There’s been a bit of press recently about schemes with members both north and south of Gretna Green and whether they would become cross border (and therefore be required to be fully funded within 12 months). But what about that increasingly common funding vehicle for schemes, the Scottish Limited Partnership? They are used as mechanisms for pension schemes to hold sponsor assets (commonly property but increasingly more exotic assets such as brands, receivables and even whisky) which deliver secured income flows to schemes with favourable treatment for both tax and scheme funding.

What would happen if the partnership was no longer in the UK? Would it still work? Reassuringly the answer is “yes” but just not as well as it did.

It is worth going back to explain why Scottish Limited Partnerships are used in the first place. The starting point is the restrictions in the Pensions Act 1995 on employer-related investments (ERI) i.e. investments in the sponsor’s business. These are hangovers from Robert Maxwell and his light-fingered way with the pension scheme assets but the principle is clear enough. A pension scheme cannot invest (or at least only to a very limited extent) in the “securities” of its sponsor – or in certain other employer assets (including commercial property used by the sponsor). A scheme could not, for example, own the corporate HQ of its sponsor directly.

Financial services regulations define securities to include shares in a “company”. Company for this purpose means any (a) body corporate (wherever incorporated) and (b) any unincorporated body outside the UK.

A Scottish Limited Partnership rather oddly is an unincorporated body but is (for now) in the UK and therefore isn’t caught. Holding the partnership interest doesn’t therefore cause an issue for a pension scheme under ERI.

By contrast the English equivalents are either body corporates (such as a Limited Liability Partnership) and would be caught by (a) or don’t work for other reasons (such as English Partnerships where the liability of the individual partners is unlimited).

But if the Scots strike off on their own and leave the UK, then the SLP would fall back into the definition of a Company and potentially become subject to the ERI restrictions. However that doesn’t mean everything is lost. There is another reason why SLPs aren’t caught by the restrictions on employer investment. That’s because there is a very good argument that the partnership interest itself is not a “security” at all. In effect there is therefore a fall back line of defence and it still would not fall foul of ERI (there would be just one less reason for that conclusion).

That said, the fall back position would apply equally to an analysis of an English Limited Liability Partnership as a vehicle. So going forward there would be no reason to favour the Scottish flavour of partnership any longer for the extra certainty on ERI. I would therefore expect the current fashionability of SLPs to fade away.

Unless of course board meetings in Edinburgh timed to coincide with the Festival was the key attraction in the first place!

Neil Bowden is a partner at Allen & Overy LLP.

Take the example of X Ltd, which decides to postpone auto-enrolment for new joiners by two months and contractually enrol them on the first day of the month after joining, before auto-enrolment applies. Ideally, X Ltd wants to avoid a scenario where employees might give an opt-in notice requiring them to be auto-enrolled in the interim period. X Ltd has up to one month after an eligible employee’s starting date to give the postponement notice, so it decides to delay giving the postponement notice until the day it contractually enrols the employee.

However, in order to validly postpone the employee’s auto-enrolment date, the notice must contain specific information set out in the regulations. This creates a confusing situation for members where they are being told simultaneously that:

1.         their auto-enrolment date has been postponed, that if they meet the eligibility conditions they will be automatically enrolled into a pension scheme on that later date, and that they have the right to opt in before that date; and

2.         they are being enrolled (contractually) into a qualifying pension scheme with effect from an earlier date.

Once the postponed auto-enrolment date comes around a month later, X Ltd has to write to the employee again, to confirm that they are an existing member of a qualifying pension scheme for auto-enrolment purposes (potentially creating further confusion about the start date of membership).

Clearly, it’s all about presentation, and it’s not impossible to get all these messages across in a way employees can understand. It’s just one example of how detailed your preparation for implementing the auto-enrolment regime needs to be.

 Stephen Richards is an associate at Allen & Overy LLP.

