Be careful when amending pension arrangements
As financial pressures on charities continue to pile up it is understandable that employee benefits will be scrutinised for possible savings. Thus the recent judgment in IBM (UK) Holdings Ltd v Dalgleish will be of interest to charity employers. The judgment considered an employer's duty of good faith and the role of that duty when ceasing benefit accrual, when asking employees to agree that future salary will not be pensionable, and when consulting with employees.
As well as examining the role of the duty of good faith in these three instances, this article will consider the new and controversial concept of a member's "reasonable expectations", and, separately, whether the final salary link remained when the employer ceased accrual by exercising the exclusion power.
SEPARATION OF THE "IMPERIAL" AND CONTRACTUAL DUTIES OF GOOD FAITH. The judge, Justice Warren, held that there are two implied duties of good faith owed by an employer towards its employees, and that these duties must not be conflated (i.e. merged):
1. The general duty of trust and confidence arising under a contract of employment.
2. The "Imperial"duty of good faith which applies to an employer's exercise of its powers under a pension scheme (Imperial Group Pension Trusts Ltd v Imperial Tobacco Ltd 1991).
Both forms of the duty should be considered prior to making an amendment to a pension scheme as both duties may be relevant, depending on the context.
TEST FOR BREACHES OF BOTH TYPES OF GOOD FAITH. The duty of good faith will only be breached if the employer's conduct is so bad that it is "irrational or perverse". The IBM case established that this means that an employer could not, in good faith, act in a way in which no reasonable employer would act.
REASONABLE EXPECTATIONS - A NEW TYPE OF RIGHT? It was accepted by both parties in IBM that a promise to a member may have contractual effect; and if a member makes a decision based on a representation which turns out to be untrue, the member may have an action in misrepresentation.
Engendering expectations
Neither of these scenarios applied in IBM. Rather, the existence of what might be called another type of right was mooted. One of the core issues was whether statements made by IBM engendered "reasonable expectations" in members as to the future of the pension scheme, and if so, whether IBM could act in a way which was contrary to them.
The judge decided that if an employer makes a statement of intention relating to the future, this may restrict the employer's future actions even if it does not amount to a cast-iron promise or a guarantee. This was referred to as a member's "reasonable expectation". Because they relate to the future, the breach of the Imperial duty occurs not when the statements are made, but when the employer seeks to act against them.
IBM was concerned that this elevated non-contractually binding statements into something with legal power. The judge recognised that this was the effect, but considered that it demonstrates the purpose of the Imperial duty – to step in where other remedies are not available - and considered that the existence of a reasonable expectation is highly relevant in deciding whether or not an employer has breached the Imperial duty of good faith.
The evidence required to establish the existence of a reasonable expectation consists of a clear representation made to the general body/ group of members. Evidence from individual members is only relevant to establish what was actually said, and how it was said, and to establish what members' typical level of understanding about pensions matters would be.
Justice Warren concluded that IBM had engendered reasonable expectations in members in relation to:
(i) Future service: benefit accrual would continue unless there was a significant change in financial and economic circumstances.
(ii) Past service: a member would be able to take advantage of the early retirement policy until 2014, unless there was a relevant justification for a change in policy.
If IBM were to act contrary to these reasonable expectations, e.g. by closing to accrual, it needed to have a good reason.
BUSINESS JUSTIFICATION. Any reasonable employer would take such reasonable expectations into account, and balance them against the business need or justification for the changes it was proposing to make.
The IBM judgment made it clear that the existence of a rational business justification is not a silver bullet – the assessment of commercial matters and the making of business decisions are a matter for management, but the existence of a coherent, rational and bona fide business case does not preclude the court from questioning the decision.
Balancing interests
In addition, the employer cannot take into account only its own interests – there must be a balancing between the members' reasonable expectations and the employer's interests, in light of all the circumstances of the case.
