On March 15, 2006, the Ontario Divisional Court released its decision in the Kerry1 case. Two aspects of the decision could have a significant financial impact on employers.
- The Court concluded that the employer could not use defined benefit (DB) surplus in its pension plan to meet its contribution obligations under the defined contribution (DC) component of the same pension plan.
- The Court concluded that the language of the historical plan and trust documents (language common in many plans) prevented even routine administrative expenses from being paid from the pension fund.
The pension plan being examined in this case (the "Plan") was established in 1954 as a defined benefit plan. By 1994, the Plan was sponsored by DCA Canada Inc. At the end of 1994, in the context of an asset purchase transaction, Kerry (Canada) Inc. ("Kerry") assumed the Plan from DCA Canada and as a result became the sponsor and administrator of the Plan. From
January 1, 1985 to the end of 1994, DCA Canada had been taking "contribution holidays" under the Plan and had authorized the payment of various administration expenses from the fund (the "Fund"). Kerry continued these practices after it assumed the Plan.
Effective January 1, 2000, the Plan was amended and restated (the "2000 Restatement") to add a DC component. The 2000 Restatement contemplated that DB surplus could be used towards Kerry’s contribution obligations under the DC component. In conjunction with the introduction of the DC component, Kerry gave notice to its employees that they had a one-time option to convert their DB entitlements to a DC account balance in the Plan.
A group of disgruntled former employees requested that the Ontario Superintendent of Financial Services (the "Superintendent") to do the following:
Order Kerry to reimburse the Plan for certain expenses paid out of the Fund. These expenses included, among other things, trustee fees and investment management fees.
Order Kerry to reimburse the Plan for all contributions it should have made, if it had not taken contribution holidays.
1. Refuse to register the 2000 Plan Restatement.
2. Decision of the Ontario Divisional Court
3. Through a series of appeals, these issues were considered by the Financial Services Tribunal (FST), which rendered a decision that was generally favourable to Kerry. The Plan members appealed the FST decision to the Ontario Divisional Court.
The Court examined the original plan and trust documents (from the 1950s) and concluded that those original documents did not authorize the expenses relating to the administration of the Plan to be paid out of the Fund. The Court noted that the original trust agreement specifically provided that the expenses of the trustee "shall be paid by the Company." Given this specific reference and the fact that there was no specific reference to payment of fees relating to the administration of the Plan, the Court concluded that Plan administration fees could not be paid from the Fund. Moreover, the Court concluded that the trustee’s fees could not be paid from the Fund because the trust agreement stated that such fees "shall be paid by the Company."
The original trust agreement had been amended several times to expand the circumstances in which Plan-related expenses could be paid from the Fund. Accordingly, the Court considered whether the employer had the power to amend the trust agreement to permit the payment of administrative and trustee expenses from the Fund where such expenses were not previously permitted to be so paid. The Court stated that such an amendment to the trust documents, which permitted the employer to direct the trustee to pay expenses out of the Plan assets, constituted a revocation of the trust. In this case, the employer had not specifically reserved the power to revoke the trust and so there was no power to make the amendments.
The Court concluded that Kerry did not have the power to amend the terms of the original trust to permit the payment of administrative and trustee expenses from the Fund. The end result was that the Court directed the Superintendent to order Kerry to reimburse the Fund for "all of the amounts paid out of the Fund after January 1, 1985 for expenses incurred to administer or operate the Plan and Fund … and for all income that would have been earned by the Fund if those expenses had not been paid from the Fund."
This aspect of the decision is troubling because it contemplates a significant payment being made to the Plan without any consideration of the potential adverse implications for Plan members and the Plan itself that could arise. For example, there is considerable uncertainty surrounding whether the Income Tax Act even permits such payments to be made to a registered pension plan, if the plan is in a surplus position.
Also noteworthy is that the effect of this reimbursement requirement is that Kerry is required to reimburse the Plan for expenses paid from the Fund not only relating to the period that Kerry was the Plan administrator, but also relating to the 10-year period before Kerry had even assumed responsibility for the Plan. Thus, Kerry was made financially responsible for improper expense payments authorized by a completely separate and independent legal entity.
Contribution Holidays - Plan Conversion
The Court concluded in favour of Kerry on the question of the validity of the contribution holidays taken since 1985 in relation to the DB component of the Plan. The Court went on to examine contributions made in relation to the DC component of the Plan, which was established effective January 1, 2000.
