ARTICLE
14 August 2008

Managing Defined Benefit Risk – The Legal Dimension

WB
Wedlake Bell

Contributor

Wedlake Bell logo
We are a contemporary London law firm, rooted in tradition with a lasting legacy of client service. Founded in 1780, we recognise the long-standing relationships we have with our clients and how they have helped shape our past and provide a platform for our future. With 76 partners supported by over 300 lawyers and support staff, we operate on a four practice group model: private client, business services, real estate and dispute resolution. Our driving force is to empower our clients by providing quality legal advice, insight and intelligence that enables them to achieve their goals whether personal or business. We are large enough to advise on the most complex matters, but small enough to ensure that our people and our work remain exceptional and dynamic. Building relationships is at the heart of everything we do.
In the rush to “de-risk”, legal principles are often overlooked. This briefing serves as a reminder to employers and trustees on the legal basics.
United Kingdom Employment and HR

In the rush to "de-risk", legal principles are often overlooked. This briefing serves as a reminder to employers and trustees on the legal basics.

Base Camp: The Employer-Trustee Relationship – employers and trustees need to work together in the overall interests of the scheme. This consensus is fine as long as each party remembers its legal role.

Of course every employer seeks to maximise its commercial return but this is subject to its duty of good faith to employees. This duty informs the way the employer can act in relation to the scheme.

Trustees may also act in a commercial way, as long as trustees remember they are fiduciaries and not themselves operating a pure commercial concern. Trustees will often find themselves having to balance interests – the interests of the scheme members against what in practice is commercially viable from the employer perspective.

Buy-Outs – these are all the rage at the moment, with keen prices perhaps due to certain economic circumstances which may soon pass. Whether this is the case or not, the market place certainly conveys a strong "buy now while stocks last" message. This must not deter trustees from being thorough about the buy-out process, including the legalities. Key legal issues include:-

  • the legal process is usually a contract under which an insurer agrees to make certain payments so that the contract becomes a scheme asset; in other words, trustees are taking an investment decision and so similar legal considerations apply as for other investment decisions e.g. following due process for employer consultation. Consultation means just that: ultimately the decision whether to proceed and on what terms is the trustees' decision and their legal responsibility;

  • as the contract is a scheme investment the "bought out" members do not achieve any special priority in a winding up of the scheme;

  • the "bought out" benefits should match scheme benefits so far as possible; the legal issues where this is not possible/practicable for whatever reason need to be addressed. A common issue involves identifying how the scheme has equalised benefits between men and women.

Inducement Payments/Enhanced Transfer Values – the offering of cash inducements by employers for members to exit DB schemes and/or enhanced transfer values paid by schemes to members to encourage them to transfer out remain hot legal topics.

Legal advice early in the process is essential to avoid numerous traps. For instance, there are data protection issues in trustees making membership data available to employers/their advisers.

The new Transfer Value Regulations which come into effect on 1 October 2008 will be relevant. The Regulations alter the way transfers and enhanced transfers have to be calculated and dealt with. There are a number of legal issues, not the least of which is to ensure that trustees who pay transfer values/enhanced transfer values are relieved (discharged) from any further liability to the transferring members.

Managing conflicts of interest will also be very important. Proposals for enhanced transfer packages will often be developed and driven by the employer's team, some of whom may also sit on the trustee board. Obtaining early legal advice when formulating strategy to manage DB liabilities or in considering the effect of corporate activity on DB schemes is essential.

Corporate Activity And DB Risks

The DWP consultation on the Regulator's proposed new powers expires on 20 June 2008. The new powers will be in regulations on which the Government will consult. It is likely it will be September/ October before this far reaching new legislation is on the statute book. Meanwhile the DWP/Pensions Regulator say the new legislation will be applied to events on or after 14 April 2008 ( the date when the new powers were announced).

The proposed new legislation drops the "motive" test for contribution notices and instead adopts an "event" approach. Where a scheme gets into difficulties the events approach allows the Regulator to look back to see whether a past corporate event has caused the scheme's financial problems (even though the event was not intended to hurt the pension scheme). The Pensions Regulator may then seek extra pension contributions from the employer, and/or associated parties involved in the historical corporate event. There are plenty of legal issues here! Safeguards have been promised but there is concern that the Regulations may not be scrutinised as carefully in Parliament as primary legislation (i.e. a full Act of Parliament) would be.

Overall, we would expect an increase in the Regulator using its powers as well as (at least initially) an increase in employers applying for clearance.

Employers carrying out corporate activity (such as external acquisitions or disposals, or internal group reorganisations, or distributions to shareholders) should obtain legal advice on the Regulator's new powers at a very early stage, as should trustees of the employer's DB schemes.

Summary

Benefit consultancies are rightly active in helping schemes to manage their DB liabilities in these difficult economic times. However, employers and trustees need to keep their respective legal responsibilities well in mind, and not overlook them in the rush to make an inducement offer or close a buy-out deal.

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.

Mondaq uses cookies on this website. By using our website you agree to our use of cookies as set out in our Privacy Policy.

Learn More