In January 2024, the High Court handed down judgment in a case that provides useful clarification on when a court will be prepared to sever a valid amendment to a pension scheme so that it is not rendered ineffective by an invalid amendment made at the same time. This scenario can occur quite often in practice so this clarification (as well as the result in the case) will be welcomed.
Avon Cosmetics Limited v Dalriada Trustees Limited concerned the validity of one of several amendments made in 2006 to the Avon Cosmetics Pension Plan (the Plan). The amendment was intended to replace final salary accrual with accrual on a Career Average Revalued Earnings (CARE) basis and to sever members' final salary link by treating them as having retired on the date the change was made.
The intended amendment potentially infringed the restriction in the Plan's amendment power, which prevented any amendment which prejudiced members' "benefits accrued or secured up to the date on which the amendment takes effect…" (the Fetter). The court was asked to consider whether the Fetter would wholly invalidate the 2006 amendment or invalidate it only for members who would be worse off as a result of the amendment.
On the assumption the 2006 amendment infringed the Plan's amendment power, His Honour Judge Davis-White KC held that the amendment was only invalid for those members who would be worse off because of it.
The purpose of the amendment
Before the amendments were made, the pensions of affected members were calculated by reference to their final salaries (the so-called "final salary link"). The amendment sought to break that link. Members would be treated as having retired on the date of the amendment, with their then salary deemed to be their final salary. Benefits they had accrued would be treated as deferred and revalued each year by reference to RPI. The amendment was part of a package of changes under which the final salary section of the Plan closed to future accrual, with future benefits based on CARE (the CARE Amendments).
Although the effect on individual members would not be known until their benefits crystallised and the impact of future salary increases and deferred revaluation determined, two categories of members of the Plan were potentially affected:
- Those better off due to the CARE Amendments if the revaluation of deferred benefits leads to a better result than calculating their final pensionable salaries taking into account future salary increases (the Revaluation Winners).
- Those worse off due to the CARE Amendments if salary increases produce a higher pension than revaluing deferred benefits (the FS Winners).
What was the court asked to consider?
Initially, it was intended that the court should decide whether the CARE Amendments were invalid. If the Fetter had that effect, it was thought it would mean that the relevant accrued rights would be calculated by revaluing deferred benefits but with a notional underpin such that, if a calculation based on the final salary basis produced a greater value, that would be substituted for the value achieved by applying revaluation when the benefits came into payment. In this way, the court would decide whether the CARE Amendments breached the Fetter and, if so, how the FS Winners accrued benefits.
However, following input from professionals who had drafted the CARE Amendments, the claim form was amended so that it more clearly asked the court to decide whether, if the CARE Amendments were invalid for FS Winners, the CARE Amendments were totally ineffective for both FS Winners and Revaluation Winners or whether they were invalid only for FS Winners, the CARE Amendments being effective for Revaluation Winners.
The Representative Beneficiary argued that the effect of the Fetter was to invalidate the CARE Amendments in so far as they purported to affect any relevant accrued rights, so across the board. In particular, the Representative Beneficiary argued that it was not possible to sever the effect of the CARE Amendments for different categories of members because the concepts of Revaluation Winners and FS Winners were not sufficiently discrete and because it was not possible to show that the same decision would have been made for the exercise of the Plan's amendment power had any potential legal invalidity flowing from the Fetter been known at the time.
Against that, the employer argued that the Fetter only potentially invalidated the CARE Amendments for the FS Winners and that the CARE Amendments were valid as far as they affected the rights of Revaluation Winners.
Accordingly, the judge had to determine whether, assuming they were invalid for FS Winners, the CARE Amendments were totally void and inapplicable to Revaluation Winners as well.
The court's decision
At its heart, this case is about the doctrine of severance in a pensions context.
The judge explained that courts use the doctrine of severance in deciding whether a purported amendment of a pension scheme which is not permitted by its power of amendment may result in only a partial invalidity of that amendment. The parties differed as to whether it was possible to sever the exercise of the power of amendment so that, for the Revaluation Winners, the CARE Amendments were valid.
The judge explained that seeking to introduce an amendment in breach of a fetter in an amendment power is an example of an "excessive exercise" of the power. It is to be distinguished from situations in which a power had been exercised following "inadequate reasoning" (for example, taking into account matters that should not have been taken into account or failing to take into account relevant matters) or where there had been a "fraud on a power" (for example, where the power had not been used for the purpose for which it had been conferred).
This was relevant because the judge noted that, at least in a pensions context, in cases of "excessive exercise", the courts will "naturally incline to uphold the validity of the exercise so far as it can".
The judge stated that, where what has been done can be conceptually separated into a valid and invalid exercise of the power, applying the principles of construction to the interpretation of pensions documentation, it is possible to imply a limit on the terms of the exercise of the power so that it is read as only effecting the valid part of the exercise. Another way of looking at the issue (and both approaches had been adopted by the courts in the case law) is to ask whether it is possible to sever the valid from the invalid so that the valid survives.
If that can be done, the judge said that the next question is whether there is a further condition, namely, that the court must be satisfied that, had they properly appreciated the true limits on the power, the person who exercised the power would have exercised it in the same way, at least as regards that part of the exercise which would be separable as valid from the invalid part.
In considering this question, the judge stated that an objective test should be applied to determine whether severance would result in a substantially different exercise of the power from the one that would have been carried out but for severance. It was not necessary for the court to look into and determine the actual states of mind of the people who exercised the power.
It had not been clear prior to this case whether, before severance could be applied, it was necessary to obtain witness evidence as to whether those who had purported to exercise the power would have done so in the same way had they known the limitation in the amendment power. That such evidence is not required will be welcome.
Applying these principles, the judge concluded that the concepts of FS Winners and Revaluation Winners and the underpin were sufficiently different and identifiable, even if there were a timing issue as to when it would be possible to determine into which concept individual members fell.
Taken as a whole, the substantial purpose of the CARE Amendments was to remove the final salary linkage by closing the final salary section of the Plan to future accrual and to move members (with accrued rights to a final salary link) to the revaluation basis.
If, as the judge was asked to assume, it was not possible to fully sever the final salary link for the FS Winners, what remained for the Revaluation Winners was within the overall objective intention behind the CARE Amendments. It followed that, if the CARE Amendments were invalid for the accrual rights of FS Winners, they were valid as regards the Revaluation Winners.
Final thoughts
Although it is a long judgment, running into 195 paragraphs, the conclusions the judge reached are set out relatively briefly. Most of the judgment (124 paragraphs) is taking up with a consideration of the case law on how to interpret pensions documentation, severance and the legal principles to be applied in deciding whether the purported exercise of a power should be set aside.
The judgment usefully summarises the facts and principles to be derived from a number of important pension cases. That the judgment was handed down in a matter of weeks after the hearing is to the credit to the judge who, with all due respect, is unlikely to have been very familiar with the law relating to pension schemes before the case. It is becoming increasingly common for pension cases to be decided by judges who have no particular experience in the law relating to pension schemes. Recent experience suggests that such judges are often not afraid to take a practical approach to deciding cases.
The judgment is likely to be welcomed by many in the pensions industry, particularly practitioners. The statement that, in a pensions context, courts will incline to uphold the validity of the exercise of a power of amendment will be welcome and there will no doubt be hope that such an approach will be adopted in other areas of pensions practice.
For more information, or to discuss any of the points raised in the article, contact Ian Gordon or Josh Sheppard.