Bulletins | January 27, 2016

A novel approach to putting right problems with a scheme’s governing documentation – just a one-off, or the start of a trend?

Problems with pension scheme documentation are sadly all-too-common these days. The precise meaning of decade-old provisions is one perennial headache for schemes and their trustees; blatant drafting errors, that give members rights “over and above” what they can ever have anticipated, is another. And traditionally there has been very little that schemes can do if they discover there to be a problem, other than suing the advisers in question (unpleasant) or seeking court-approved “rectification” of the documents to give effect to their true intent (difficult beyond belief). Add to this the duty of trustees to give effect to what a trust instrument actually means (rather than what it was meant to mean), and their potential personal liability for breach of trust if they don’t, and things all appear rather one-sided.

In an unusual departure from normal methods of remedy and recourse, the High Court has approved an application for what might be termed “rectification by construction” – something which is, essentially, tantamount to giving documents their intended meaning (rather than the meaning which, on their face, they actually bear). Whilst unlikely to become a significant means of putting right the drafting errors of professionals who should have known (and could have done) better, the decision does give an interesting insight into how – in appropriate circumstances – the court will take a flexible approach to construing documentation in line with its perceived intent not its actual meaning.

Background: escalation of pensions in payment

Schemes are required by statute to increase pensions in payment by “5% limited price indexation”, or 5% LPI, where those benefits were earned by service between April 1997 and April 2005.  What this means in practice is that, each year, a pension in payment must increase by the lesser of (i) 5% and (ii) the increase during the previous 12 months of the relevant index (normally the Retail Price Index but in some cases the Consumer Prices Index).  Benefits earned by service from April 2005 onwards are required to be increased by 2½% LPI: in other words, the increase in the relevant index up to the lower 2½% cap.

Prior to 1997 there was no statutory requirement to escalate pensions in payment, although many schemes did.  The BCA Pension Plan was one such scheme.  Pensions earned by service prior to 1997 were required, under the scheme rules, to increase in payment at the fixed rate of 3% per annum.  This requirement was excised from the scheme’s rules once “5% LPI” was introduced in 1997, which in turn gave way to the lesser 2½% LPI requirement for service as from 2005.  Each of these provisions were correctly documented in amending deeds relating to the scheme over the course of its history.

“There but for the grace of God…”

However, when the scheme’s rules were consolidated a few years later, somebody slipped up.  The correct increase provisions were documented, but the temporal limitations to them – “3% fixed” for benefits earned prior to 1997, and LPI (of various sorts) for benefits earned thereafter – were left out of the scheme’s rules.  And so they read, on their face, as giving both fixed increases and LPI-based increases to the entirety of a member’s pension, regardless of when it was earned.  This clearly cannot have been intended.  (And in certain respects it makes little, if no, logical sense.)  But it was very clearly what the documentation said.  And there is a presumption, which is equally difficult to rebut, that a document agreed between two or more parties and drafted with professional input is to be taken as meaning, absent exceptional circumstances, what it actually says.

For whatever reason, it seems that it was decided to have been inappropriate (and/or insufficient) to seek recourse from the professional advisers involved, via a negligence claim, and/or to seek rectification of the documents, which involves showing (via an exceedingly high burden of proof) that the documents do not give true effect to the objectively-demonstrable intent of the parties who signed up to them.  Nor could the documentation simply be amended, as this would have resulted in members being deprived of their accrued rights, something which runs strictly counter to the principles espoused by section 67 Pensions Act 1995.  And so the BCA Pension Plan was faced with a significant increase in its liabilities, that it had no alternative but to honour.  Or rather it would have done, had an alternative and little-used route – involving section 48 of the Administration of Justice Act 1985 – not been followed instead.

Administration of Justice Act 1985, section 48

Section 48 provides that:

  • if there is uncertainty as to how a trust should be construed (interpreted);
  • if a barrister of at least ten years’ call has given a counsel’s opinion about its meaning; and
  • if it is satisfied that no dispute exists which would necessitate a fully-argued hearing;

then the High Court may, if asked to do so, make an order authorising the trustees to proceed on the basis of the barrister’s opinion, without having to hear argument from those with different interests.

Notwithstanding its apparent simplicity, there have been very few reported cases on the use of section 48 in the pensions context.  BCA therefore provides an illuminating insight into how the Court will approach any such application.

