UK: Good Faith: An Employer's Duty

Summary and implications

In a bumper 435-page judgment, the High Court has ruled that IBM UK breached its duty of good faith to its employees and former employees. The breach was triggered by the way in which it closed the DB sections of its pension schemes to future accrual and introduced new benefit restrictions. The judge (Mr Justice Warren) also found that consultation with employees about the changes was not open or transparent and held that this was also a breach of IBM's duty of good faith. The remedies flowing from the breaches will be considered at a later hearing.

Nabarro LLP represented the pension scheme trustee in this case.

This case is an important step in establishing the extent of the obligations employers owe their employees and former employees in relation to pension provision. It will be of great interest to any employer who has, or who is considering, ceasing DB accrual or introducing new restrictions on benefits. Key to this decision were the communications issued to members in the months and years before the changes were made – these were found to have given members Reasonable Expectations as to their future pension benefits.

Employer duties: contractual and under trust

The duties an employer owes it employees in relation to pension provision can be divided into contractual duties arising under the employment relationship and a duty of good faith in the exercise of discretionary powers under the pension scheme (often referred to as the "Imperial" duty). The IBM decision addresses these duties in great detail – with the judge then coming to the conclusion that in practice there may often be no significant difference between the two.

Contractual duty
An employer must treat his employees fairly in his conduct of his business, and in his treatment of his employees, an employer must act responsibly and in good faith; he must act with due regard to trust and confidence (or fairness).

Imperial duty
An employer must not act irrationally or perversely in the sense that no reasonable employer could act in that way.

The background to the case

The key changes which were the subject of complaint in the IBM case were the closure of the DB sections to future accrual, a freeze on pensionable salary (to be achieved through contractual agreement with employees), a more restrictive early retirement policy and an early retirement window before the new policy came into effect. The closure to accrual was effected by IBM unilaterally by the exercise of an "exclusion power" which allowed IBM by notice to determine that individuals would cease to be members. These changes were collectively referred to as Project Waltz.

Relevant to the decision were two earlier benefit change exercises known as Project Ocean and Project Soto. Some of the information and statements given to members during those earlier exercises were relevant to the court's findings insofar as they had given rise to members' reasonable expectations as to their future pension benefits.

IBM claimed two main reasons for wanting to make the changes. The first was so that the global group could reach its target for pensions related costs in order to meet its Earnings Per Share commitments to shareholders. The second was a local desire for the UK business to make operational improvements and savings (and cost savings in pensions would contribute to this).

The judge summarised the whole case in a single sentence: Was Project Waltz an appropriate response to the combinaton of problems facing IBM, taking into account the reasonable expectations of the members?

Key findings of the court

Crucially for IBM, the judge found that the exercise of the exclusion power in the manner that it was exercised was within the scope of the exclusion power (thus enabling the decision to stop future accrual for all DB members in one scheme and the majority of DB members in another scheme) but this was subject to members retaining the right to final salary linkage.

The judge also found that IBM was in breach of both its contractual and Imperial duties in imposing Project Waltz. He held that it was not something a reasonable employer would have done given his finding that that IBM had engendered amongst the members certain Reasonable Expectations relating to future benefit accrual and the operation of its early retirement policy. The Project Waltz changes were inconsistent with these Reasonable Expectations and this went to the heart of the relationship between IBM and its employees. In the judge's view alternative proposals could have been adopted which would have met both IBM's commercial needs and the members' Reasonable Expectations.

Members were entitled to expect IBM to carry out its consultation on the proposed Project Waltz changes in line with the requirements of the legislation and its own expressed core values. The judge found that the consultation exercise had not been open or transparent and that misleading information had been provided. He therefore held that IBM was in breach of its contractual duty of good faith in this regard.

The findings in this case are specific to its facts but some useful general points come out of the findings, particularly in relation to reasonable expectations and to the conduct of consultations.

Reasonable Expectations

The key factor in leading the judge to make findings that IBM had breached its duties was his conclusion that IBM had by its own acts engendered in its employees reasonable expectations, in contrast with mere expectations, as to what the future would hold for their pension benefits and then introduced changes which were inconsistent with those expectations.

A REASONABLE EXPECTATION IS AN EXPECTATION AS TO WHAT WILL HAPPEN IN THE FUTURE ENGENDERED BY THE EMPLOYER'S OWN ACTIONS, WHICH GIVES EMPLOYEES A POSITIVE REASON TO BELIEVE THINGS WILL TAKE A CERTAIN COURSE.

Not every breach of a reasonable expectation will necessarily give rise to a breach of duty – the employee must then go on to show that the confounding of that expectation was sufficiently serious to constitute a breach of the contractual or Imperial duty (or both).

This emphasises the importance of clear and accurate communication with members. Employers should take care not to make any statements of intention, unless they are absolutely certain they will stand by them. Particular consideration should be given to setting a time limit on any statements as to future intention ("We will review the position again in 2016") or in making any promises subject to future business or market conditions.

Even though not establishing any immediate rights, the decision in IBM shows how difficult it can be to move the goalposts once expectations have been raised and members have made important decisions on the basis of information provided to them.

Consultation exercises

Employers are required by the Consultation by Employers Regulations to consult affected employees on certain changes to their pensions. Those regulations require the employer and employee "to work in a spirit of co-operation".

IBM purported to consult under the regulations but the court has found that they did not do so in an open or transparent way and deliberately provided misleading information as to the proposed changes. IBM was found to be in breach of its contractual and Imperial duties in the manner in which it carried out the consultation.

The consultation regulations allow the Regulator to impose a penalty of up to Ł50,000 for a breach of the consultation requirements. However, the judge rejected IBM's argument that the penalty under the regulations was the only remedy which could apply where there had been a breach of duty in relation to the consultation requirements.

Employers should take note. Consultation on changes to pensions is not just a tick-box exercise under the regulations. They must also be carried out in accordance with the duty of good faith. Conversely, a failure to consult under the regulations does not in itself give rise to a breach of duty.

Trustee consideration of employer proposals

Trustees should ensure that they consider an employer's proposals for future service changes in the wider historical context of the scheme, and not just the employer's current rationale and business case for its proposed changes. They should also ensure that the employer is exercising its powers for a proper purpose and, where a power is exercised jointly, that they as trustees can properly agree to the proposed changes. If Reasonable Expectations may have been engendered by an employer's past actions then it may be necessary for trustees to test this in court before agreeing to scheme amendments.

What next for the IBM schemes?

The judgment does not include any specific remedies and there are still a number of issues to be decided. It is also open to any of the parties to request permission to appeal. This means that the immediate practical consequences of the case are not yet clear and further judgments on consequential issues can be expected.

The full judgment of Warren J can be found here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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