Clearly, schemes which are used for contractual enrolment need to meet the quality standards for auto-enrolment: if a worker isn’t a member of a qualifying scheme on their auto-enrolment date, you’ll have to auto-enrol them into a qualifying scheme anyway. If the end result is the same, then why does it matter?

- Contractual enrolment just means enrolment under the terms of the employment contract – you must have worker consent to making deductions from their wages. If you’re enrolling workers under the auto-enrolment regime, express consent is less important because the legislation covers you.

- If a member leaves a scheme after being contractually enrolled, then you need to know whether he or she was at any point eligible for auto-enrolment (broadly, aged over 22 and earning more than GBP9,440) during the period of membership. If so, then you don’t need to reassess the worker until re-enrolment rolls around – but if not (for example, if the member left the scheme before their 22nd birthday), then you will have to auto-enrol that worker under the regime when they first become eligible (for example, on the day the worker turns 22), even if that is very shortly after he or she left the scheme.

- You will provide different information to workers who have been contractually enrolled, as they will already be members of a qualifying scheme on their auto-enrolment date: for example, you need to confirm that they are an active member of a qualifying scheme and tell them that if their membership ceases (other than through their own actions), you will be required to auto-enrol them into a qualifying scheme with effect from the following day.

- If the scheme rules provide an opt-out period for contractually enrolled members, this may well be different to the opt-out window under the auto-enrolment regime – you might have two members enrolled on the same day but with different deadlines for opting out. The trustees will need to be clear which members are contractually enrolled, and which are auto-enrolled, in order to get this right as well as to comply with their record-keeping duties. You also need to find a way of explaining to members what their opt-out rights are – that will need careful planning.

One final tricky point that may not have occurred to you: many employers will think of the prohibition on inducing members to opt out in terms of the auto-enrolment regime, not in terms of contractual enrolment more generally. In fact, it could apply to both, because of the second bullet point mentioned above. If, for example, you contractually enrol a worker who is eligible for auto-enrolment, and you incentivise them to opt out of membership under the scheme rules, you may not have to enrol them again for up to three years (unless they exercise their right to opt in). That could put you in breach of the ban on inducements to opt out. This combination of circumstances may seem a remote possibility, but it’s one which is mentioned by the Pensions Regulator in its note on the differences between the two enrolment methods: click here to read more.

Watch this space for Stephen Richard’s post on some of the practical communications issues for employers using contractual enrolment.

 Helen Powell is a senior professional support lawyer at Allen & Overy LLP.

If either of these changes are currently in the pipeline for your scheme, take a look at what you can do to ensure that your scheme retains a statutory employer.

A statutory employer is not the same thing as having a company sponsoring the pension scheme. You may remember that Däna Burstow looked at identifying your scheme’s statutory employers before (Do you know who your statutory employers are?). A scheme’s statutory employer is important for a number of reasons. A key one is that only the insolvency of a statutory employer will trigger admission to the PPF. If a scheme does not have a statutory employer at the time it loses employer support, members won’t qualify for PPF compensation. The scheme will be left with nothing more than a refund of scheme levies…as the PPF would say, rules are rules.

Over time employers may change and the businesses sponsoring the scheme will not necessarily satisfy the statutory definition. This is because a statutory employer is someone who has either employed active members of the scheme or people who were eligible to become active members. In certain situations this can cause problems because employers taking over responsibility for a scheme, for example, a scheme closed to future accrual, will not have employed any active members of the scheme and so are unlikely to meet the statutory definition. Trustees should therefore monitor any proposed changes to the scheme’s employers closely, particularly if one of the following changes is being considered:

- an employer substitution in a single employer scheme which is closed to future accrual. The G&H scheme is a stark reminder of this risk (Independent report 27 January 2011); and

- a bulk transfer of defined benefit liabilities to a group scheme in which no DB liabilities have accrued. This is because employers who have only ever employed scheme members earning defined contribution pots do not count as statutory employers.

