Madeleine Frost looks at the options available to trustees if a mistake is found in scheme rules.
- If a mistake is found the first thing to establish is what has happened and what evidence exists
- Prevent the problem from being compounded further by capping off potential liability
- Producing a “time-capsule” containing evidence that has been collated by the company, trustee and their advisers is recommended
Unfortunately, it is not uncommon for mistakes to be made when drafting or amending pension scheme documentation and they can remain undiscovered for years. It is therefore important that when a mistake is discovered, trustees and employers know what action to take.
Collating and preserving evidence of the parties' true intention of what the trust deed and rules should say may be key to providing the intended benefits and avoiding escalating costs.
In this article we consider what to do if a mistake is discovered and suggest that producing a "time-capsule" of evidence is often a good idea whatever action the parties take next.
Has a mistake really been made?
A mistake is usually first discovered when someone has cause to look closely at a particular provision, either to clarify what benefits should be provided in a particular case or as part of wider scrutiny of the rules on a merger, buy-out or rule re-write or a member dispute.
In many cases the problematic wording was introduced many years ago and it may not be immediately clear whether it was introduced by mistake or was intended.
Therefore, the first step is to establish what happened and what evidence exists. If an application to the court is required, the case will stand or fall on the quality of the evidence (documents and witnesses) and it will be necessary to demonstrate what the intention was at the time both on the part of the employer and the trustees.
If it is concluded that there has been a clear mistake, then there are options to consider.
Contain the issue - a capping deed
An early priority will usually be to prevent the problem from being compounded any further by capping-off the potential liability. The trustees and the employer will want to consider whether it is appropriate to enter into a deed to amend the rules to reduce the benefits to the "correct" level for future service.
What benefits should the trustee pay while investigations are ongoing?
It is likely to be appropriate for the trustees to continue to operate the scheme as they currently do, despite this potentially being on a less generous basis than the incorrectly drafted rules provide. It would complicate matters and confuse members if more generous benefits were paid and there was a need at a later date to abate them. It is however important that investigations continue without delay.
If the trustees felt it necessary, particularly if investigations were not progressing as they would like, they could apply to court for directions over the issue or consider paying the more generous benefits in issue into a suspense account.
What to do next
1. Confer the more generous benefit
The simplest but potentially most expensive option may be to pay the higher benefit (i.e. pay the benefits prescribed in the rules (albeit incorrectly). The trustees and the employer will need to consider the funding strain of implementing the more generous benefit along with paying arrears from the relevant date (where required). The costs of this will have to be weighed by the employer against the substantial legal costs that may be involved in a court application to correct the rules along with the human resource and other commercial implications that arise.
This option may not be appropriate if it is very unclear what benefits would have to be provided or the scheme administrators do not have the necessary information to calculate the benefits on the basis described in the rules.
2. An application to court to rectify the rules
Rectification is an equitable remedy by which the court can amend the rules to correct a mistake common to the parties. The court will require convincing proof that the rules do not reflect the common intention of the parties. Only a court application will provide certainty that the rules can be rectified.
The evidential hurdle for rectification applications is a high one. The courts do not lightly infer that commercial parties and trustees with fiduciary duties signed up to documents that did not reflect their intentions.
The legal costs involved in a court application are substantial. The trustees, the employer and the representative beneficiary(ies) have their own separate legal teams and the fact-sensitivity and heavy reliance on witness evidence increases cost.
In clear cases, there is a practice emerging of the parties not opposing applications for summary judgment which dramatically shortens the process and saves cost.
3. Deed of "correction" - an alternative to rectification in a clear cut case?
Rather than make an application to court the trustees and employer may consider executing a deed to correct the mistake in a clear-cut case to avoid the costs of a court application. This is a controversial area and advisers are more cautious about this than they once were.
This is because the effectiveness of a deed of correction is not certain. It is clear that the parties cannot "rectify" scheme rules with retrospective effect in the strict sense - only a court can do so.
One issue is whether such a deed would be prohibited by section 67 of the Pensions Act 1995 which prevents modifications which adversely affect an entitlement or accrued right of members.
However, there is a reasonable argument that where a benefit has purportedly been conferred by a deed by mistake and the deed is liable to be rectified by the court, then the member cannot be deemed to have accrued a right to the benefit - it is always subject to being defeated by an application to court for rectification.
Therefore, there is a reasonable view that a deed can operate in a similar way i.e. it is not modifying rights and entitlements and only gives formal effect to the rights which would subsist under the scheme as rectified. However, the courts have not considered this particular question, so the position is not clear.
If a deed of correction were challenged, in practical terms, it would be necessary to obtain an order from the court to rectify the rules at that point to defeat the member's purported right under the incorrect document. The deed of correction will not therefore defeat a member's claim - only an order for rectification from the court can do that.
If the parties decided to proceed without an application to court, they should be confident that had the matter gone to court, there is a strong case that the error would be rectified by the court.
Investigations will help establish if an obvious mistake has been made and will assist the parties in deciding whether to make a court application or whether to rely on a deed of correction. Whatever the decision producing a "time-capsule" containing evidence that has been collated by the company, trustee and their advisers is recommended.
Even if the parties are not going to court at this stage, it is vital that evidence is preserved to support the opinion that rectification would have been granted by the court. If there is a challenge, the only way to establish that operating the scheme on the basis of the deed of correction is legally effective is to prove that the rules were rectifiable.
Gaps in the evidence could reduce the chance of success of rectification in the future because documents and witnesses are not available and the court could draw adverse inferences from that. A time capsule will reduce the chance of this happening.
In order to produce a time capsule it is necessary to conduct reasonable searches for documents. This will mean identifying and documenting the search process including relevant sources of information including any limitations on the searches. Sources of information will likely include personnel on the trustee and company side, the scheme actuary, lawyers and administrators. Individuals identified as potential ‘sources' should complete a short "Disclosure Statement" confirming the searches they have made.
The documents that should be included in the time capsule will of course depend on the circumstances surrounding the mistake, but will usually include witness statements from people involved in agreeing and drafting changes to the rules, drafts of the rules, drafting notes and comments, minutes of meetings discussing or approving the rules, instruction letters documenting the scope of the amendments, communications to members about the benefits to be provided and any relevant actuarial valuation or trustee report and accounts. Finally the time-capsule should include legal advice about the search and collation process.
There is no one size fits all approach. Whether to go the ‘deed' or ‘court' route will depend on the factors such as the nature of the error, the size of the liabilities in issue and the attitude of the trustees and employers to the risks of future challenge and need for certainty.
Madeleine Frost is managing associate at Linklaters
Tim Shepherd and Beth Brown look at the legal implications of working from home and how pension professionals can mitigate the risks.
The Pensions Regulator (TPR) has substantially increased the usage of its powers against trustees – posting a sharp rise in the use of formal information gathering powers and High Court production orders during the three months to the end of September....
The Pension Schemes Bill has completed its third reading, crossing its latest hurdle in the House of Commons.
An amendment to the Pensions Schemes Bill which would have seen people given a pre-booked Pension Wise appointment ahead of accessing their retirement savings has been defeated.
A proposal to ensure savers receive a Pension Wise appointment prior to accessing their retirement pot has received cross-party support in parliament, while Labour seeks net-zero pensions by 2050.