Three recent cases have revealed the significant cost consequences for pension schemes following failed and flawed attempts to change member benefits. What mistakes were made and what do the judgments mean for employers proposing to make future benefit changes?

The first case is the high profile High Court decision of IBM on the employer's duty of good faith, the second is the Court of Appeal case of Honda on the construction of wording in a deed of participation, and the final case is the High Court case of Briggs v. Gleeds, which looks at the formal requirements of execution clauses. Briggs v. Gleeds also considers some difficult areas including restrictions in rules which prevent breaking the final salary link and when benefits can be amended by contract.

IBM

IBM UK Holdings Ltd and another v. Dalgleish and others [2014] EWHC 980 (Ch)

Facts

The facts in IBM are complex but can be summarised as follows. Before 2009, IBM carried out two exercises to alter members' benefits across two of its schemes, which included increasing DB member contributions and restricting accrual of benefits. IBM's member communications at the time included a statement that there would be no further changes to the DB schemes over a long-term horizon. However, shortly after introducing these changes IBM initiated further proposals to change the schemes' benefits, including closing them to future accrual, preventing future pay increases from being pensionable and introducing a new, more restrictive, early retirement policy on cost neutral terms.

Court's decision

The High Court decided IBM's decision to make the further changes was in breach of its "Imperial duty", which is an implied duty of good faith not to destroy or seriously damage the relationship of trust and confidence between an employer and an employee. The judge said the test of whether the duty was breached is whether, objectively, the employer's conduct was enough to seriously damage the relationship. He stressed it is a severe test, is not based on fairness and requires an employer to exercise its discretion in a genuine and rational manner (rather than in an empty or irrational manner).

In this case, it was held IBM was in breach of its Imperial duty as:

  • members had "reasonable expectations" that no further changes would be made (due to the communications issued by IBM);
  • no reasonable employer would have made the changes; and
  • IBM had not conducted a genuine, open and transparent consultation in relation to the proposed changes.

Comment

This case helpfully provides further analysis on the court's interpretation of the employer's implied duty of good faith in relation to members of pension schemes. However, it does not alter the existing position in that the bar to breaching this duty remains high. It reinforces the importance of carefully considering all member communications to avoid any risk of members obtaining "reasonable expectations" in relation to future benefits. The judgment also adds teeth to the employer consultation regulations. Although a failure to comply with the regulations cannot invalidate a decision (the penalty is a fine of up to £50,000 for the employer), this case shows the courts will consider whether a failure may amount to a breach of the employer's duty of good faith, which could then impact on the employer's decision. A further hearing is to take place to consider the remedies in respect of the breach of duty. In addition, IBM is appealing the decision so it could be overturned by the Court of Appeal.

Honda

Honda Motor Europe Ltd and another v. Powell and another [2013] EWHC 3149 (Ch)

Facts

Honda Motor Europe Ltd (Honda Europe) was principal employer of the Honda Group UK Pension Scheme. Honda Europe decided to extend membership of the Scheme to Honda UK Manufacturing Ltd's (Honda UK) employees, albeit on the basis of less generous benefits than the benefits available to Honda Europe employees. The deed of adherence for Honda UK provided that the benefits should be extended to all eligible employees and directors of Honda UK with effect from 1 August 1986. However, the Honda UK scale benefits were not formally incorporated into the Scheme's trust deed until December 1998. The question considered by the court was whether Honda UK employees should receive Honda Europe or Honda UK scale benefits in the period up to December 1998.

Court's decision

The Court of Appeal, upholding the decision of the High Court, decided that the deed of adherence must be construed in the context of the deed as a whole and that a reasonable person would have assumed the words "extends the benefits of the Scheme" simply a reference to the advantage of access to the Scheme and the opportunity to accrue benefits under it. In other words, the deed should not be construed as creating a new category of benefits for Honda UK members. Honda UK members must be treated as receiving the same, greater benefits as Honda Europe members until the Scheme's trust deed was amended in December 1998.

