Merchant Navy case helps solve some long-standing legal problems

12 minute read
07 April 2015


There are some questions in pensions law that are frequently asked: It is often stated that trustees have a duty to act in members' best interests - but what exactly does that mean? Also, in a scheme that is closed to accrual but provides more generous ongoing increases to accrued rights, does that count as still being in 'pensionable service'? New case law has provided some important clarity in relation to these questions.

The case of Merchant Navy Ratings Pension Fund Trustees Ltd v Stena Line Ltd and others covers two areas of particular interest:

  • first, the nature of trustee duties when exercising their powers (here, the power of amendment); and
  • second, what constitutes "pensionable service" for the purposes of the Pensions Act 1995.

Much of the case is relevant only to the specific facts concerning the Merchant Navy Ratings Pension Fund (MNRPF) - an industry-wide scheme - but there are some points that will be of wider relevance. The most important of these are summarised below:

1. Trustee duties

Background

The amendment power in the MNRPF was held by the Trustees with no requirement for employer consent; except that the employers had the right to be represented on the trustee board, and an exercise of the power required a majority of employer representatives to support it.

The question at issue was whether it would be a proper use of that trustee power to amend the scheme rules such that all participating employers were liable to fund the scheme. The effect of the change would be to bring historic employers within the scope of the obligation, even though they were not "Current Employers" for the purposes of the rules as in force at the time.

The judge made various interesting comments on trustee duties generally.

Duty to act in the best interests of the beneficiaries

A phrase commonly used in relation to pension scheme trustees, notably by the Pensions Regulator, is that they have a duty to "act in the best interests of the members"[1]. That has caused some difficulty for trustees, for example when they are asked to agree an amendment to scheme rules to close a scheme to accrual - some trustees ask how can it be in members' best interests to be prevented from accruing further Defined Benefit (DB) rights?

In fact, that phrase is a convenient but somewhat broad-brush summary of the legal position regarding the duty owed by a trustee to a beneficiary of the trust, which is governed by the English law of trusts.

The judge in the Merchant Navy case helpfully clarifies the position on this, stating that there is no "paramount stand-alone duty" of a trustee to act in the best interests of the beneficiaries. Rather, that principle is another way of stating the trustee's duty to promote the purpose for which the trust was created (which is another fundamental principle of English trust law).

The judge held that the purpose of the trust and the best interests of the beneficiaries are two sides of the same coin, because to determine whether a proposed action is in the best interests of the beneficiaries, it is first necessary to determine the purpose of the trust and the benefits which the beneficiaries are intended to receive.

This is a useful clarification which should aid the trustees' understanding of their legal duties. To return to my example above regarding closure to DB accrual, if the purpose of a pension scheme is to give effect to the benefit design of an employer to reward its staff, then consenting to an amendment that only affects future benefits (or the lack thereof) - e.g. a closure to DB accrual - is unlikely to appear inconsistent to the trustees with their duty.

Taking into account the interests of the employers

The judge held that the interests of the employers were a legitimate consideration for trustees, and that the continued viability of the employers was something which the trustees were entitled to promote.

That confirmation will be useful for employers when negotiating with trustees. However, the nature and extent of the respective powers of the employer and the trustee in each individual scheme, and the background context, will be relevant when determining the extent to which the trustees can take the employers' interests into account.

Decision-making process

Other parties to the litigation also sought to criticise the decision-making process adopted by the trustees of the MNRPF, as a way to undermine the validity of the decisions the trustees had made. The judge dismissed that criticism.

Much of the argument in this area was specific to the facts, but the dismissal of the attack on the trustees' process might be useful to other trustees who are faced with a similar attempt to undermine their decisions.

2. The issue with "pensionable service"

Background

The law has long been uncertain on the treatment of a DB member who is no longer accruing benefits - in the sense that his pensionable service, as a period of time, is not getting any longer - but whose benefits are to be increased by something other than the normal revaluation linked to inflation while he remains employed by the scheme's sponsor.

The area of uncertainty was whether such a member is still in "pensionable service" as defined in the Pensions Act 1995, or whether his "pensionable service" comes to an end when he ceases to accrue years of service.