If such an event is planned, the risk of being left without a statutory employer can be avoided, provided you take action before the change is made. One route is to arrange for the new employer to employ an active DB member of the scheme. You may need to amend the scheme rules to re-open the scheme temporarily to accrual. Accrual doesn’t need to continue for long, the fact it has happened is enough to give the scheme a new statutory employer and continued protection from the PPF.

For more information on identifying your statutory employers, please see the Pension Regulator’s statement of July 2011.

Emma Bichard is an associate at Allen & Overy LLP.

Do you remember the introduction of personal pension schemes in 1988 and the subsequent misselling saga when commission-driven salesman persuaded members of defined benefit pension schemes to transfer to a personal pension scheme?  This was followed by the SIB review and in many cases the payment of compensation.  Many employers were happy to allow their employees, but not necessarily those who had left the business, to be reinstated in the scheme, effectively offering an amnesty.

At first sight it looks straightforward to put the position right.  The personal pension provider will have paid compensation which was received by the pension scheme and the member re-credited with his past pensionable service. 

But was any more offered?  There might have been a temptation to recognise that the employee had been in a DC personal pension plan, which might still have looked attractive to a member, enhanced with compensation, compared with the reinstated added  years, so that some sort of underpin may have been offered as part of the amnesty.

I recently came across such a case where the additional promise took the form of a fixed pension at normal pension age as an alternative to the pension secured with the bought-back years.  When the issue came to light at first glance the numbers involved looked extraordinary.  The fixed pension guarantee relating to the bought-back service (only a quarter to a third of a working life) amounted to one and half times any annual pensionable salary that the member had ever earned.  The fixed pension alternative was around six times the pension calculated on an added years basis.  No, the member had not suffered drastic reductions in earnings and there had been no obvious error.  In fact the fixed pension had been calculated on the MFR* basis, consistently with transfers out at the time.  The member must have thought Christmas, or at least retirement, had come early.

In the old days of Inland Revenue approval no doubt Inland Revenue limits would have limited the maximum pension which could have been paid from the scheme.  But what do your rules say in the post-A Day period?  Possibly they would have continued Inland Revenue limits but, quite likely also, they would have permitted the full pension to be paid (and it could be well within the lifetime allowance).  Even if there were some facility to restrict the benefit arising from the guarantee there could well be difficulties.  What information had the member been given in the past?  Had transfer value quotations been given previously?  Has information been provided to a court for divorce or pension sharing purposes? 

Despite the Pension Regulator’s best intentions on data accuracy, information on administrative systems dating back many years may not be fully accurate or up to date.  If an amnesty case such as this crosses your desk it is well worth digging into the archaeology of the scheme records to see if there are any other unexpected or perhaps long-forgotten commitments to members – and finding out whether the actuary has been aware of them for valuation purposes.

* Minimum funding requirement: the statutory funding requirement in the 1990s

Mervyn Parry is a consultant at Allen & Overy LLP.

If you wanted to pick just one, starting from a blank piece of paper, your options would be:

-  RPI – the traditional retail prices index

-  RPIJ – new and improved RPI, which is calculated based on the same basket of goods as RPI but using a different formula

-  CPI – the consumer prices index, now used as the measure for statutory minimum revaluation and indexation of pensions in payment

-  CPIH – this is CPI with added OOH: it is calculated in a similar way to the consumer prices index but incorporates owner-occupiers’ housing costs.

The issue for schemes and their sponsors is, of course, that they are not starting from a blank piece of paper. The question of whether scheme rules and promises made to members allowed a move from RPI to CPI, in line with the Government’s changes to the statutory minimum requirements, has been a hot topic in the last two years. We’re currently seeing a steady trickle of Pensions Ombudsman decisions on complaints from disgruntled members of schemes which have moved to CPI uprating. It’s worth noting that all the complaints so far have been unsuccessful. It’s difficult for members to establish that they made decisions about pension saving in reliance on general statements in member booklets and letters (which may have been correct at the time) about pensions being increased in line with RPI.

