Court of Appeal upholds that amendment power proviso protects future service benefits

In this insight, we consider the dismissal of an employer’s appeal against the High Court’s decision that an amendment power proviso covering active members’ interests protects both past and future service rights and benefits.

Summary

In a judgment handed down on 9 July 2024, the Court of Appeal (Lewison J providing the only judgment) has dismissed an employer’s appeal, upholding the High Court’s finding that a proviso in the amendment power of a defined benefit (DB) pension scheme relating to active members’ ‘interests’ protects both past and future service benefits.

This means that the ability of the employer to make amendments which will ‘substantially prejudice’ future benefit accrual is significantly curtailed, including changing the basis of ongoing accrual and closure of the scheme to future accrual.

Although the amendment power in this case was particularly restrictive, schemes with similarly worded amendment powers will wish to consider the impact of the decision on both past and future amendments.

The Court of Appeal’s consideration of the interpretation of deeds and rules is also of interest confirming previous court decisions that the focus should be on a textual analysis of deeds and rules when construing the meaning of provisions with less weight on the ‘background factual matrix’ that might be appropriate in a commercial contracts position. It also ruled that a ‘reasonable and practical’ construction of amendment powers to give effect to the ‘exigencies of commercial life’ does not necessarily require an interpretation that will allow an employer to address increased scheme funding costs.

Our case summary of the High Court case can be found here.

Background

The case was brought by the scheme’s principal employer as part of a pension review looking at ways it might be able to limit the future funding costs of the scheme including removing or restricting future service benefits.

The courts were asked to determine the scope of one of the five provisos (the Proviso) to the scheme’s amendment power (exercisable by the trustee with employer consent) as the interpretation of this fetter will determine what flexibility the employer might have in making changes to future service and reduce its costs.

The Proviso

The Proviso provides that an alteration or modification that affects active members’ interests cannot take effect unless, broadly, it does not substantially prejudice those interests, the scheme actuary certifies that substantially equivalent benefits are provided, or the amendment is approved by the active members in a meeting.

Both parties agreed that the Proviso included those rights relating to past service (albeit the employer asserted that the Proviso did not protect any link to future final salary). The employer in contrast to the representative beneficiary (who represented the interests of the active members with the trustee being largely neutral) contended that this is where the protection ended and that the Proviso did not cover future service matters such as changing the accrual rate, increasing member contributions, or closing the scheme to future accrual.

Court of Appeal analysis of interpretation principles

The Court of Appeal confirmed the applicable interpretation principles relating to pension scheme documents from previous court cases – the focus should be on a textual analysis of deeds and rules when construing the meaning of provisions with less weight on the ‘background factual matrix’ that might be appropriate in a commercial contracts position. It highlighted the importance of finding the ‘natural and ordinary meaning’ of the phrase under consideration, viewed in its context – in this case, “whether a proposed amendment affects the interests of the relevant Active Members (or sub-group of Active Members) as a class”.

(The Court rejected the employer’s assertion that ‘interests’ required some form of actuarial valuation and related to active members on an individual basis – such a position was ‘very difficult to accept’ because to do so would place ‘onerous’ duties on the actuary. Furthermore, this fitted with the Proviso which permitted amendments that had active members’ approval which they provided as a class.)

The Court of Appeal agreed with the High Court that, although the meaning of interests will be the same (referring to matters of relevant concern) in different circumstances, it does not need to have the same ‘content’ on every occasion – the content can change depending upon the context and parties affected and the character of the relevant amendment.

Employer’s assertions on interpretation rejected

Exigencies of commercial life

The employer’s position was that applying a ‘reasonable and practical’ construction of an amendment power provision to avoid undue fettering and to allow for the “exigencies of commercial life” supported its interpretation of the Proviso as extending to past service only – applying an interpretation that would prevent the employer from acting commercially to address increased funding costs and discrepancy in pension provision between those employees with DB and those without amounted to undue fettering of the amendment power. The Court of Appeal rejected this, noting that this was not an autonomous or overriding interpretation principle and interpreting an amendment power required even-handedness between the parties.

Use of interests in other parts of the deed and rules

The employer also relied on how the word ‘interests’ was used in other rules such as the winding up rule and in other amendment power provisos and said that meant that interests in the Proviso was restricted to benefits already accrued. The Court of Appeal agreed that interests had the meaning contended for by the employer in the other instances in which it was used but this was because of context and the relevant factual situation. It did not mean that interests in the Proviso was restricted to past service.

Court of Appeal decision – Proviso extends to both past and future benefits

The Court of Appeal agreed with the High Court that, if a proposed amendment meant that the position of active members following the change would be different, then their interests would be ‘affected’, and the Proviso protection would be triggered. The Proviso then prevented an amendment being made if the interests concerned would be ‘substantially prejudiced’ or ‘substantially worse’ unless “the difference is made up in some way the Actuary deems appropriate” or the change is approved by the active members (as a class).

The word ‘interests’ was a “deliberately simple, broad and open-textured word” which was not: (1) restricted in the same way that fetters in other amendment powers previously considered by the courts were, such fetters referring to ‘rights’ or rights that have ‘accrued’ or been ‘secured’; (2) limited by references to past contributions or contributions already made; or (3) restricted by a cut-off date.

Indeed, the Court said that one of the ‘most valuable’ interests of an active member under the scheme was being able to continue benefit accrual on specific terms as pensionable service built up, even if there was no legal right under the scheme for their employment to continue.

In conclusion, the word ‘interests’ in the Proviso referred to past rights (including a final salary link subject to the Court of Appeal’s previous decision in a 2017 case concerning the employer that the employer could determine what part (if any) of pay rises would count as basic salary and thereby be pensionable) and the ability to accrue future benefits (both on the same terms as before any amendment and at all).

Concluding remarks

This landmark decision is a significant one for the employer given its ramifications for future DB pension provision and could have implications for those schemes with similar or the same amendment power wording. It also provides up to date Court of Appeal consideration of the applicable principles of interpretation for pension scheme documentation.