Pensions and employer duties of good faith
8 August 2017
The Court of Appeal has delivered a lengthy judgment in IBM v Dalgleish. The case considers what employers need to take into account when exercising discretionary powers under their occupational pension schemes. This issue is likely to be of great importance to employers over coming years as they consider options under scheme rules for managing liabilities.
In 1991 in the Imperial case, the court held that “In every contract of employment there is an implied term “that the employers will not, without reasonable and proper cause, conduct themselves in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee”… that obligation… applies as much to the exercise of… rights and powers under a pension scheme as [it does] to the other rights and powers of an employer…”.
The main question in this case is what is necessary to show a breach of this duty and, in particular, whether it is enough that members’ reasonable expectations are disappointed or whether something more significant is required.
The case concerned various changes IBM wanted to make to two of its DB schemes between 2009 and 2011. These changes, known as “Project Waltz”, involved closure to future accrual, new less favourable early retirement terms and withholding pay rises from members who did not agree that they would be non-pensionable. IBM did not need to make rule amendments to implement these changes; it was proposing to use a combination of existing discretionary powers under the scheme and agreements with members.
Project Waltz was the third benefit reduction exercise in five years. In 2004 and 2006, separate projects had involved an increase in member contribution rates and an option either to move to DC or accept that only part of future pay increases would be pensionable. Members were told that these changes were intended to ensure the long term future of the scheme (although IBM did say that there were no guarantees).
The High Court decision
The High Court held that IBM had breached its implied duties of mutual trust and confidence in implementing Project Waltz. Members had reasonable expectations, engendered by statements from IBM during the two previous benefit reduction exercises, that no further changes would be made at that time. The breach of these reasonable expectations was so serious as to go to the heart of the relationship between the parties.
What the Court of Appeal says
The Court of Appeal took a different approach to the High Court and found in favour of IBM – that they had not breached their implied duty of good faith.
The duty: The Court of Appeal approached the duty by saying that you must determine whether the employer acted irrationally or perversely. In assessing this, the right questions to ask are whether (a) all relevant (and no irrelevant) matters have been taken into account and (b) the result is such that a reasonable decision maker could have reached it. If the answer to these questions is yes, there is no breach of duty. Even if the court does not like what was done, it cannot substitute its own view of what would have been reasonable for the view actually taken.
Reasonable expectations: The reasonable expectations of members have no special status; they were just one factor which needed to be taken into account when determining whether a course of action could properly be taken. Other relevant factors included the financial needs of IBM.
In any event there was insufficient material to show that the members had reasonable expectations which needed to be protected. In relation to the closure to accrual, members had been specifically told in the previous benefit reduction exercises that IBM could not guarantee the future of the scheme. In relation to the proposed change to the policy of allowing early retirement on favourable terms, the Court said that past consistent practice in the exercise of a company discretionary power did not of itself mean that members could have a reasonable expectation that the practice would continue in the future.
Mechanics of change: In terms of the propriety of the mechanics that IBM used to implement the changes:
- The members argued that the power in the rules to exclude categories of employees from active membership was being used for an improper purpose. The rule allowed members to be excluded from the scheme as a whole; it did not allow the salary link to be broken nor did it refer to members being able to join another (DC) section as was proposed here. The Court of Appeal held that the power was not being used for an improper purpose. The object of terminating DB accrual was the principal reason for using the power and that was entirely within its scope.
- It was also argued that the way in which IBM asked members to agree that salary increases would be non-pensionable (or they would not receive them) amounted to improper coercion. The Court of Appeal said that it was not a breach of duty “for the employer to say that it did not intend to award pay increases in future except on a non-pensionable basis… we cannot see that the firm terms in which the pay increases were to be offered constituted any breach of the relevant duty”.
Statutory consultation: It was claimed that IBM had not complied with its statutory consultation duties. The Court of Appeal accepted this but said that it would make no sense to consult in 2017 about proposals designed to take effect in 2009/11. Therefore no new consultation process was ordered and the failure to properly consult in the past would not prevent Project Waltz taking effect. The only remedy available to members for the IBM’s past failure was in damages.
Responsibility of wider corporate group: An important point which was overlooked at times by the High Court was that the principal employer under the scheme was not the employer of the affected members. In addition, the initial pressure to reduce pension costs came from the US parent company who was neither the employer nor principal employer. The question arose therefore as to which companies owed what duties.
A duty of good faith is owed both by the employer under the employment contract and by the principal employer in relation to the exercise of its powers under the scheme. However, no obligations were owed here by the wider corporate group; the decisions to implement Project Waltz had been taken by the relevant UK companies who had not simply been rubber stamping the decisions of the US parent.
Lessons from the case
The judgment will in general be good news for employers who are considering restructuring DB pension arrangements to make them more affordable (or have already done so).
Where current exercises follow on from earlier exercises, it will now be harder for members to argue that they had a reasonable belief that no further changes would be made to the pension arrangements and that this restricts the employer from making further changes.
Nevertheless, in any case involving a potential reduction of accrued benefits (such as breaking the link with final salary), employers will always need to tread carefully. Careful consideration will still need to be given as to what members may have been told or promised in the past, the purpose of any powers that they intend to use under the scheme rules and any other relevant facts leading to the decision.
In addition, employers should ensure that the rationale behind any exercise is properly documented and the governance behind it is clear. This will help to ensure that it can be demonstrated that all relevant (and no irrelevant) factors have been taken into account and that the decision is one a reasonable employer could take.
It is also important for employers to ensure that consultation exercises in relation to pension changes are genuine. In many cases trustees ought not to give effect to a pension change unless they are satisfied there has been proper consultation. Even though the appropriate remedy for failure to consult in Project Waltz was damages, in other circumstances a court could order that consultation be re-run.