The definition of "pensionable service" in the Act is "service in any description or category of employment to which the scheme relates which qualifies the member (on the assumption that it continues for the appropriate period) for pension or other benefits under the scheme".

Why does it matter?

The reason why this matters is that it affects when section 75 debts are triggered. A "section 75 debt" is a statutory debt due to the scheme from an employer, to reflect that employer's share of the deficit in the scheme against the cost of buying out benefits with an insurer. Given the cost of buying out benefits and the size of many pension schemes' deficits, it will often be the case that the triggering of a section 75 debt is a significant, or even fatal, blow to an employer's financial health.

A section 75 debt is triggered on various events, the one with which we are concerned here being an "employment-cessation event" in a multi-employer scheme. This is not an issue for single-employer schemes.

An "employment-cessation event" occurs when an employer ceases to employ any members who are in "pensionable service" (on the above definition) at a time when another employer who is responsible for DB liabilities continues to do so.

When is this usually an issue?

As noted above, the definition of "pensionable service" causes difficulty where a member is no longer accruing years of service, but his accrued benefit is increasing by something different to the normal revaluation in deferment (for so long as he remains in employment with the scheme's sponsor).

This can arise in various scenarios, but in practice, the most common situation is where there is closure to DB accrual, but the accrued benefit of members who remain in employment continues to increase in line with future salary increases, for as long as they remain with their employer. This is generally known as members keeping the "final salary link".

In a DB scheme of that description, is a member in 'pensionable service' for the purposes of the Pensions Act 1995 while he remains in employment? For the member, it makes little difference, but for the employer, it could make a very significant difference.

Closure to accrual and the final salary link

When a scheme closes to accrual, employment-cessation events usually do not occur, either at the time of the closure or at any time thereafter, because all pensionable service (i.e. with all employers) is terminated at the same time. That means there is never a situation where an employer ceases to employ anyone in pensionable service at a time when another continues to do so.

However, if a scheme closes to accrual but keeps the final salary link, the position becomes more risky.

If an employee with the final salary link is deemed to be in "pensionable service", then employment-cessation events would occur at any time after the closure when an employer ceased to employ any members who had the salary link (e.g. through resignation, termination or retirement) at a time when another employer continued to do so. Continued vigilance by employers would be essential to prevent section 75 debts being triggered by accident.

Trustees would also have to be vigilant to ensure that if a section 75 debt were triggered, then it would be collected or otherwise dealt with to avoid disadvantaging the scheme.

How Merchant Navy has advanced this issue

The Merchant Navy case did not concern the salary link, but it did consider an analogous issue, and its conclusion helps to solve the problem described above.

The MNRPF closed to accrual on 31 May 2001, but the rules continued to define a category of member known as "Active Members". A member would be an "Active Member" if he fell within one of various descriptions; one of which was defined by reference to continuing to be employed by an employer in the scheme.

Members in the category of "Active Members" were entitled to more generous revaluation for so long as they remained in that category. If they ceased to be in it, they reverted back to normal revaluation in line with RPI increases capped at 5% per annum. The more generous revaluation was linked to national average earnings or, at the member's option, RPI increases capped at 7% per annum.

The judge concluded that "Active Members", despite being entitled to this more generous revaluation, were not in "pensionable service" for the purposes of the Pensions Act 1995.

Reading that into the situation described above, it follows that members who retain the final salary link in a scheme that is otherwise closed to accrual are not still in pensionable service - so ceasing to employ them would not create an employment-cessation event.

Action

This is a notoriously complex issue. The above case is a welcome clarification, but it does not provide a universal answer - each scheme's individual benefit structure will need to be analysed to determine what will constitute an employment-cessation event. This will be affected not only by the existence of the final salary link, but the provision of any other benefits post-closure, e.g. Defined Contribution benefits, or enhanced benefits on ill-health.

Any employers or trustees in relation to schemes which are closed to DB accrual, but which continue to provide the final salary link, or indeed any other form of benefit beyond (or instead of) normal deferred revaluation, should consider taking legal advice on what the section 75 debt triggers would be. If they already have such advice, they should consider whether it needs to be updated in the light of this case.

Footnote

[1] It may also be a specific statutory requirement, e.g. in the regulations relating to investment. In this alert we focus on the general duty rather than specific statutory provisions.


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