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In a judgment[1] published on 21 October, the High Court has decided that the appropriate way to construe a pension increase clause in a scheme’s governing documents was the one which was most favourable to members.

The facts

The amendment power in the trust deed and rules which governed the FDR Limited Pension Scheme (the Scheme) contained a proviso which prevented amendments being made to the Scheme which would have a detrimental effect on benefits previously accrued.

In 1980, new rules were adopted which contained a pension increase provision. This provided that pensions would be increased by 3% compound on each anniversary of the pension coming into payment (the First Rule).

A deed was executed in June 1991 that included a provision which attempted to delete the First Rule and replace it as follows. On each anniversary of the date on which a pension was first paid, following 1 January 1991, the pension would be increased by the lesser of 5% and the increase in the Government’s Index of Retail Prices since the previous anniversary date (RPI) (the Second Rule).

From 1991 the Scheme had been administered on the basis that the Second Rule was valid, despite its retrospective effect.

The parties to the case had already agreed that even though the Second Rule purported to replace the First Rule, it could only take effect for future service, because of the proviso in the Scheme’s amendment power which prevented a reduction in members’ benefits already accrued. The Second Rule had the potential to provide lower increases than the First Rule, if RPI dropped below 3%. However the Second Rule could also have the effect of providing a higher pension increase than the First Rule if RPI rose above 3%. Therefore the position was not as simple as just applying the First Rule in respect of pensions accrued prior to June 1991 (the pre-1991 pensions).

The trustees (on behalf of the members) and the principal employer agreed that the effect of the First Rule, the Second Rule and the Scheme amendment power was to create an underpin in respect of the pre-1991 pensions of 3% pa compound. Where the parties did not agree was how the underpin should be applied. It should be noted that the Court was considering pensions in excess of GMP, as GMPs were dealt with separately in the Scheme’s rules.

Calculating the increase to pensions

Three options were put before the Court, although one was an alternative put forward by the trustees if the first option failed, so we will focus on the two initial positions. The trustees contended that the combination of the First Rule and the Second Rule (taking into account the proviso to the amendment power) should be construed so that the annual increase to the pre-1991 pensions should be the greater of the following: 3% or the figure which was the lower of RPI or 5%. Therefore the annual increase would fall between 3% and 5%.

The principal employer was of the view that two calculations should be made each year to calculate the increase: the amount of pension at retirement should be increased year on year by 3% pa compound and compared with the amount which would be payable, if the pension at retirement had been increased each year by applying an increase of the lesser of RPI and 5%, with the higher amount being payable. It argued that the two calculations should be separate, whereas the trustees’ calculation each year would be based on a current pension, the level of which would most likely have been increased by a combination of applying each of the First Rule and the Second Rule over the years, depending on which rule produced the greater increase. The principal employer’s “cumulative increase” approach would have meant a lower increase in overall Scheme liabilities and could have meant that over a period of time, the increases applied would have been lower than 3% each year.

Decision

The judge decided in favour of the trustees. She took a practical approach, considering that in 1991, when the Second Rule was drafted, actuarial systems were less sophisticated and it was unlikely to have been intended to adopt a more complicated, expensive system of calculation. She noted that the provision should be construed as it would have been understood by a reasonable person with all the background knowledge available to the parties in 1991. She said that it should be construed to give reasonable and practical effect to the Scheme, technicality should be avoided and it should be borne in mind that if the consequences of a construction are impractical or technical in practice, it is likely that the interpretation is not the right one.

Good news for trustees?

While the decision in this case is specific to the facts and the wording of the Scheme rules, the practical approach applied by the judge is to be welcomed. It will not always be the case that it is the trustees (and members) who benefit from such a practical approach, but the case helpfully clarifies the way in which trustees should be interpreting similar wording in their scheme documents, namely that they should be applying a sensible approach, avoiding an overly technical interpretation and considering the factual circumstances which existed at the time a rule was drafted.

This post was edited by Jill Walters. For more information, email blogs@gateleyplc.com.

[1] Carol Dutton, Annelyse Fournier, Ty Miller, Peter Motley and Keith Rowling v FDR Limited


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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.