The Court spent quite a bit of time comparing and contrasting two seemingly-irreconcilable principles that apply to the construction of formal documents: the first, that they must be given what a reasonable reader with all relevant background information would consider to be their natural meaning; and the second, that obvious and easily-correctable mistakes will (even though this requires inferring the intention of the draftsman) be corrected.  But the latter should never be seen as some kind of “open sesame” for re-constructing the bargain struck by two independent, intelligent parties; and in particular, a Court will never read into a document whole clauses omitted in error, where the document makes perfect sense without them.

It then moved onto section 48 of the AJA, and the formal Opinion given by one eminent pensions QC that there was no doubt in his mind that the scheme’s trust deed meant – on its proper construction – that 3% fixed increases should be applied only to pre-97 benefits, and that limited price indexation (with either a 5% or 2.5% ceiling) should similarly be given only to benefits earned from 1997 onwards.

An integral part of the Judge’s reasoning (and of the QC with whom he agreed) was the clear intent, and effect, of a long history of previous documentation relating to the scheme, which made it clear beyond doubt that this was what had always been intended.  Also noteworthy was the fact that member literature had always explained matters on this basis, the scheme had always been administered on this basis, and the total absence of member complaints seemed to illustrate how their expectations had always been that benefits be provided on this basis.  The Court therefore authorised the trustees, in its written judgment, to proceed on the basis that this was the proper construction of the scheme’s governing documents.

The protection that section 48 provides; and what it doesn’t

There seems no doubt that in appropriate circumstances an order under section 48 will provide the parties with a quick, easy and (in relative terms) cheap means of resolving the interpretation of a trust instrument (i.e. pension scheme deed or rules).  However, there are also shortcomings, and for this reason it appears to us that – whilst groundbreaking on the one hand – an approach such as this might not become as de rigeur as some industry commentators have already suggested it might soon be.

The first is that an order under section 48 does not bind anybody who was not a party to it.  So, although it authorises the trustees to proceed on the basis of a particular interpretation of a scheme’s deed (meaning there is no risk of personal liability for breach of trust), it does not represent a judgment based on a fully-argued hearing that that is what the document actually means.  In some respects, therefore, it is no substitute for a full construction hearing (or, of course, rectification proceedings).  This is a subtle distinction, but a very important one: by not binding (the employer or) a scheme’s members, an order under section 48 leaves it open for any such party to bring a claim asserting a different interpretation of the provision in question.

Now that may well be unlikely, particularly given how the sponsoring employer is almost certain to be contending for the same interpretation as sought by the trustees; but, say as regards members, it is not beyond the bounds of theoretical possibility that they might assert a claim for a different interpretation.  Even in BCA this could be the case: personally, I think there are cogent arguments that for service between 1997 and 2005, members should as a starting point get 5% LPI escalation on their pensions in payment, but with this underpinned by a fixed 3% collar which would bite should inflation ever fall below such a level.  Hybrid provisions of this nature are not unheard of, and particularly if one ignores the post-2005 position this could certainly be said – from the face of the scheme’s trust deed – to be what is required.

But then again, I’m not a High Court judge (or even an eminent pensions QC), and nor do I have any desire – or the aptitude – to be.  So if we take it at face value that the decision in BCA is correct, how likely is it that such an approach will be adopted in similar cases in the future?

WB comment

We would suggest that as a starting point, when mistakes have come to light and the best way of putting them right is being formulated, section 48 will undoubtedly feature more heavily in those initial deliberations.

However, as for the instances in which this is the route actually pursued, we wonder how much favour it will find?  There does seem, in more recent years, to have been something of a move by the Courts away from using principles of construction as a means of correcting documents (be they pension scheme deeds or commercial contracts).  Section 48 will clearly have its uses, where there has been a blindingly obvious error; but the judiciary’s move back towards a preference for formal rectification will, it is suggested, mean that in most instances section 48 does not transpire to be the most appropriate way to proceed.  This is even more likely to be the case where insurers are involved: the certainty of a fully-argued hearing outweighing the cost savings occasioned by obtaining an ex-parte order under section 48 is also, we think, something that probably goes without saying.

But it will certainly be interesting to see how things develop; and from the perspective of common sense and commercial rationale, we would like nothing more than to be proven wrong!