12 Sep 2018

Is a closed defined benefit (DB) scheme with a final salary link "open" or "frozen" for section 75 debt purposes? The recent decision in G4S plc v G4S Trustees and another [2018] EWHC 1749 (Ch) brings greater clarity for sponsoring employers and trustees of closed DB schemes as to the circumstances in which a section 75 debt could become due. 

The High Court has ruled that where members in a DB pension scheme closed to future accrual retain a link to their final salary, the linkage does not amount to "pensionable service". The scheme is therefore "frozen" for the purposes of the employer debt requirements. This is significant because an employer with members in pensionable service may trigger a debt under section 75 of the Pensions Act 1995 on ceasing to employ such members. 

"Open" or "frozen" scheme? 

In an underfunded multi-employer DB pension scheme, one of the triggers for a section 75 debt becoming due from an employer to the trustees of the scheme is an "employment-cessation event" (ECE). An employer will suffer an ECE where it stops employing at least one person who is an "active member" of the scheme (or of the section in a segregated scheme) at a time when at least one other employer continues to do so. An active member is defined as a person in "pensionable service" under the scheme. In practice, an ECE can occur, for example, inadvertently when the last remaining active member in a scheme leaves employment, retires or dies or as a result of corporate reorganisations and restructuring activity. A "frozen" scheme, in contrast, is one which has ceased to have any active members. This means an ECE can no longer occur automatically. A former employer in a frozen scheme will of course still be ultimately liable for a section 75 debt if the scheme winds up or on insolvency.

When a scheme is closed to accrual of benefits for future service, there has been uncertainty as to whether members who retain a link between their past service benefits and their future final salary post-closure actually remain in "pensionable service". The G4S case considered this question. 

It is common for a final salary link to be introduced on scheme closure, either voluntarily or because there is what is known as a "Courage restriction" on the scheme amendment power. This is so-called after the leading case which decided that a fetter on an amendment power which prevents any reduction in a member's "secured" benefits includes the future entitlement to have pension based on the member's final salary. This is interpreted to mean that it prevents a scheme from being amended to break the final salary link on scheme closure.  

The High Court considered a similar question to that in the G4S case in the Merchant Navy Ratings Pension Fund (MNRPF) case in 2015. On closure of the fund to accrual, a certain category of members continued to enjoy entitlement to revaluation at an enhanced rate. The court decided that the enhanced revaluation did not mean they continued to be in "pensionable service" - the members were not active members and therefore the scheme was frozen. Crucially, that case did not comment directly on the impact of a final salary link. 

Facts

The G4S Scheme was a sectionalised scheme. The main benefit was a pension on retirement at normal retirement date of n/60 x final pensionable salary (FPS). The Scheme's amendment power contained a Courage restriction. In 2011, the Scheme was closed to future accrual in two sections and a new category of "Employed Deferred Member" was created. "Employed Deferred Members" were entitled to a deferred pension, revalued in line with statutory requirements. They also enjoyed a final salary link. This acted as an underpin so that if the final salary link was more valuable than revaluation, the final salary link would bite.

Decision

It was decided that the Scheme was frozen. The court found that the definition of pensionable service for employer debt purposes has two separate limbs: (i) whether the member is in service in a description or category of employment to which the scheme relates; and, (ii) whether that service qualifies the member for pension or other benefits under the scheme.

The court focussed on the second limb. It looked at the ordinary meaning of pensionable service and said that in relation to a final salary pension of the n/60 type, it means service under which pension continues to accrue and counts towards the 'n' in the formula - termed "year-on-year accrual". The Employed Deferred Members were not in pensionable service post-closure. Even though, because of the final salary link, the FPS part of the pension formula was subject to change, their service after the closure date did not qualify them for any further pension; it quantified the pension that they had already earned by their service before the closure date.

The judge concluded, in line with previous case law, that if a member remains in service post-closure, and enjoys continued final salary linkage, the extra pension received in line with any salary increases is not earned by his post-closure date service but "is inherent in the rights he earned by his pre-closure date accrual". 

Our comment

The judgment provides welcome comfort to sponsoring employers and trustees of closed DB schemes on what has been an long-standing area of doubt. G4S, like MNRPF, is however only a first instance decision meaning it would be open to a higher court to take a different view in future.  It is also arguably restricted to its facts - the judge acknowledged that pensionable service could not be equated with year-on-year accrual in all circumstances and that there are notable exceptions. For example, life assurance only members and defined contribution (DC) only members in a hybrid DC/DB scheme are deemed to be in "pensionable service" despite not accruing years of service. There may be other types of rights which members continue to enjoy post-closure, in conjunction with a final salary link or separately, which could still raise a doubt as to whether the member remains in pensionable service. 

Employers and trustees should continue to take advice on the specific circumstances of their schemes.