Comment

This decision has serious consequences for Honda. The additional cost of providing the better benefits for Honda UK employees is estimated to be around £47 million. We suspect that it will be appealed, possibly on the grounds of rectification. All parties appeared to have the common understanding that Honda UK employees should have received reduced benefits at the time the deed of adherence was entered into, but the correct process for implementing these benefits was not followed. The lesson here is that employers and trustees must ensure that, where changes are being made, the documentation amending the scheme sets them out in full and in accordance with the requirements of the trust deed and rules to avoid any risk of doubt.

Briggs v. Gleeds

Briggs and others v. Gleeds and others [2014] EWHC 1178 (Ch)

Background

The principal employer of the Gleeds Retirement Benefits Scheme was established as a partnership. In 2010 the trustees discovered that 30 deeds dated between 1991 and 2008 had not been properly executed. They had been signed as though the principal employer was a limited company, rather than a partnership. In particular, the signatures of the individual partners who signed the deeds had not been attested by a witness, which is a necessary requirement for deeds signed by partnerships. The deeds included amendments to equalise male and female normal retirement dates, the introduction of two new money purchase sections, amendments to require final salary members to pay contributions and the closure of the final salary section to future accrual.

Court's decision

The High Court held that the relevant deeds had no effect because they were not properly executed in accordance with the requirements for partnerships. This decision may increase the Scheme's deficit on an on going basis by £45 million.

The court did not accept that members were estopped from denying the defective deeds were validly executed since it was obvious on the face of the deeds that they did not comply with the relevant requirements. It also did not accept that members had bound themselves to accept benefits in accordance with the defective deeds by virtue of extrinsic contracts (with the exception of where members had signed a form acknowledging a change in benefits in exchange for a one-off salary increase).

Despite his decision that the deeds had no effect, the judge considered some specific provisions of the 1993 deed and rules in the event that they were found to have force on one basis or another. The highlights of his analysis on the provisions which are likely to have the most common application across schemes are set out below.

Power of amendment

Where an amendment power requires a change to be made by deed and for the parties to "forthwith declare such alteration in writing", the judge held that both a deed and a declaration were required to make amendments. However he also held that a failure to make a declaration did not render the amendment ineffective. This is helpful guidance for any schemes which have a similar amendment power.

Removal of the final salary link

The 2006 deed provided for final salary members to be treated as having left the service of the employer on 1 June 2006. Effectively, the intention was to cut the link to final salary so that members' pensions would be calculated by reference to service up to that date. The judge considered whether, even if the 2006 deed was effective, the link to final salary could be removed due to a restriction in the amendment power. The restriction provided that "no such alteration…shall be such as would prejudice or impair the benefits accrued in respect of membership up to that time".

The judge held the restriction in the Scheme amendment power should be interpreted as preventing a break in the final salary link. The term "accrued" simply meant "acquired" or "got" and there was no reason why the amount of the right could not depend on whether future events (such as pay rises) occurred.

Comment

The court's decision clearly has very serious consequences for the Scheme and the employer. For example, many members will receive a windfall as they will be treated as continuing to accrue final salary benefits. Other members, who joined the Scheme following the introduction of the money purchase section, did not in fact become members. The judge concluded that "unfortunate consequences are, I am afraid, unsurprising when so many documents have not been validly executed". Employers must ensure that they have taken clear advice on the legal formalities necessary to ensure amending documents are effective.

Breaking the final salary link where there is a restriction which prevents certain amendments, such as those which "prejudice or impair the benefits accrued", is a difficult and uncertain legal area. Each case will depend on its facts and this case helpfully builds on the existing case law. Employers and trustees must continue to review the impact of any restrictions in the relevant governing deed and rules carefully before making any changes.

Where changes cannot be made due to such a restriction, employers can attempt to change benefits contractually through signed member consent. However, this is also a difficult and uncertain legal area. This case illustrates that the bar on when members' benefits can be changed contractually remains high. Members should agree in writing to the change and the change should be clearly explained with the option of taking independent financial advice. Written consent is also more likely to be binding where members receive more than an ex gratia benefit in return for their agreement (e.g. a salary increase).