Many employers are exploring options for closing (or
"freezing") their defined benefit pension plans to cease
future benefit accrual as the costs, volatility, and risks
associated with these types of plan have reached unprecedented
levels. Whether closure is possible without incurring significant
costs or triggering employee relation issues requires an
understanding of the issues that may apply.
This Commentary outlines those issues and, in particular,
the restrictions that need to be considered when closing plans
established in Belgium, France, Germany, Italy, Spain, and the
United Kingdom. Many employers are looking to replace defined
benefits with defined contribution benefits, wherever this is
possible, but the complexity of such closures, and issues such as
consultation with employees and their representatives, can outweigh
the advantages of reducing the cost and uncertainty inherently
connected with generous defined benefit plans.
Employee and Works Council or Trade Union Consent
Generally, employees have a contractual right to the benefits
provided under the plan and closure would constitute a breach of
contract in the absence of consent. As a result, the first step in
a closure exercise should always be to check employees' terms
of employment.
It is rare that this is an obstacle in the UK, as most pension
plans are offered subject to the terms of the plan, which will in
the vast majority of cases provide for their amendment and
termination. In a minority of cases, a UK defined benefit
plan's governing documentation may contain restrictions that
prevent the closure of the plan and give employees an ongoing right
to the benefits provided under it, or limit the extent to which
future accrual can be stopped. In these cases, employees will need
to give their consent to the cessation of benefit accrual, and it
is unlikely that consent would be forthcoming.
Employee consent is also required in Germany, where employees have
a contractual right to the benefits, and if the right is contained
in a collective bargaining agreement, works council consent will
also be required. In either case, unless objective reasons for the
closure acceptable to the Labour Courts can be shown to exist,
there is a risk that employees could successfully seek continued
participation in the relevant pension plan.
In France, employee consent is required if the employee has a
contractual right to the pension benefits. Collective bargaining
agreements or arrangements provided through custom and practice may
be modified without employee consent, although a prescribed
modification procedure must be followed involving notice and, in
respect of collective bargaining agreements, works council
consultation.
In Spain and Belgium, consent must be given by the pension
plan's governing body and by the relevant employees because a
reduction in benefits is considered to be a substantial
modification of the employment conditions. However, if the
employees refuse consent, it may still be possible to close the
plan if the employer has valid grounds (for example, economic,
technical, organisational, or productive reasons for the
closure).
Industry-wide plans in Italy may be closed only with the consent of
the parties that set up the plans, usually the employer
associations and the trade unions. Pension plans operated at the
company level can be closed only with the consent of the relevant
trade union, unless closure occurs in the context of a company
insolvency or as a result of the termination of the business.
Replacement Benefits. In most jurisdictions, the
consent of at least one interested party (i.e., employees or their
representatives) will be needed for a closure. This consent is
unlikely to be forthcoming unless employees are provided with a
benefit of an equivalent value.
In the UK, as already mentioned, most pension plans are offered
subject to the terms of the plan, which will often provide for
their termination. Although trustees must generally consent to the
closure of a pension plan, trustees usually take the view that
their duties to plan members are confined to protecting past
service benefits. They do not, as a result, tend to get involved in
negotiating the level of future benefits. It is therefore possible
to replace a defined benefit arrangement with a defined
contribution arrangement in the UK because the consent of the
employees or their representatives is not required.
Dealing with a Refusal to Consent. If employees or
their representatives refuse to consent to a closure, an employer
may wish to consider other options, most often the "dismissal
and rehire" route. By this method, the employee is dismissed
and then reemployed on different terms that do not include the
right to accrual of further benefits in the pension plan.
This approach has been used with some success in the UK. Although
employees who are dismissed can bring claims for unfair dismissal,
the costs to the employer may well be lower than the costs of
retaining a defined benefit plan, and depending on the market
sector and seniority and skills of the affected employees, many
employees might accept reemployment rather than bring a claim,
particularly in the current economic climate. Of course, this may
give rise to employee relations and reputational issues for the
employer.
"Dismissal and rehire" is not an option in many other EU
jurisdictions. In Germany, the dismissal would be ineffective to
terminate employment. In Belgium, the employee can claim damages
and also request the Labour Court to reinstate the original pension
plan. In Spain, the employer could try to stop making contributions
to the plan on economic, technical, or organisational grounds, but
this would not have the effect of closing the plan, and this
approach is susceptible to challenge. In France, the grounds for
dismissal would not be the refusal by the employee to consent but
the necessity for the company to close the plan, notably for
economic reasons (under the French criteria), which is more
difficult to establish.
Consultation
In addition to consent, consultation with certain parties is
often required. Consultation must be conducted before any clear
decision to close can be made so that the issues raised by the
consulted party are properly considered before any final decision.
Consultation can be time-consuming and add to the uncertainty on
any closure. Consultation does not require an employer to obtain
agreement to the closure, but it does mean that the employer must
give employees and their representatives an opportunity to share
their views on the proposed closure. The employer should take those
views into account when reaching a final decision. However, the
employer is generally not prevented from going ahead with the
closure, except in Belgium, where the decision to close without
valid consultation may lead to the annulment of that
decision.
As noted above, consultation with works councils and unions may be
necessary in most jurisdictions, depending on the agreements
entered into. In addition, specific consultation with employees is
required in the UK and France. In the UK, closure of a pension plan
to future accrual is a "listed change" requiring 60
days' consultation with the affected employees or their
representatives. In France, the length of time for works council
consultation is not regulated. Depending on the number of meetings
necessary to obtain an opinion from the employees'
representatives, the consultation would take between 15 and 60 days
for benefit arrangements set up as a result of a collective
bargaining agreement.
Payments to the Plan on Closure
Although the closure of a pension plan reduces long-term
uncertainty and cost for the employer, it may not have such an
effect in the short term. In fact, the closure itself often results
in an immediate payment becoming due to the plan.
In the UK, if trustee consent is not obtained, closure of the plan
may require the employer to buy out members' benefits with an
insurance company. The cost of doing this is likely to be very
significant. Often trustees will seek something from the plan
employers (for example, a lump sum contribution to the plan or a
guarantee in favour of the trustees) in return for giving their
consent.
In Spain and Belgium, the employer will be required to guarantee
the level of benefits accrued under the plan and will need to cover
any shortfall in the plan funds in order to meet this obligation.
In Italy, the members' accrued benefits will need to be
transferred to an insurance company, and there will be an
administrative cost to the employer in purchasing the necessary
insurance policy.
Conclusion
Closure of a defined benefit pension plan is an attractive option for many employers in the present climate, given the ever-growing costs of providing pension benefits. However, the need for consents and consultation, as well as the costs occasioned by such a change, mean that any proposed closure requires careful planning.
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.