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The opdu Report - Issue 20, June 2006 Mistakes in long and complicated defined benefit scheme documentation are sadly not uncommon. Errors often lie buried in the rules for years before being detected. The real problem arises where the erroneous drafting appears to confer more generous benefits than were intended and the scheme is being operated on the basis of less generous benefits in apparent breach of the express provisions of the rules. The employer and trustees have to consider what options are open to them. This may be against the backdrop of members being unaware of the issue or indeed pressing for the more generous benefits. Is it really a mistake? In many cases the problematic wording was introduced many years ago. It may not be clear what was intended without investigation. Whatever course is adopted, the starting place has to be to work out what happened and what evidence exists. If an application to the court is required, the case will stand or fall on the quality of the evidence (documents and witnesses) and it will be necessary to demon-strate what the intention was at the time both on the part of the employer and the trustees. The investigation will depend of course on the particular point at issue but it should be thorough. The relevant sources of documents (including e-mail) should be identified (who was involved, archives, third parties (actuaries, lawyers, administrators)) and a reasonable search of each source made. It is important to keep a record of what searches are undertaken and the reasons for any limitations on the search (for subsequent justification). If it is concluded that there has been a clear mistake, then the options can be considered. A capping deed An early priority will probably be to prevent the problem from being compounded any further by capping-off the potential liability. The trustees and the employer will want to consider whether it is appropriate to enter into a deed to amend the rules to reduce the benefits to the “correct” level for future service. As part of the investigations, the trustees and the employer will consider the funding strain of implementing the more generous benefit along with paying arrears from the relevant date (where required). The costs of this will have to be weighed by the employer against the quite substantial legal costs that may be involved in a court application to correct the rules along with the human resource and other commercial implications that arise. Construction arguments One option is to consider whether there is a reasonable argument that the rules - properly construed - in fact provide for the lower benefit. If so, a deed clarifying the position could be executed. The current approach of the courts is to construe the rules to give a reasonable and practical effect to the scheme and adopt a common-sense approach to the meaning of contractual language i.e. a commercial interpretation. The court also considers all the surrounding circumstances at the time the deed was executed. Armed with this purposive approach, courts have been prepared to conclude that if something must have gone wrong with the language such that it is going to lead to a conclusion that flouts business common sense, it must be made to yield to business common sense. There are limits to this. It is usually difficult to argue, as a matter of construction, that the conferment of the more generous benefit leads to a commercially absurd result and the courts will not (for public policy reasons) in this exercise look at drafts of the deed, the parties’ negotiations or subsequent conduct in construing the rules. In contrast, they will look at these matters on an application to correct the mistake - see below. Another basis for the application (which is typically brought in the alternative to a rectification claim) is that the decision of the trustees to execute the rules should be set aside on the basis of the rule in Hastings-Bass (named after the case in which this type of application was first granted). The court will be prepared to set aside the trustees’ decision under this doctrine if, in exercising their discretion, they failed to take into account all the necessary considerations relating to the decision and, had the trustees taken those matters into account, the decision would have been different. There has been recent case-law over whether a further condition needs to be satisfied; namely that the trustees must also have acted in breach of trust. The most recent view expressed is that this does not need to be satisfied. As a further alternative, it is also typical for the employer to make an application on the basis that it executed the rules under a mistake, and invoke the court’s power to relieve the parties to a written agreement or instrument of the consequences of mistake in the document. It is conventional for the employer to bring such proceedings. It has the incentive and desire to control them given that it will bear the additional cost under its balance of cost obligation if the application fails. In this situation, the trustees would be defendants to the claim together with one or more representative beneficiaries. The trustees’ role before the court should be one of helpful neutrality (i.e. they are interested to ensure that the appropriate evidence and arguments are put forward and that any order obtained is administratively workable). However, the job of the representative beneficiary is to represent the interests of the relevant class of members affected by this issue. They are therefore expected to oppose the application. The legal costs involved in these applications are substantial. The trustees, the employer and the representative beneficiary (ies) have their own separate legal teams and the fact-sensitivity and heavy reliance on witness evidence increases cost. The proceedings are likely to involve the cross-examination in open court of all key witnesses on the trustee and company side as well as relevant advisers. Rather than make an application, trustees may consider executing a deed with the employer to correct the mistake in a clear-cut case to avoid the costs of a court application which appears almost certain to succeed. This is a controversial area and advisers are more cautious about this than they once were. One issue is whether such a deed would be prohibited by section 67 of the Pensions Act 1995 which prevents modifications which adversely affect an entitlement or accrued right of members. A court ordered rectification does not, because the order takes effect back to when the error was made and nothing is therefore being modified. If the court would order rectification, there is a reasonable view that a deed can operate in a similar way i.e. it is not modifying rights and entitlements and only gives formal effect to the rights which would subsist under the scheme as rectified. Settlement with the beneficiaries Individual settlement is not practical. It may, however, be possible for a court application to correct the rules to be compromised in a way that is binding on the membership. This is achieved through the mechanism of a representation order made by the court that the representative beneficiary represents all those claiming through them. A settlement would have to be reached with the representative beneficiary and their lawyers. The application would be compromised and the settlement approved by the court. The judge would be provided with opinions on behalf of the parties explaining why the deal is an appropriate one for all affected members - effectively driven by the parties’ views of the overall legal merits. The membership would be notified in advance of the settlement terms in order to have an opportunity to dissent from the compromise (which is very rare in practice). The legal costs involved are clearly less than a full-blown application, but before any deal is struck the representative beneficiary will need to take advice from lawyers who have thoroughly investigated and advised. If no settlement is achieved, the case would proceed as a contested application. Under this doctrine, when parties have proceeded on the basis of a common assumption, neither of them will be allowed to go back on that assumption when it would be unfair to allow them to. In contrast to rectification, the Ombudsman has jurisdiction to deal with these arguments and the strength of an estoppel argument is helped by delay. Rather than a pro-active application to court to determine whether members are bound by an estoppel, these arguments are usually more effective when deployed as a fall-back if and when a member complains on the basis of what the particular member was told and has done. Claims against advisers Claims should be considered in parallel against those who drafted the erroneous rules. In particular, the relevant limitation periods for claims to be issued before the court should be checked and diarised (and a standstill agreement to extend time considered if required). Care should be taken in handling the advisor as their co-operation will usually be required in collecting evidence about the error. The loss that can be claimed may be confined to the costs of an application to court to correct the rules (if such an application is successful). If no rectification application is made, a likely defence to a claim against the adviser will be that such an application could have been made and the loss recoverable from the adviser should be limited accordingly. It is possible that the adviser (or more accurately their insurers) will agree to pay for the costs of the application if a sufficiently strong case can be advanced against the adviser. It is likely to be appropriate for the trustees to do so, provided that investigations are continuing without delay. It would also complicate matters if benefits were paid and there was a need at a later date to abate them. Mark Blyth |
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