The Pensions Time Bomb

1
The Pensions Time Bomb

• The Relationship between
• Employer and Trustee
• UCD Commercial Law Centre

Peter Fahy Eversheds ODonnell Sweeney 9
September 2009
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The Relationship between Employer and Trustee

• Why is it important?
• In the private sector it is the key relationship
  governing how the pensions time bomb will be
  dealt with
• My focus will be on defined benefit schemes,
  because that is where the current problems are
• The timebomb problems with defined contribution
  schemes are in the future comment at end.

3
Overview of Legal Framework

• Solvent Employers
• Limited statutory regulation of sponsoring
  employer obligations to schemes
• S58A Obligation to remit employee contributions
  deducted from wages to trustees within 21 days of
  month end
• S87 Pensions Board can seek High Court order
  directing payment of contribution arrears
• Limestone Construction case (2008)

4
Overview of Legal Framework

• Solvent Employers (cont.)
• Trust Deed primarily governs relationship
• Notifications or announcements may vary Trust
  deed if estoppel by convention arises, or trust
  deed allows it
• Insolvent Employers
• Social insurance fund will cover unpaid employer
  contributions payable in the 12 months preceding
  insolvency, up to the value of the scheme deficit
• If contribution not demanded prior to insolvency,
  no claim arises

5
Overview of Legal Framework

• Other State supports are limited
• Pension Insolvency Minimum Guarantee Scheme
• 300 million over 3 years maximum
• Very low thresholds of protection
• 12,000/annum (Pensioners)
• 6,000/annum (Actives/Deferreds)
• Pension Insolvency Protection Scheme
• Provision of annuities by State, but supposed
  to be cost neutral no 100 underwriting

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Legal Position of the Sponsoring Employer

• The employer is the settlor of the pension scheme
  trust but with many ongoing obligations
• Employers obligation to contribute is defined by
  the Trust Deed commonly balance of cost
• Key Characteristics
• Obligation is given under seal
• Enforceable as a covenant
• 12 year limitation period for enforcement

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Legal Position of the Sponsoring Employer

• But note Terms of the Trust Deed usually qualify
  obligation, e.g. rate of contribution to be
  agreed by employer, or contribution rate to be
  certified by actuary in consultation with
  employer
• Contribution rate is also determined by changing
  circumstances of scheme
• Per Alitalia
• Construe the rule in a way which makes good
  commercial sense both when the Scheme is
  operating on an ongoing basis, with no financial
  worries, and when a winding up is either in
  prospect or imminent

8
Legal Position of the Sponsoring Employer

• It is clear that an immediate deficit
  contribution can be demanded of the employer in
  appropriate circumstances, once they have power
  to do so under the Trust Deed
• Once a demand is validly made, the employer is
  bound by his covenant under the Deed
• It is a preferential claim against an Irish
  corporate employer, ranking ahead of floating
  charge holders

9
Legal Position of Employer (cont.)

• Duty of Good Faith
• Trust Deed is subject to limitation that the
  rights and powers of the employers can only be
  exercised in accordance with implied obligation
  of good faith not to act so as to destroy or
  seriously damage employer/employee relationship
• Per Imperial Tobacco, approved in Boliden Tara
  Mines (2007)
• Part of Irish law, but how far does it bite when
  an employer has genuine issues with funding
  scheme?

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Legal Position of Trustees

• Nature of Trustees Fiduciary Duty
• Trustees duty is to fulfil purposes of the
  Scheme - provide for the payment of relevant
  benefits in accordance with Trust Deed
• In doing so, act in best interests of
  beneficiaries
• Current employees
• Former employees and pensioners
• Contingent beneficiaries including employer
• Trustees must have equal regard to the interests
  of different classes of beneficiaries

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Legal Position of Trustees (cont.)

• What Trustees not responsible for
• Primary duty is to administer the Trust as
  constituted, not to restructure or amend it
• Rarely responsible for the sustainability of
  the scheme under the Trust Deed
• Trustees have particular difficulties with
  benefits already accrued under scheme rules
• May be prohibition on amendment
• Even if not, altering accrued benefits must be
  justified by other factors

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Legal Position of Trustees (cont.)

• Key statutory duties
• Ensure contributions payable are received
• Provide for the payments of scheme benefits as
  they become due
• Submit funding proposal, if MFS deficit
• Exoneration and Indemnity
• Usually have an indemnity from employer for
  liability (absent wilful default, misconduct,
  fraud) can be used tactically

13
Employer Trustee legal relationship

• A Volatile Situation?
• Employer
• Employer liability largely regulated by Trust
  Deed, not statute
• Employer commitment to scheme under pressure
• Cost assumptions not borne out
• Life cycles of companies and employees shortening
  
• Increased risk of opportunistic or adversarial
  behaviour particularly if scheme obligations
  owed to ex-employees or non-core employees

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Employee Trustee legal relationship

• Trustees
• Have statutory duty to deal with funding deficit
• Must balance enforcement of legal rights against
  ongoing relationship with employer
• Trust law points to protection of accrued
  benefits
• Availability of S.50 an opportunity or dilemma?

