UK: Early Retirement Benefits On Business Transfers

Beckmann v. Dynamco/ Martin & Ors v. Southbank University
Last Updated: 4 February 2004
Article by Michael D. Calvert

1. SUMMARY

On business transfers there is a risk that where the seller provides a company sponsored "occupational" pension scheme which allows benefits to be paid before members reach their normal retirement date, the obligation to provide those benefits will become an obligation of the buyer. The buyer’s obligation would apply to benefits calculated by reference to the period before the transfer as well as to the period after the transfer. It is arguable that this obligation transfers only in certain cases, for example where the employees have at some point been members of public sector schemes. However, these arguments cannot be relied on. Buyers should be advised to take account of the potential obligation to provide the benefits when valuing the business or to seek some form of protection, such as an indemnity from the seller.

2. LEGAL BACKGROUND

In their original form, the Transfer of Undertakings (Protection of Employment) Regulations 1981 ("TUPE") provided that contracts of employment effectively transfer to the buyer on a business transfer (regulation 5) with the exception of the contractual terms relating to occupational pension schemes (regulation 7). On this wording, the obligation to provide early retirement benefits under such a scheme would NOT transfer.

Any obligation on the seller to contribute to a personal pension scheme WOULD transfer under TUPE because personal pension schemes are not occupational pension schemes.

However, the government recognised that certain benefits payable solely under public sector schemes were not conventional retirement benefits (eg temporary pensions payable from redundancy up to normal retirement date). The Acquired Rights Directive, which TUPE is designed to implement, suggested that such redundancy benefits should have the protection of TUPE. In 1993, TUPE was therefore amended to provide that the exception under TUPE relating to occupational pension schemes applied only to "benefits for old age, invalidity or survivors". This reflected the wording of the Acquired Rights Directive.

In the 1999 case of Frankling v. BPS the claimant argued that when a pension under an occupational pension scheme which was payable for life was brought into payment early when an employee was made redundant, the pension was not a benefit for old age and that the liability to provide the pension there-fore passed to the buyer on a TUPE transfer. The Employment Appeals Tribunal held that the pension retained its character as a retirement benefit payable in respect of an employee’s old age, even when early payment was triggered by redundancy.

The decision in Frankling was effectively overturned in 2002 by the European Court of Justice in the case of Beckmann v. Dynamco Whicheloe MacfFarlane. The facts in Beckmann were similar to those in Frankling. However, the ECJ felt that there were issues of European law which had not been properly taken into account in the earlier decision. It held that contractual obligations relating to the payment of early retirement benefits payable on redundancy were not old age benefits within the meaning of TUPE or the Acquired Rights Directive and therefore DID transfer to the buyer on a business transfer.

It was not clear whether the Beckmann judgment applied equally to early retirement benefits paid in circumstances other than redundancy. The decision in Martin & Ors. v. Southbank University clarifies the position slightly in that it established that contractual provisions relating to benefits provided on early retirement when an employee is dismissed or when the employee retires by agreement between the employer and the employee will transfer. In either case, of course, there is an element of control on the part of the employer (as to whether to dismiss the employee or agree to the early retirement). It is not clear if the ECJ would say that the same approach should also apply where the early retirement is voluntary on the part of the employee, but the employer does not agree or consent. It is perhaps logical to conclude that the ECJ will take the same view for all early retirement benefits apart from ill-health benefits (which are clearly excluded by the Acquired Rights Directive and TUPE).

3. THE CONTRACTUAL OBLIGATION TO PROVIDE BENEFITS

One point which has not been tested is the extent of the employer’s contractual obligation to provide benefits under its occupational pension scheme. This is because the cases which have gone to the ECJ concern transfers out of the public sector where the pension benefits are described in collective agreements and statutory instrument and the argument that they have been incorporated into the contract of employment is a strong one. This will often not be the case with private sector employers where the contract of employment may say nothing more than that an employee will be eligible to join the company’s occupational pension scheme subject to its trust deed and rules. It must at least be arguable that there is no contractual obligation on the employer to provide the benefits under the scheme and that a transfer between private sector employers (where there has not been a previous transfer from a public sector employer) should be treated differently, though it is not clear exactly what the contractual obligation would be in that case. Given the ECJ’s attitude in Beckmann and Martin, there is no great confidence amongst pension lawyers that the ECJ would agree that there is a material difference between such transfers and transfers from a public sector employer.

4. IMPLICATIONS FOR TRANSACTIONS

The buyer must be told that there is a risk that, where the seller provides an occupational pension scheme, then the buyer will effectively have to provide the same benefits on early retirement for any reason (other that ill health) as transferring employees would have been entitled to under the seller’s scheme had they been able to remain members of it. This obligation applies to early retirement benefits calculated by reference to service with the seller as well as benefits calculated by reference to service with the buyer.

