Pensions World Article - Remember the Members

This article was first published in Pensions World, 1st July issue.

Summary:

• There has been an increase in litigation involving the correction of pension scheme documents.
• Trustees may often choose to remain neutral in scheme-wide litigation.
• The Courts have developed ways of protecting scheme members during the litigation through the use of representatives.
• Normally members’ representatives will not have to pay any costs in litigation as long as they follow their legal advice.
• Members will often be given a period of notice before a judgment becomes binding.

Article:

Background

Many lawyers are seeing an increase in litigation relating to pension schemes.  One area of particular growth is litigation to correct drafting errors in the Deeds or Rules.

Obviously, such drafting errors can give rise to litigation against the organisation who drafted the document but that is not the focus of this article, which looks at the way in which members are protected during the litigation process.  For simplicity we will call all cases in this category “rectification” cases, although other legal principles, such as the law of mistake, may be relevant.

Representative Beneficiaries

A rectification case is normally brought by the employer when the error gave more generous benefits than intended.  If the error gave less generous benefits, it can be solved simply by a retrospective amendment.  But amendments cannot reduce members’ accrued benefits and so court action is required where the error gave more generous benefits.

The result of rectification litigation will be (if it is successful on the part of the employer), to correct the scheme documents, thereby reducing members’ benefits. This may affect some or all of the members and where it affects some they are normally in a discreet category of member - for instance all members who joined before the date of a correcting deed for future service.

But for individuals (eg the scheme members) to be bound by a Court judgment the normal process is for each individual to be a party to the litigation. Clearly in the pension scheme context this is entirely impractical and, where it involves a current workforce, extremely disruptive to the employer’s business. The Courts have a process where they allow a class of individuals who would be affected by the results of litigation to be represented by a single person representative of their interests. As pension scheme members and their spouses and other dependents are known in trust law as “Beneficiaries”, pension lawyers will normally call the representative the “Representative Beneficiary” or, for those in the know, “RepBen”.

A few years ago, the practice was, in complex cases, to find a representative in each category who would be affected by each drafting error in dispute, even though they may each end up using similar arguments against rectification being granted. More recently, practitioners have developed a very useful practice where representatives represent several categories who will be using similar legal arguments. It is common to see, these days, a representative representing “all members who would be adversely affected if the Deed was corrected”.

Often, the employer will be instrumental in finding members prepared to act as representative beneficiaries. It would not normally be appropriate to have anyone who had been a trustee at any point since the document in question was executed, nor anyone who is or has been a director of a sponsoring employer.

Sometimes no members step forward for this role. Although it is rare, there are some cases where the lawyers involved in the litigation may themselves become the representative of the beneficiaries who may be affected by the litigation.

Costs Agreement

Litigation is expensive.  One of the most important protections to get right at the very beginning is protection for the representative beneficiaries from paying for other peoples’ legal costs. The normal position in litigation is that where one party loses a case they have to pay the costs of the successful party. Clearly this is inappropriate for pension scheme litigation where the representative beneficiary has only a limited personal involvement. The sums involved in correcting drafting errors in terms of their effect on the schemes liabilities are often many millions of pounds meaning that it is in the employer’s interest to give a binding agreement that it will pay the legal costs of the representative beneficiary.

It would be normal in such an agreement to provide some restriction on the employer’s commitment. It is usual for the commitment to be restricted to circumstances in which the representative beneficiary is acting reasonably on legal advice. In return it is important to provide that the RepBen’s lawyers are not unduly restricted by the employer in performing all the work which they think they need to perform in order to represent the beneficiaries appropriately. Any audit of the representative beneficiary’s lawyer’s fees needs to be carefully managed so that the confidentiality of their work is not compromised. 

There can be challenges in ensuring that employers understand that litigation to rectify scheme documents involves paying substantial legal bills over which they have very limited control. As with any litigation, the time to do this is before the whole process starts.