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Practical implications Obligation to Fund the
Scheme

• Under most schemes, the primary obligation falls
  on the employer to meet the balance of the
  funding cost. If the scheme fails the Pensions
  Act funding standard, a funding plan or
  proposal is required.
• 2000-2008 Funding work out periods extended 3
  years, 10 years, working life time
• Mixed results over-optimistic assumptions
  employer terminations
• Current phase
• Moves by some trustees to fix employer with
  debtor liability pre-emptive issue of
  contribution demands

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Obligation to Fund the Scheme (cont.)

• In parallel, some employers have acted on ability
  to terminate contribution obligations
• Many legal issues have resulted
• Ability of trustees to change basis of
  contribution rate
• Ability of employer to terminate without notice
  (Capital Cranfield)
• Several potential arbitrations, no court cases as
  yet

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Obligation to Fund the Scheme (cont.)

• Other employers and trustees inching towards
  solutions, based
• on respective bargaining power under trust deed
• Funding proposals turned into binding funding
  agreements
• If employer seeks to terminate, acceleration of
  remaining contribution payments
• More realistic investment assumptions
• Benefit freezes or reductions
• Employer terminations, followed by negotiations
  on replacement arrangements. Attempts to agree
  funding plan for a frozen scheme, or to inject
  funds into DC replacement, or simply avoid demand
  for buy out cost.

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Obligation to Fund the Scheme (cont.)

• Trustee contribution demand, followed by
  compromise of debt due
• Section 59 and Re Brogden requirements
• Pursuing demands always has risk factors
  litigation risk, credit risk etc.
• Use of S.50 procedure
• S.50 is starting to be used
• Even if not, informs basis of other compromises

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Practical ImplicationsLiability for
Continuation of Scheme

• Schemes can only continue if financially viable,
  just like companies
• Pension Board guidance in this area is very
  frank
• the fundamental issue is what can be afforded,
  and any rethink must avoid overpromising.
  Overpromising does not achieve anything in the
  long run for scheme members
• No policy incentive to continue DB or DC schemes
  this is a concern
• Certain employers have incentive to continue DB
  schemes e.g. large financial institutions,
  organisations competing with public sector,
  semi-States.
• Initial phase saw move to hybrid schemes for
  future benefits

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Liability for Continuation of Scheme (cont.)

• Reductions in future accrual of benefits becoming
  more common
• Caps on pensionable salary increases some
  debate on legal effect
• Restructuring wind ups used in some cases
• Now some employers seeking accrued rights
  reductions
• e.g. reduction in pension increases in payment
• Trustees have looked at justifications around
  what active members contribute to the scheme, or
  greater sustainability for remaining rights
• S.50 often not attractive for such employers

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Practical Implications Liability for Solvency of
Scheme

• Employers have no statutory liability in Ireland
• Policy has not gone in this direction
• Speculate on reasons for this PPF?
• This places significant burden on Trustees
• State supports for solvency are limited
• S.50 is a mechanism to reduce liabilities, rather
  than increase funding.
• Is there a policy imperative to push schemes with
  weak employer covenants into S.50 (Robins-proof
  them)?

22
Solvency is Section 50 the panacea?

• Pensions Board may direct the Trustees of a
  scheme to reduce the benefits payable to current
  employees or deferred members and to reduce
  future increases to pension benefits
• Effectively triggered on application by Trustees
  where they cannot agree a funding proposal under
  existing benefit structure employer co-signs
  where appropriate
• Purpose of benefit reduction is to return scheme
  to solvency immediately or over period of a
  funding proposal

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Section 50 Key constraints

• Trustees must have considered all options to
  address deficit and be of view that application
  is in best interests of members how to
  demonstrate this?
• Must also conduct fundamental review of
  scheme, covering benefits, investment strategy,
  future contributions and risk management

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Key Constraints (cont.)

• Key question is how much the Trustees de-risk the
  investments -Pensions Board require scheme to be
  costed based on long term gilt yields
• If investment strategy too de-risked, funding
  proposal may be too expensive
• but employers likely to resist open-ended
  commitments to contingency funding, as an
  alternative
• These factors may make S.50 unattractive to many
  employers but difficult for trustees to
  initiate S.50 without them so possibility of
  stalemate ensuing.

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Conclusions

• Even without UK policy interference, Irish DB
  pensions provision will shrink over time.
• What might be a DC alternative?
• Mandatory
• Cash balance (joint contributions) or combined
  10
• New tax relief structure to apply
• Centralised investment
• State to act as annuity provider on retirement
  (or global contract with major provider)

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Thank you
Peter Fahy Eversheds ODonnell Sweeney One
Earlsfort Centre Earlsfort Terrace Dublin
2 Tel [phone] Email
pfahy_at_eversheds.ie