There are a number of steps which can be taken to address the issue:

  • Calculate the potential liability and reduce the purchase price. This would be unattractive to a seller because it crystallises an obligation which is contingent on employees retiring early (which may require employer consent under the seller’s scheme). Also, the seller will already have contributed to the liability through its contributions to its own pension scheme and would effectively be paying twice for the same benefits.
  • Take an indemnity from the seller. This seems to be the most popular approach in practice, though it obviously depends on the strength of the seller’s covenant. In the past, buyers and sellers have adopted this approach partly in the hope that the Beckmann decision would apply only in the case of early retirement benefits paid on redundancy. The parties may have a good under-standing as to whether redundancies were likely. However, following the Martin decision, it is now more likely that all early retirement benefits are caught, in which case it is much more likely that payments would be made under any indemnity. This may make sellers more reluctant to give them. Also, they would be concerned to limit their scope – for example, to benefits calculated by reference to the period up to completion, leaving the buyer to pick up the tab if it does not replicate the benefit structure in the seller’s scheme for service after completion.
  • Buyer sets up an occupational pension scheme mirroring the provisions of the seller’s scheme and a transfer is made of all the benefits accrued by transferring employees in the seller’s scheme to the buyer’s scheme, together with a transfer value negotiated by the buyer and seller to cover the cost of the benefits for the period up to completion. This is the approach which is most effective in ensuring that there is no latent liability. Effectively, the buyer assumes, through its scheme, the liability for past and future service. The liability for past service is funded by the transfer from the seller’s scheme, which should be negotiated with an appropriate allowance for early retirement benefits. The liability for future service is funded by the buyer and reflected in its valuation of the business. However, this approach is unattractive because buyers do not usually want to replicate the seller’s pension arrangements, particularly where the seller operates a defined benefit scheme where the early retirement issues are most acute. Defined benefit schemes tend to be more expensive than defined contribution schemes (because they generally provide larger benefits) and are subject to volatility in the employer’s contribution rate, particularly where they apply to small numbers of members.
  • Where a number of redundancies are planned following the purchase, the buyer could be allowed to remain a member of the seller’s scheme for a limited period so that the employees affected would receive exactly the same benefits on their redundancy as if the transfer had not taken place. How the cost of any enhancements to the pension benefits on redundancy would be split between buyer and seller would be a matter for commercial negotiation.
  • The buyer could try to change the employees’ contracts of employment to remove any right to early retirement benefits. This will involve dismissing the employees on notice and re-hiring them on new contracts (because it is not possible to agree changes to contracts with employees following a TUPE transfer if the reason for the change is connected with the transfer). The risk is that the dismissals would be automatically unfair unless the buyer can show an economic, technical or organisational reason justifying its actions. The cost of providing the benefits may be such a reason, but the point has not been tested. It is not clear whether this route would be sufficient to close off liability in respect of past service.
  • The transaction could be restructured as a share sale so that there would be no TUPE transfer. The position of the employees would then be the same as on a normal share sale. This doesn’t remove all potential liability – the buyer would still have to consider what the contracts of employment provide in respect of pensions and the extent to which its proposed replacement arrangements discharge these contractual obligations. But the buyer will have greater room for manoeuvre and employees will be able to agree to changes in their contracts to address the new situation.

5. IMPLICATIONS FOR PAST TRANSACTIONS

The Beckmann judgment has retrospective effect, so there could be latent liabilities for companies arising out of past transactions where they have acquired businesses. This should be an issue which is investigated during due diligence, whether on a purchase of shares or of a business. In theory, all purchases of businesses which took place since TUPE was introduced in 1981 could have given rise to such liabilities for the buyers concerned. This is possibly overstating the case. Until TUPE was amended in 1993 (see section 2 above) its wording clearly excluded ALL benefits under occupational pension schemes from transferring. The courts will try to interpret a regulation consistently with European law where they can, but not where the language of the regulation is clearly inconsistent with this interpretation. So most concern should probably focus on business transfers since 30 August 1993 when TUPE was amended to bring its wording into line with the Acquired Rights Directive (although the government may be vulnerable on the basis of the Francovich case to claims that, until that date, it had not properly reflected the Directive in UK law).

6. CONCLUSION

There is no simple solution to the problems arising out of the Beckmann judgment. Each business transfer must be considered on its own facts according to the pension arrangements provided by the seller. The value of the benefits in issue in relation to the purchase price will also be relevant, together with the buyer’s attitude to risk. Also, if the buyer has a comparable defined benefit scheme already, it may be happy to take the transferring employees into that scheme with an appropriate transfer value or price adjustment.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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