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Education Pensions Speedbrief: Scheme closures and benefit changes, High Court sheds light on some do's and don'ts

  • United Kingdom
  • Education - Briefings

01-05-2014

The High Court, in IBM UK v Dalgleish & others, found that an employer had breached its implied duty of good faith in the way it went about closing its DB schemes to the future accrual of benefits.  This speedbrief looks at the case and its practical implications for employers and trustees who are considering (or have previously carried out) DB benefit change exercises.

Background

This significant case (IBM UK v Dalgleish & others) was heard by Mr Justice Warren, who himself describes the judgment as “stupendously long” - it weighs in at 434 pages.  The facts are very complicated and involve more than 5,000 members spread over two schemes and various benefit structures.

In summary, IBM decided to make a range of changes to two of its DB schemes between 2009 and 2011.  This was known as “Project Waltz” and involved closure to the future accrual of benefits, imposing new early retirement terms and withholding pay rises from DB scheme members who did not agree to break the link between DB pension accrual and final salary. 

IBM planned to close to future accrual by using an “exclusion power” in the scheme rules.  This said that the principal employer could exclude “any specified person or class of persons” from membership. 

Project Waltz was the third benefit change exercise that had been carried out in recent years.  In 2004 and 2006, separate projects had involved an increase in member contribution rates and members being given the option either of part of their pay increases being non-pensionable or moving to a DC scheme for future benefits. 
 
The trustees of the schemes had some doubts about the lawfulness of the Project Waltz proposals, so guidance was sought from the court.

What did the High Court decide?

Key conclusions

In summary, the court decided that:

• IBM was, (subject to certain restrictions relating to a “Re Courage” type fetter on the amendment power), entitled to use the exclusion power described above to exclude DB members from future accrual; but
 
• in implementing the wider Project Waltz changes, IBM breached both its duty of good faith under the pension schemes and its duty of mutual trust and confidence under employment contracts.

Members’ reasonable expectations

As a result of the earlier pension change projects in 2004 and 2006, the judge found that members had been entitled to hold “reasonable expectations” (as distinct from “mere expectations”) about the future of the schemes, and in particular, the continuation of DB accrual for a period.  According to the court, these reasonable expectations were engendered by IBM through communications issued to members as part of the previous scheme change exercises. 

The court analysed the content of communications very closely.  IBM had been careful to avoid saying it would never close the schemes.  The court, however, honed in on phrases used by IBM, such as a “continuing commitment” to the DB schemes, putting the schemes on a “secure” footing and a “commitment to underpin [their] sustainability”.  It concluded that these words were not just vague expressions of intent, but communications on the basis of which affected members took decisions relating to their careers and retirement.

Breach of the reasonable expectations

The breach of these reasonable expectations via the closure of the schemes a few years later was, on the facts, a serious matter going to the heart of the relationship between IBM and its employees.  In particular, the time period between one phase of change and another was felt to be too short when compared to the reasonable expectations of members.  Changes had previously been made in 2004 and 2006; Project Waltz began only three years later.

The UK business case (as distinct from corporate strategy set by IBM HQ in the US) was not sufficiently strong or compelling to justify interference at that time with the reasonable expectations of members.  A key driver for the UK business acting as it did was a desire to comply with requirements from IBM HQ to “meet its commitment to Wall Street” (i.e. to close the schemes so as to improve its global position for US accounting purposes and meet “earnings per share” targets).

The court felt that it may have been possible for the UK business to comply, in a different way, with the demands of IBM HQ while at the same time developing proposals which respected the reasonable expectations of the members; perhaps changes could have been made which had less effect on them.

The consultation process

The consultation process appeared to satisfy the strict letter of the statutory pension consultation requirements but it was found lacking because IBM had not kept an open mind and ignored feedback.  While IBM was careful to phrase member communications so as to give the impression that closure was not a foregone conclusion, internal communications showed it had made up its mind before the end of the consultation period.  It also misled the trustees and members about the real date it had in mind for implementation, in order to preserve its negotiating position. 

In addition, IBM refused to share full details of the business case for change with the trustees. The true rationale (the desire for the parent company to meet targets and maximise global profit for US accounting purposes) was not explained.

What does this case mean for other DB scheme change exercises?

We highlight below some of the practical “dos and don’ts” that can be drawn from the case.

Is this the end the line for DB closures and benefit changes?: This case very much turns on its specific facts.  It does not mean that other DB scheme change exercises will necessarily be in breach of the employer’s duty of good faith or trust and confidence but it does emphasise that employers will need to tread very carefully when planning and implementing these exercises. 

Beware skeletons in the communications cupboard: In formulating any proposal for future pension benefit changes, a lot of thought will need to be given to what the members’ reasonable expectations are likely to be as a result of communications made to them (and to the trustees) in the past.  We would suggest that thorough due diligence is carried out on communications to identify any reasonable expectations, and that these are then considered carefully. Even seemingly innocuous phrases in historic communications could now mean that the employer is unable to act with a free hand; they could make future changes more difficult to implement lawfully, and could also potentially prompt member complaints relating to previous benefit change exercises.

Ensure there is a robust business case for change and share this with trustees:  Careful thought will need to be given to understanding what the business justification is for any proposed change.  Generic explanations such as “the need to reduce cost and funding volatility” will not (without significant further detail) be sufficient.  In the case of an international business, ensure that the UK employers are not simply responding to orders from the overseas HQ. 

Be prepared for trustees to ask more questions, and to give them answers:  We consider that trustees are generally the guardians of past (rather than future) service benefits.  However, this case may lead to trustees seeking more assurances around, for example, members’ reasonable expectations and the details of the business case for change.  IBM was criticised for refusing to share its true rationale for change with the trustees – employers should be clear and honest in their dealing with trustees.

Communicate extremely carefully: In the IBM case, internal communications were reviewed and, in the main, criticised.  This was particularly so in the context of IBM’s largely failed approach to a reasonable and genuine pension consultation process and in relation to the formulation of the business rationale for the scheme change proposals.
 
Do not make decisions before consultation ends: Employers should understand the critical importance of not making final or pre-determined decisions until any consultation process has concluded and all responses have been considered.  They must carry out a genuine and proper consultation, and be careful about what is said in internal emails, memos, presentations etc.  Employers should be prepared to revisit their initial proposals with an open mind in light of feedback received, and to respond to any questions raised about the legitimacy of the proposals.

Timing is everything: Finally, the case indicates that the changes proposed by IBM might otherwise have been acceptable had there been a longer period: (a) between the various benefit change projects; and (b) for members to make decisions on some of the key benefit options presented by IBM, options which were “of great importance...to their career and retirement”.  This does, however, indicate that, where a considered approach is taken, and changes are not rushed through in a short timescale (and are well supported by a business case), it is more likely that an employer will be acting in accordance with the duty of good faith owed to its employees.

What happens next?

This judgment does not deal with the implications for IBM or the scheme members.  A separate hearing will consider remedies.  This might potentially result in benefit changes being unwound but monetary remedies are another possibility.

Importantly, we understand IBM has applied to appeal the judgment.  So, although this judgment represents the current state of the law (and benefit change projects must be implemented accordingly), an appeal could potentially change the position.  We may not hear the last word in this complex saga for some time.

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