Pensions and the duty of good faith – a regular visitor to court

Jason Shaw

February saw the IBM pension scheme returning to the High Court for the third time in a little over a year. The first IBM case concerned the rectification of the scheme’s rules to give active members a right to retire from age 60. The second case concerned the question of good faith and whether IBM would have breached its implied duty of good faith if it refused to amend the scheme to allow deferred members to also take their benefits at age 60. The latest instalment also concerns the issue of duty of good faith but in a different context. So what exactly is the implied duty of good faith and why is it such a popular argument in pensions disputes?

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.

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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