of pension changes known as Project Waltz.

Project Waltz was set up in 2009, with the main aim to close the two defined benefit schemes to further defined benefit accrual; to cap pensionable pay by ensuring pay increases would not count for defined benefit accrual; and to introduce a cost neutral retirement policy. The trustees refused to put the changes into effect without a court declaration.

The Imperial duty of good faith

In the High Court, Warren J held that IBM Holdings (the principal employer under the schemes) had acted in a number of respects which were in breach of the so-called Imperial duty. This is the duty imposed on a party exercising a non-fiduciary discretionary power under an occupational pension scheme. The key factor in finding the breach was based upon the reasonable expectations that had been engendered among the scheme members as a result of earlier projects (Reasonable Expectations).

So what did Warren J mean by Reasonable Expectations? He defined Reasonable Expectations by contrasting it with a “mere expectation”, ie an expectation that an employee might have as to the future, in the sense that they might expect, assume or anticipate that something would happen in the ordinary course of events if things remain unchanged. On the other hand, a Reasonable Expectation meant an expectation to what would happen in the future which had been engendered by an employer’s own actions and in relation to matters where it had some control, which gave the employees a positive reason to believe that things would take a certain course.

Warren J held there to be a number of specific Reasonable Expectations:

  • that future defined benefit accrual would continue unless a significant change in financial and economic circumstances might cause IBM Holdings to make further changes to its plans; and
  • that a member would be able to take advantage of the early retirement policy as it stood until 2014, unless Holdings had relevant justification to change it.

Further, that IBM UK (a participating employer employing the bulk of the members) had been in breach of its implied contractual duty of trust and confidence by getting members to sign non-pensionability agreements or receive no pay increases in the future.

Warren J also held that both Holdings and UK had been in breach of section 259 of the Pensions Act 20042 and the Pension Consultation Regulations3 and for UK, it was in breach of its contractual duty of trust and confidence in the manner that the consultation was carried out.

On appeal, the Court of Appeal was asked to consider a number of questions, among them:

  • On what basis did Warren J decide that Holdings and UK had breached their duties?
  • Was the judge wrong to decide Reasonable Expectations limited the exercise of a non-fiduciary discretion by an employer under an occupational pension scheme?
  • What did Reasonable Expectations mean in the case? Were they qualified by a significant change in circumstances?
  • Was the judge wrong to conclude there was an insufficient business justification for disappointing the members' Reasonable Expectations?
  • Was it a breach of trust and confidence to offer non-pensionability agreements?
  • What was the effect of defective consultation?

Court of Appeal decision

Although Warren J had held that the Project Waltz changes had been the result of a “rational commercial decision” it was the existence of Reasonable Expectations that led him to conclude that they could not be justified unless there was a way to achieve the business aims through compatibility with the Reasonable Expectations that had been engendered.

The Court of Appeal held that the correct test to apply is a rationality test which is equivalent to the Wednesbury test4. That is (a) whether only relevant matters (and no irrelevant matters) had been taken into account by the decision maker and (b) whether the result was such that no reasonable decision maker would have reached it.

The existence of Relevant Expectations was a relevant factor but the Court of Appeal considered that Warren J had wrongly elevated those expectations to a level of “special significance” in the decision making process and not just one of the factors which should have been taken into account. The elevation of the Reasonable Expectations to a higher status over and above other relevant factors was wrong in law. Warren J was therefore wrong to hold that IBM had breached its Imperial duty or its contractual duty of trust and confidence. The Court of Appeal did not need to answer the other questions relating to Reasonable Expectations but proceeded to provide very valuable analysis regarding how it can be proven that they exist, standards of clarity and certainty, and justification for disappointing those expectations. Employers seeking to embark on similar exercises should take note of these observations.

The Court of Appeal refused to grant an injunction to prevent the implementation of Project Waltz until a new consultation exercise had been carried out. To do so would have required the unravelling of the project and the formulation of entirely different proposals. The passage of time led to this refusal. The Court of Appeal did however allow the members to claim for damages for breach of contractual duty regarding the conduct of the consultation, although it is difficult to see how this will be quantified.

Conclusion

Many employers who have embarked on similar exercises since 2014 have had to consider Reasonable Expectations as part of the project to change their schemes. Some will have been put off making changes due the elevated position these expectations were afforded by Warren J. Clarity about their relevance and the test to apply is now very welcome.

For those about to embark on exercises, it is important to carefully assess if Reasonable Expectations have been engendered and include them as relevant factors to the overall decision making process.

The Court of Appeal was not asked to consider the proper conduct of a statutory consultation exercise. This means that Warren J’s views still stand. He considered that there must be openness about the main drivers for change and consultation must be with an open mind. Employers should therefore be careful not to fall foul, particularly now the Court of Appeal has allowed the IBM members to seek damages. We find that often employers carry out pension consultation in the same way as employment consultation. Although there is plainly a similarity, they are distinct and employers should therefore take appropriate pensions advice.