UK: Members' Reasonable Expectations May Scupper Scheme Amendments

Last Updated: 8 May 2014
Article by Alison Hills

For years employers and trustees have been amending benefits provided under defined benefit schemes safe in the expectation that their amendment would be effective provided the relevant party complied with consultation requirements and the amendment power in the trust deed and there was no infringement of section 67 Pensions Act 1995. In addition, trustees must have acted properly in accordance with their fiduciary duties and employers must have complied with their duty of good faith.

In relation to the employer's obligation of good faith, an important additional consideration has been highlighted following the recent High Court case of IBM v Dalgleish: Has the employer given members a reasonable expectation with regards to certain benefits to be provided under the scheme?

This case concerned two final salary pension plans operated by IBM.  IBM claimed that (i) a desire to reduce pension costs with a view to the global group achieving its earnings per share commitments to its shareholders; and (ii) a desire to make local operational improvements and savings led to it making a number of changes to the two schemes in question.

What changes did IBM make?

  • Closure of the defined benefit sections to future accrual;
  • Pensionable salary was frozen; and
  • Restrictions imposed on early retirement (subject to a two-month window where beneficial early retirement terms could be accepted).

These changes were collectively called "Project Waltz".

How were the changes made?

IBM consulted under the regulations and then exercised its unilateral power under the scheme's "exclusion power" to issue notices which determined individuals ceased to be members of the scheme.

What was the problem?

Formalities: Consultation requirements not complied with

The High Court found that whilst the exercise of the power was valid (subject to the requirement to provide continued final salary linkage for members of one of the schemes) the employer's consultation was not conducted in an open or transparent manner and deliberately provided misleading information as to the proposed changes.  This represented a breach of IBM's contractual and "imperial" duties (see below).

The past

IBM had already carried out two similar exercises, Project Ocean where member contributions were increased and Project Soto where members were offered continued membership of the final salary scheme but with reduced accrual or a transfer to an enhanced money purchase scheme (whilst retaining certain benefits in the final salary scheme).

These changes were introduced following an extensive communication programme by IBM.  Of great importance was that these communications included statements to the effect that there would be no further changes to the final salary schemes over the long-term horizon.  These statements gave rise to members' reasonable expectations as to their future pension benefits.  Making further changes under Project Waltz, which were inconsistent with the previous communications issued under Projects Ocean and Soto was therefore a breach of the employer's duty of good faith.

Good faith

The Court discussed in detail the two key areas of good faith:

  • The Imperial duty; and
  • The contractual duty

The Imperial duty (stemming from the Imperial Tobacco case in 1991) was summarised by the High Court judge in IBM v Dalgleish as "an obligation on both an employer and a member (whether an employee of ex-employee) not to destroy or seriously damage the relationship of trust and confidence between them".  The exercise of the discretion should be "genuine and rational", not "empty or irrational" and the test "is not one of fairness".  Importantly it was clarified that "Dishonestly or recklessness is not needed to establish breach of the Imperial duty in relation to statements made; there is no reason in principle why trust and confidence cannot be undermined by making a false or misleading statement without reasonable cause or negligently".  The reasonable expectations of members, as a result of information they have been supplied by the employer, are therefore relevant when determining whether the Imperial duty has been breached by an employer.

The contractual duty was summarised by the High Court as an implied "term that the employers will not, without reasonable and proper cause conduct themselves in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee".  Essentially a very similar duty to the Imperial duty, but arising through different means.


Continued accrual and the option to take early retirement on the existing terms were reasonable expectations of the members as a result of the communications previously issued to them by the employer.  The expectations were not "mere expectations" on the part of the members and they were created by the employer.  In light of the facts Mr Justice Warren (the High Court judge in the case) concluded that no reasonable employer could have introduced the changes made by Project Waltz and that IBM's actions constituted a breach of its duty of good faith.

A further hearing is being scheduled to consider the possible remedies in relation to IBM's breaches of duty.  IBM has confirmed it intends to appeal the decision.

Lessons to take away from this case

Trustees and employers should be wary of making promises or references to the prospect of any potential future changes.  If the parties feel it necessary to give such reassurances to members then suitable caveats such as "subject to any changes in market conditions" should be considered and included where possible.

Trustees must also carefully consider any requested amendments by the employer in light of the historical bigger picture.  Past communications by the employer must be taken into account by the employer when considering making further changes to the benefits available under a scheme.

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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