Settling Cases

Normally in litigation each party has a commercial interest in balancing the costs of the case against the risk of not winning. But for representative beneficiaries their role is to test the case on behalf of all the members in the class which they represent. Can they settle a case if they think that the majority of the members would support them? Or should they only settle if they think that every single member in their group would support them? Or should they simply use their own judgement as to any offer of settlement? Or are they required to see the case through so that a Judge issues a judgment regardless of what they consider the merits?

A number of these difficult questions have been answered in recent years by practices developed by lawyers and approved by the Court. First of all, the representative beneficiary is not an elected representative who has to consult all the members in the class to make decisions. The representative is entitled to make decisions based on the information available, which includes the legal advice which will not be available to the other members, or only in outline. The representative is entitled to make his or her judgement as to whether a settlement is appropriate.

Separately the Court will normally approve a process to give all members in the class the opportunity to object to a proposed settlement. Usually a 28 day period is given for this and a draft letter is often presented to the Court for approval setting out an explanation of the settlement offered. The members are not asked to vote on the settlement but are told they will be bound by the Court judgment (which will endorse the settlement) unless they object within the period. A process such as this was endorsed by the Court of Appeal in Smithson v Hamilton (No 2) in 2008. 

Where the settlement is supported by the advice of the representative beneficiary’s lawyers, any new member who steps forward on the grounds that he or she objects will probably end up taking the risk of all the costs of the case going forward. This member will not be covered by the representative beneficiaries’ costs agreement. The representative beneficiary would also be unlikely to be covered if he or she decided to continue proceeds as costs agreements tend to cover only behaviour which was reasonable in accordance with the legal advice received: it would not be reasonable to proceed with a case when the representative beneficiary’s lawyers have recommended settlement.

The Role of Trustees

It is often said that trustees are under a legal duty to operate the trusts in the best interests of the beneficiaries. Where a rectification case centres on a change to the rules that will reduce members’ benefits producing a cost saving for the employer, it would appear that acting in the best interests of the members would involve objecting to the employer’s case and actively taking part in the litigation.

Often, however, that is not how representative beneficiary litigation is conducted. In most litigation the trustees choose to take a neutral stance (although they must be involved in the proceedings as they would be bound by any judgment) because above the duty to act in the best interests of the beneficiaries, the trustees have a legal obligation to follow the terms of the trust documentation. Following the terms of the documentation means following the terms which the Court rules at the end of the litigation should have been in the documents from the time when they were drafted. Therefore it is inappropriate for the trustees to argue one side of the case or the other because whichever side wins they will be under an obligation to operate the trust in accord with the judgment. It is far easier for them to do that if they have been impartial during the stage in which arguments are made.

Individual trustees may still have a role in giving evidence as witnesses, in particular where they have to explain what they thought was meant by a document when they signed it.

This neutral role also makes it easier for trustees to explain the litigation to members both in advance (when they may be asking for representative beneficiaries), during the litigation, during any objection period when members may be given the opportunity to object to a proposed settlement and subsequently in administering the trust in accordance with the judgment. 

Conclusion

Pensions litigation is special - the role of trustees and the way in which the cases affect hundreds or thousands of members who are not themselves parties to the case means that everybody involved in the litigation must act carefully. It is important to ensure that the network of protections which members have in the normal course of running a pension scheme are reflected in the processes adopted by lawyers, litigants and the Courts in representative beneficiary cases. It is good to see that the Court system contains enough flexibility to develop working processes which maintain this protection.

But pensions litigation does remain expensive for the parties, in particular employers. Maybe cases of obvious drafting mistakes with smaller financial implications should be dealt with by a new streamline procedure - perhaps managed by the Pensions Regulator or Pensions Ombudsman. Currently the only route remains taking a case to the High Court in London. Where additional liability created by the drafting mistake is less than £500,000, there is unlikely to be a clear benefit for the employer in taking the case to Court.