The ONS may now have brought the issue back to life, with a surprise announcement that it has demoted RPI from having the status of a national statistic, though it will continue to publish it month by month. It has also published a report which includes its estimate that RPIJ would have been on average 0.4% lower than RPI over the last ten years (and more like 0.6-0.7% since 2010 due to earlier changes in the method of calculation).

For sponsors of schemes where a link to RPI for revaluation and indexation has been maintained, the question must therefore be whether a move to RPIJ would be a possibility. Some commentators have suggested this could reduce scheme liabilities by up to 10%. Depending on the wording of the scheme rules, will we now see schemes reconsidering – yet again – their choice of reference index, given the introduction of an amended (and improved) RPI measure?

One issue to bear in mind is that the Pensions Act 2011 provides that, in periods when CPI inflation is higher than RPI, schemes which uprate benefits by reference to RPI still meet minimum statutory requirements. It also says that, where RPI is not published for a month, uprating by reference to ‘any substituted index or figures’ published by the ONS would also meet the test. We’re not there yet: RPIJ is being assessed for national statistic status, and RPI will, the ONS says, still be published. However, if those elements change, many sponsors might find RPIJ an attractive prospect.

 *apologies for the earworm.

Helen Powell is a senior professional support lawyer at Allen & Overy LLP.

The duty of good faith has its origins in employment law and the duty of trust and confidence that an employer owes to its employees.  The good faith argument was, rather creatively, first advanced and recognised in the pensions context in the case of Imperial Tobacco in 1991.  It is: “a duty that the employers will not, without reasonable and proper cause, conduct themselves in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee.”

The duty is not, however, a duty to act reasonably or fairly.  A breach of the duty of good faith requires more than unreasonable or unfair conduct on the part of the employer.  An employer would have acted in breach of its obligation of good faith if:

- it acted irrationally or perversely; and

- the irrational or perverse act was sufficiently serious to destroy or damage the relationship between employer and members.

As is immediately apparent, establishing a breach of the duty of good faith is far from easy.  One of the key difficulties is that an employer is entitled to take into account its own interests when exercising its discretion.  If an employer exercises a discretion with a view to reducing its costs or exposure to ever increasing pension liabilities, then it is difficult to argue that the employer’s desire to save money is perverse or irrational.  Obviously it is a little more complicated than that but, as Newey J noted in Prudential, the fact that employers can have regard to their own interest “must limit severely the circumstances in which a decision could be said to be irrational or perverse“.

Despite the steep uphill climb facing any party advancing a breach of duty of good faith argument, there seems to be no stopping the argument from being advanced in pension cases, not just the recent IBM cases.  The reason is probably quite simple – there are very few other ways of constraining or challenging an employer’s actions when it has the power to take those actions under the scheme’s governing documentation.  For this reason, whether the duty of good faith argument finds favour in the recent IBM case or not, I suspect this won’t be the last we hear of it.

Jason Shaw is a senior associate at Allen & Overy LLP.

So who bears the legal responsibility for sub-standard performance – the scheme member?  Trustees? The employer? The professionals such as the investment adviser or manager?

In deciding to offer a DC scheme – rather than DB – employers believe they are transferring the investment risk to their employees – who become individually responsible for their own ‘pots’.

There is no doubt that it’s the member who bears the risk where the scheme is set up on a contractual basis, barring perhaps serious misrepresentation or impropriety on the part of those handling the investment.  Contractual schemes involve a direct contract between the employee and the insurer – sometimes arranged by the employer, as would be the case with a group personal pension plan. 

With a trust based scheme the legal position is widely treated as being the same. It isn’t. With the increasing reliance of the UK workforce on DC arrangements and a gradual realisation that the amounts saved in them are not going to meet expected living standards in retirement, I think it’s only a matter of time before we see this being challenged.

