In this insight we report on the High Court’s decision that a proviso in a scheme’s amendment rule protects future service benefits and the High Court’s approval of a trustee decision to issue winding-up petitions for a scheme’s employers that will effectively lead to the trustee winding-up the scheme. We also cover the latest on the Pensions Regulator – confirmation that the amount of a contribution notice is not limited to a scheme’s losses and its latest blog on pension diversity.
Caselaw round-up
High Court finds amendment power proviso protects future service benefits
In a High Court judgment issued on 28 July 2023, Mr Justice Adam Johnson ruled that a proviso in the amendment power of a defined benefit occupational pension scheme relating to active members’ ‘interests’ protects both past and future service benefits. This means that the ability of the sponsoring employer to make amendments which will ‘substantially prejudice’ future benefit accrual is substantively curtailed, including changing the basis upon which future benefits accrue and closing the scheme to future accrual.
The proviso
The case was brought by the principal employer of the scheme as part of a funding review looking at ways it might be able to limit the future funding costs of the scheme. The High Court was asked to decide on the scope of one of the five provisos (the Proviso) to the scheme’s amendment power as the interpretation of this fetter would determine what flexibility the employer might have in terms of making changes to future service.
The Proviso provides that an alteration or modification to the scheme’s governing provisions that affects active members’ interests cannot be made unless one of three conditions is satisfied:
- the scheme Actuary certifies that the alteration or modification did not substantially prejudice those interests;
- the scheme Actuary certifies that substantially equivalent benefits were provided; or
- the amendment is approved by the active members in a meeting.
The employer and the representative beneficiary
The employer asked the Court to rule on what types of interest were protected by the Proviso. Both parties agreed that it included those rights relating to past service. However, the employer contended that this is where the protection ended (except for a possible link of past service rights to final salary). On the other hand, the representative beneficiary (who represented the interests of the active members) argued that ‘interests’ extended beyond this to “the ability of members to accrue any future service benefits under the Scheme (e.g., reducing the rate of future accruals) and/ or those members’ interests in some other right or benefit” (e.g., closure to future accrual).
High Court’s decision
The High Court decided that, as “a matter of ordinary language”, ‘interests’ was not confined to whether the benefits had already been earned (past service) or had yet to be earned (future). If the result of any proposed amendment was that the position of the active members changed, then their interests would be ‘affected’, and the Proviso protection would be triggered.
Following on from this, the Proviso prevented an amendment being made if the interests concerned would be ‘substantially prejudiced’ or ‘substantially worse’ unless “the difference is made up in some way the Actuary deems appropriate” or the change is approved by the active members.
Employer’s limited flexibility argument rejected
The employer’s argument that giving it ‘limited flexibility’ to alter future benefit terms did not satisfy the requirement to construe a pension scheme so as to give it reasonable and practical effect was not accepted.
Procedure for making amendments
The Court also looked at whether the procedures which govern how the employer can alter employees’ benefits and which require consultation and agreement (either individual or through union consultation) needed to be followed when making an amendment to the scheme. It held that the amendment power was a ‘self-contained code’ for making alterations and did not require these consultation and agreement procedures to be followed before the power could be exercised (subject to other relevant formalities of the power being satisfied). (Note that there are separate legislative obligations on an employer to consult with employees on certain ‘listed’ changes which include changing the accrual basis and closing a scheme.)
Conclusions
Impact: The decision means that the future pension provision of the active members of the scheme is to a large extent protected (unless they agree to changes). However, it significantly restricts what the employer is able to do under the scheme to reduce its future pension spending.
Interpretation of deeds and rules: The ruling also confirms that the Court will focus on a textual analysis of deeds and rules when construing the meaning of provisions – this requires consideration of the words used with less focus on the background facts than might be the case in a contractual scenario. Furthermore, the requirement for a ‘reasonable and practical’ construction does not necessarily require a provision to be interpreted in a way that means it should not have an adverse financial impact on the employer.
Application to other pension schemes: The relevance of this case to other pension schemes will depend on the precise wording used in the amendment power and whether it includes protections couched in the same or sufficiently similar way. The amendment power in this case is particularly restrictive, and many other schemes will not contain such restrictive provisions. However, those schemes which have similarly worded amendment powers should consider the impact of the decision on both past and future amendments.
The employer is considering its next steps including the possibility of an appeal.
High Court sanctions trustee decision to petition wind up of sponsoring employers
The High Court has approved Brass Trustee Ltd’s decision, as sole trustee of the Biwater Retirement and Security Scheme, to issue petitions to wind-up the scheme’s two sponsoring employers.
The scheme
At the end of 2022, the hybrid occupational pension scheme had a £28.3m deficit. The trustee could only wind-up the scheme without principal employer agreement on the principal employer’s insolvency. As at May 2023, the employers owed the scheme more than £39.74m including around £8.5m of outstanding contributions. The trustee had carried out ‘assiduous’ inquiries into the employers’ financial position and prospects and had concluded that it would not be able to fund the scheme going forward. There were also wider problems regarding employer conduct including a failure to provide required information and breach of a negative pledge obligation.
Scheme drift and PPF (Pension Protection Fund) drift
All these issues meant that the scheme was experiencing both scheme and PPF ‘drift’.