RIGHT TO FUTURE SALARY INCREASES. The judge confirmed that IBM employees had no reasonable expectation of future pay increases. Nevertheless, an employer which indicates or threatens that an employee will not be eligible for any future salary increases unless they agree that they will be non-pensionable will be in breach of the contractual duty of good faith.
CONSULTATION. It was held in IBM that a consultation exercise must involve an employer engaging with members during a consultation process and giving genuine consideration to any comments or suggestions received from the members. A clear (and honest!) explanation for making the proposed changes must be given.
IBM did not approach the consultation with an open mind as it did not engage with suggestions from members during the consultation. In addition, it was less than upfront during the consultation – it did not give members a clear explanation of why it was really making the changes (namely to reduce pensions expense to meet 2010 global profit targets).
Even though closure was only intended for 2011, it told members it wanted to close the scheme in 2010. Justice Warren considered that this was a deliberate attempt to preserve its negotiating position, and a tactic to persuade the trustee and members to accept the package it was offering.
Regulations governing the consultation process were also considered during the case. There is no remedy for a breach of the consultation regulations themselves in the ordinary courts. Rather, the remedies include complaining to the Pensions Regulator who may issue an improvement notice or a penalty. IBM argued that a claim under the contractual duty of good faith was therefore precluded. The judge disagreed and considered that the breach of the duty of good faith arose from the way in which the consultation was carried out.
Audit trail
Employers would be well advised to create a clear audit trail demonstrating that the consultation process has been properly carried out. It is worth noting that internal communications regarding the consultation process, including advice obtained by the employer (excluding legally privileged advice), will probably be disclosable should the legitimacy of the consultation exercise be challenged.
HOW DID IBM ACHIEVE CESSATION OF ACCRUAL UNDER THE SCHEME? Closure was achieved by ending membership for all active members under a power which provided that the employer could notify the trustee that "any specified person or class of persons shall cease to be a member or members". The judge considered that as the power could be exercised in relation to a class of members it could be used to end membership for all members.
It was common ground that using this power would break the final salary link as the rules stated that final pensionable earnings were fixed when membership ceased. However, the power was not one which was in the original trust deed and rules, but was added to the scheme at a later date. The issue which arose was whether the addition of the exclusion power to the scheme breached a restriction in the amendment power which protected the link to members' final salary in respect of benefits earned up until the date of any amendment.
The judge held that the power was validly introduced, but was subject to an overriding limitation that protected final salary linkage in respect of benefits accrued up to the date of the exercise of the exclusion power. There was nothing objectionable about the plan being amended to introduce the exclusion power to enable IBM to close the scheme to future accrual at a future date, as long as the final salary link was preserved.
WIDER RELEVANCE OF THE JUDGMENT. Whatever the outcome of the appeal against the judgment, the principles arising from the IBM case will need to be taken into account by charity employers in relation to any decisions regarding changes to a pension scheme.
Charity employers may also wish to look back at statements previously made by the employer to the employees and to the pension scheme trustees, and revisit previous decisions - particularly decisions to close a pension scheme to future accrual - to ensure that those decisions did not breach either of the implied duties of good faith owed by the employer, thereby making the decision subject to a potential challenge by affected members.
In IBM the judge suggested that the following could be relevant to a possible breach of the duty and indicative of the possible existence of reasonable expectations:
• Statements made by the pension trustees to the employees based on a message from the employer.
• Employee knowledge that the pension trustees assume that accrual or other benefits will continue and the pension trustees act upon this.
• Assurances from the employer to the trustees which the trustees act upon;
• If the scheme's investment strategy has been agreed as a long term answer to the employer's commercial requirements, this may strengthen any message that a scheme is sustainable and on a firm footing for the future.
The traditional view is that future benefit design is a matter for the employer. Following IBM, does the employer really have a free hand to change future service benefits?
IBM intends to appeal the High Court's decision so please be aware that there may be further developments of the issues raised in this article.