Looking at it from a purely legal point of view, it’s the scheme’s trustees who are most exposed – though employers may end up having to meet the bill, for example where they have given the trustees an indemnity.

Both trust law and pension legislation (the Pensions Act 1995) make the trustees responsible for investments. So how do we get from that to the view that it’s members who bear the risk? The short answer is that members don’t bear the whole risk – and there’s even an argument that, if scheme practice and documentation are inadequate, they don’t bear any.

There’s no doubt that it’s the trustees who are responsible for choosing the investment funds which are offered to members – and for monitoring their performance and removing a fund if expected future performance is sub-standard. An issue I had to advise on recently is the extent to which, as part of the trustees’ duty to monitor performance, they need to keep the members informed on developments which could materially affect a fund’s performance. The fund in question was overweight in a particular category of investments which the investment advisers said was a bad place to be at the time.

Typically trustees don’t pass this sort of information on to members but sit on it pending discussion at the next quarterly trustee meeting on whether to drop a fund. The problem is that the trustee decision-making process is usually slow relative to the speed at which investment outlooks change. With today’s technology, it should be easy for trustees to communicate information they have received warning them of a material development in a fund. If they don’t do that and a member, unaware of the risk, suffers a loss by continuing to invest in the fund, it isn’t hard to see how a claim could be made for breach of trust and/or statutory duty.

If members are to bear the investment risk they need to have up-to-date investment information. In the past there would have been some defence that it was impracticable to expect trustees to issue a member communication every time they received this sort of information. But today, with pension scheme websites and intranets being the norm, this sort of excuse would seem weak.

Apart from feeding investment information, is there any other way in which schemes can pass risk to members? The starting point is the investment ‘duty of care’ in the legislation – section 33 of the Pensions Act 1995. This invalidates any attempt to exclude or restrict the duty to ‘take care or exercise skill in the performance of any investment function, where the function is exercisable’ by the trustees or their delegates. The point is that, if the scheme’s investment function is positioned with the member rather than the trustees, then the trustees should be able to avoid liability. The argument is that, by giving the member the total freedom to choose between the funds offered by the trustees, this choice is removed from the trustees’ investment function. So, if a member chooses a fund which is inappropriate for his circumstances (perhaps a volatile equity fund close to retirement) then that is at his risk. Scheme documentation needs to be clear on this. The strength of a claim could turn on the precise documentation used.

But, however strong the words used, there remains the underlying duty on the trustees to select the funds to be offered and monitor them properly. The extent to which the duty includes keeping members up to date on key information is likely to come increasingly under the spotlight – a fertile ground for future complaints and litigation no doubt..

Jonathan Goodwin is a consultant at Allen & Overy LLP

Last year the High Court confirmed that enhanced early retirement rights under occupational pension schemes can transfer with the member on a TUPE transfer (Procter & Gamble v SCA).  In July, Mervyn Parry posted about some of the questions left unanswered by this case (Early retirement rights and TUPE – where next?).  These unanswered questions are now turning into real lurking obstacles which employers are finding difficult to navigate.  Here are a couple of examples we’ve seen recently.

Take an employee who TUPE-transferred from Employer A to Employer B ten years ago.  Employer A’s pension scheme entitled active members to an unreduced pension if they retire early – aged 50 or over – due to redundancy.  No such enhancement is available to deferred members.  Because the right does not relate to a benefit payable on old age, invalidity or death, it would seem (following Procter & Gamble) that the obligation to provide this benefit passes to Employer B under TUPE. 

Employer B is now considering redundancies but it needs to be wary of these enhanced early retirement rights.  To pay these enhanced benefits in a tax efficient way, Employer B wants to provide them through a registered pension scheme.  But this could be difficult because, according to the judge in Procter & Gamble, Hildyard J, only liability for pension payable before normal pension age actually transfers under TUPE.  However, the tax rules say that a scheme pension must not normally be reduced once it comes into payment.  So how can Employer B pay a pension from a registered pension scheme to cover those enhanced early retirement rights, which stops when the member hits normal pension age? 