Scheme drift refers to a scheme in deficit where the funding position worsens over time because of benefits being paid out which uses up assets and payment of ongoing expenses (without being addressed through funds being paid in and/ or investment returns).
PPF drift is where over time, the amount of PPF compensation becomes greater because more members reach normal pension age and become entitled to higher compensation levels, increases and revaluation is provided, and more survivor pensions may have been granted (which are paid in full rather than the lower level that is provided where a member dies during a PPF assessment period). There is also the possibility of the scheme’s assets reducing over time meaning less funds being available for the PPF when the scheme transfers.
The trustee’s application
The trustee had decided in January 2023 that, provided it obtained the Court’s approval, it would issue winding-up petitions in respect of the sponsoring employers. It was satisfied that it had the power to issue a winding-up petition and, upon insolvency of the employer, wind-up the scheme, but sought the Court’s approval given the importance and effect of its decision. Employer insolvency would mean that staff would lose their jobs, and this would obviously have a significant financial impact on members. However, the trustee felt that it had no alternative in the circumstances than seeking to wind-up the scheme in the interests of scheme members.
The PPF as a relevant consideration
In arriving at its decision to issue winding-up petitions, the trustee had concluded that the decision would be made irrespective of the PPF’s existence.
This point is important because the High Court in the case of Independent Trustee Services Ltd v Hope [2009] ruled that trustees cannot change how they act because of the existence of the PPF – they should disregard the availability of PPF compensation when “deciding whether to exercise a power capable of detrimentally affecting the asset coverage for benefits under the Scheme”. Furthermore, although there is no “single all-purpose answer”, generally the PPF’s interests are not a relevant consideration for a trustee when exercising its powers.
Although the judge did not have to comment directly, he agreed with the trustee that it would not have been able to take ‘advantage’ of the PPF to support the trustee not taking action to prevent the deficit and scheme drift getting worse.
The Court’s approval
In ‘blessing’ applications, the Court must be satisfied that the trustees have formed the necessary opinion as to how they should act, this opinion is one which a reasonable body of trustees could have properly arrived at, and the opinion is not invalidated by a conflict of interest. The Court does not substitute its opinion for that of the trustees.
As part of its deliberations, the Court considered whether the trustee had considered relevant but not irrelevant factors. It was satisfied that the trustee had taken into account relevant factors, these being the scheme’s financial circumstances, the member impact of continuing the scheme, the trustee’s duties to call in and protect scheme assets, and the trustee’s duties to protect scheme beneficiaries’ and members’ interests. It was also satisfied that the trustee had taken relevant professional advice. An irrelevant factor in this case would have been taking into account the existence of the PPF.
On the basis of being satisfied that the relevant tests had been met, the Court approved the trustee’s decision to issue winding-up petitions for the sponsoring employers’ insolvency.
Comment
This case provides a useful reminder that trustees cannot ‘game’ or exploit the PPF by taking decisions they would not otherwise (or could not) take simply because the PPF will step in as a ‘funder of last resort’.
The Pensions Regulator round-up
Upper Tribunal confirms contribution notices not limited to scheme losses
The Upper Tribunal has upheld a 2020 Pensions Regulator (TPR) decision to issue a £1.875m contribution notice (a CN) to Anant Shah, the previous owner of the sponsoring employer of the defined benefit Meghraj Group Pension Scheme. The decision provides confirmation as to the calculation of CNs and that they are not ‘purely compensatory’.
In 2020 the Determinations Panel issued CNs to Anant Shah and his nephew, who was also connected with the employer on a joint and several basis for £3.6m, this being the value of sale proceeds that had been provided to a nominee company in Jersey related to the individuals instead of to the scheme’s employer. TPR settled the case with Mr Shah’s nephew before the Tribunal’s hearing.
The CNs related to payments made from the employer to its parent company following the employer’s disposal of shares in a joint venture company, the majority of which were distributed as dividends. TPR concluded that these payments should have been paid to the scheme and not doing so was materially detrimental to the likelihood of members receiving their accrued scheme benefits (this ‘material detriment’ test being one of the Pensions Act 2004 grounds under which a CN can be issued). TPR must believe that it is reasonable to impose a CN liability.
The Tribunal agreed that the requisite grounds for imposing a CN were met and that it was reasonable for the former owner to pay the CN (which comprised 50% of what should have been paid to the scheme with an uplift accounting for the time that had passed since the materially detrimental acts). It also agreed with TPR that the amount of a CN should be reasonable and that it is not limited to the scheme’s loss arising from the acts concerned (at least in material detriment test cases).
The scheme is currently in a Pension Protection Fund assessment period following the sponsoring employer entering a qualifying insolvency event on 9 October 2014. Its estimated section 75 debt at that date was £5.85m.
Blog on how trustees can improve diversity
TPR’s 1 August 2023 blog covers diversity. It forms part of TPR’s recent push on improving diversity within the pensions sector. The main message from the blog is that trustees should complete the diversity and inclusion survey that was launched in July (see our Insight). By the time this insight is published the deadline will already have passed – however, there are plenty of other things that trustees can look at when considering how to improve equality, diversity and inclusion on their scheme (see our Insight).
The blog also acknowledges that TPR (as well as many others in the industry) have more to do on equality, diversity and inclusion but that this can be achieved with the right approach and working together with a good evidence base that can be used to identify relevant gaps that can then be addressed.