The Court held that the effect of the 2000 Restatement which added the DC component to the Plan, was to partially revoke the trust relating to the Plan because it permitted the assets held in relation to the DB component of the Plan to be used for purposes other than for the exclusive benefit of the members of the DB component (i.e., to fund employer contribution obligations under the DC component of the Plan). While the FST had reached the same conclusion, the FST had proposed that Kerry could be permitted to use DB surplus to fund its DC contribution obligations under the Plan through an appropriately worded amendment to the Plan with effect from January 1, 2000 (the effective date of the 2000 Restatement). However, the Divisional Court concluded that no matter what language was used it was not possible for Kerry to use DB surplus to fund its DC contribution obligations. The Divisional Court appears to have interpreted the amendment implementing the plan conversion as creating "in law, two (2) pension plans, two (2) pension funds and two (2) classes of members."2
The Court ordered the Superintendent to refuse to register the 2000 Restatement. Curiously, unlike its order dealing with expenses, the Court did not specifically order Kerry to reimburse the Plan for the amounts allocated from the DB component of the Plan to the DC component. Nor did the Court deal with the plethora of complications that arise from the refusal to register the 2000 Restatement. For example, what is the impact on affected Plan members who, from January 1, 2000, earned benefits under the DC component contained in the 2000 Restatement? What did this mean for employer and member contributions made under the DC component of the Plan? The Court merely directed Kerry to "go back to the drawing board."3
While it appears from the Court’s comments on the use of surplus from the DB component of the Plan to fund employer contributions under the DC component that the Court’s conclusion must apply in all similar cases, there may be factual features relating to the Plan which would cause this decision to have a more limited application. Unfortunately, the limited analysis in the case of the facts and trust law principles (including the absence of any analysis of the actual funding arrangements themselves) means that there is considerable uncertainty surrounding the relevance of particular distinguishing features.
Adequacy of the Notice to the Employees
The Court held that Kerry had a duty under section 22 of the Pension Benefits Act (Ontario) (the PBA)4 to comply with the notice requirements in section 26 of the PBA5 and to fairly disclose and describe the proposed changes to all affected parties, including employees who were beneficiaries under the original pension plan. The Court further held that Kerry’s failure to give proper notice of those changes meant that the Superintendent was required to refuse to register the 2000 Restatement.
This aspect of the decision highlights the importance of full and fair disclosure to plan members. However, it is now unclear what a plan administrator’s obligations are where an amendment might be considered as "adverse" for the purposes of section 26 of the PBA. Section 26 of the PBA indicates that it is for the Superintendent to determine exactly who must receive any applicable notice. However, in the Kerry case, the Court seemed to suggest that it was the administrator’s responsibility to determine whether or not an amendment might fall within the scope of section 26 of the PBA and to then anticipate to whom the Superintendent may require notice to be given.
The Kerry decision is the most recent in a series of decisions in which the courts have reached conclusions on complex pension issues with little or no meaningful analysis. If the decision stands, plan sponsors who have pension plans with a DB and a DC component will need to carefully review the way in which their pension plan is structured in order to determine if it is permissible to use DB surplus to fund DC contribution obligations under the same plan. The Kerry decision also creates considerable uncertainty with respect to past uses of DB surplus to fund DC contribution obligations. This could affect a great number of employers and pension plans.
Also, where the historical plan and trust documents have similar wording to the wording considered in the Kerry case, many employers may find that their ability to pay even routine plan administration expenses from the pension fund is severely curtailed. In such cases, all plan expenses, including routine administration expenses, may need to be paid from the employer’s own assets rather than from the pension fund, even if the plan is in a significant surplus position.
The impact of this decision on pension plans registered outside of Ontario is unclear. As an Ontario Divisional Court decision, the Kerry decision is not binding outside of Ontario. However, even with the apparent deficiencies in its analysis, as the first case to specifically consider the use of DB surplus to satisfy DC contribution obligations, and as one of the few cases to comment on the ability to pay plan expenses out of the pension fund, the Kerry decision may have some persuasive impact on the courts of other Canadian provinces.
Of particular note, however, is the March 2005 decision of the Québec Court of Appeal in Hydro-Québec, which ruled that the consent of retirees was not required in respect of a plan amendment providing for the payment of administration expenses from the plan fund. The Court noted that Québec pension legislation specifically authorizes such payment and also concluded it was not prohibited by the Civil Code of Québec. The Kerry decision may therefore have limited impact in Québec.
There has been no indication yet whether Kerry and/or the Superintendent will be appealing this decision. One hopes there will be an appeal so that the Ontario Court of Appeal will have the opportunity to analyze the issues in detail and produce a more reasoned decision.
1 Nolan v. Superintendent of Financial Services (March 15, 2006), Court File Nos. 178/04 and 520/04 (Ont.Div.Ct.) ("Kerry").
2 Kerry, para. 72.
3 Kerry, para. 88.
4 Section 22 of the PBA imposes a fiduciary standard of care on pension plan administrators.
5 Section 26 of the PBA requires an administrator to provide notice of adverse amendments to plan members, former members and other entitled to payments from the pension fund if the Superintendent requires.
Authors Credit: Anthony Devir is a partner in the firm's Pension & Benefits Department, practising exclusively in the pension and employee benefits law area. Louise Greig is an associate in the firm’s Pension & Benefits Department.
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