The employee’s age may also be an issue.  Employer B’s pension scheme may not be able to pay benefits from age 50, because the normal minimum pension age increased from 50 to 55 in April 2010.  So Employer B would need to check whether the employee has a protected pension age of 50.  If he does not, could Employer B argue that the terms of the original deal with the employee have changed as a result in the change of tax laws, so the employee will need to wait until age 55 to take his benefits?  He may dispute this. 

Employer B may therefore consider paying these benefits directly to the former employee outside the registered pension scheme regime, or persuade the individual to wait until age 55.  If the latter, should there be an actuarial uplift on account of late payment? This could be an augmentation of the member’s benefits so you then need to consider the possible impact on the member’s annual allowance, and so on… 

Difficult questions also arise if the employee’s past service benefits have been left behind in Employer A’s scheme.  Here, Employer B will want to find out when the individual can require (or request) his benefits to be paid unreduced from Employer A’s scheme.  This is because Employer B may need to pay instalments of unreduced pension directly to the former employee until at least this time.  That raises another question: what if the member can ask Employer A for his unreduced pension at say age 60, but Employer A says no?  Must Employer B continue paying these instalments until the individual’s normal retirement date?  

These examples are merely the tip of an iceberg; an iceberg of pretty much unfathomable depth and complexity.  Procter & Gamble is now being appealed, but surely the Department for Work and Pensions now needs to take the helm, and steer these developments in TUPE laws onto a different, safer course?

Robert Tellwright is a senior associate at Allen & Overy LLP.

There are essentially two key stages for a lump sum death benefit: (1) decide who is in the frame in the first place and (2) work out who is most worthy.

Who do the pension scheme rules treat as a potential beneficiary? Take the Pensions Ombudsman determination in Ellaway and others. With no will or nomination form available, the trustees decided to pay the death benefits to Mr Ellaway’s fiancée. This was jumping the gun. They might have had good reasons for preferring her over his parents or siblings, but they should have checked first if she was eligible under the scheme rules, which required either financial dependency or for her to be his “common law wife” (i.e. living with him as if husband and wife). Only then should they have weighed up the merits. To do that, the trustees were told they should have got details of the fiancée’s actual financial position and her contribution to the joint household and found out how solid her relationship had been with the member, as well as checking the circumstances of the other potential beneficiaries.

How much information do you need to make your decision about who should be paid the lump sum death benefit? In Crossan, the trustees did a fair few checks, but were still found guilty of maladministration. They had asked potential beneficiaries to complete an “information on relatives” form, asked the member’s partner to answer a financial questionnaire, looked at her joint bank statement with the member and spoke with the member’s manager. However they were criticised for making their decision on limited information. For a 12 year relationship, the partner should’ve been able to produce more paperwork, e.g. joint tenancy documents, electoral roll papers. The trustees had also failed to look into inconsistencies about how long the partner had lived with the member. Given she wasn’t even the informant on the death certificate, warning bells should have rung.

These cases are not far fetched: they underline the need for trustees to fill in all the gaps they practicably can. This means asking the right questions (who are the potential beneficiaries? what were their relationships with the member? what are their current circumstances?). You need to build up a picture of the member’s life when he died and the lives of those who could be eligible to receive the death benefits. Double-check the answers, look into inconsistencies, pull together supporting documentation and record the factors you take into account. Every case has its own nuances and complexities. Do be sensitive: the people you are talking to have been bereaved; but that’s no excuse for making a decision based on insufficient information…

Check out the official guidance: the Pensions Ombudsman’s “How to avoid the Pensions Ombudsman” and the Pensions Regulator’s “Trustee Guidance“. You can also click here for details of another useful Ombudsman decision in the area, this time from the July 2012 edition of our “Pensions in Dispute” client newsletter.

Francesca Parnell is an associate at Allen & Overy LLP.