Pension schemes have been warned they may now face a more challenging legal test if they wish to fix drafting errors.
Where trustees discover that a document that they entered into does not reflect the intentions of the parties, they can apply to the courts for the contract to be rectified to reflect their intentions.
While not a pensions case, a recent Court of Appeal judgment, FSHC Group Holdings v GLAS Trust Corporation, has confirmed that the test applied to determine what the parties' original intentions were is a subjective one by reference to their actual beliefs. This is rather than based on how an objective observer would have understood the parties' intentions.
In doing so, the court has departed from the previous leading cases in this area that had held that the parties' common intention should be determined objectively.
In this case, two errors occurred. First, a document concerning security that should have been provided by FSHC was not executed. In attempting to fix this error, FSHC entered into two further deeds. The knock-on effect of the way that these agreements were drafted was that FSHC became liable to pay the secured obligations of its subsidiaries on demand, which was not what the parties had intended, as they had merely intended to plug a gap in security.
The court confirmed that, in order for rectification of a contract to be granted in cases such as this, two things needed to be proven. First, that the terms of the contract do not reflect the common intentions of the parties (which is to be established by reference to what they in fact believed); and second, it needs to be demonstrated that all parties understood each other to have that shared understanding by means of an outward expression of that common understanding.
Linklaters managing associate Geoff Egerton said that, where a mistake is discovered in agreements entered into by pensions trustees, evidence of the parties' intentions is key if they decide to apply for rectification.
He noted: "The quality of evidence is now even more important in these cases since intentions are now to be assessed by reference to the parties' subjective intentions and there needs to be an outward expression of the parties' common understanding of those intentions."
"In any rectification case, we advise trustees that, where they discover a mistake in drafting, they should take advice straight away and gather evidence of that mistake and its background quickly. That way they can capture the evidence in its fullest form."
He added: "Where that evidence just isn't there, or there isn't that much of it, such as when an agreement was made many years ago, it may now be more difficult to prove what the parties' intentions were under a subjective test.
"In the Court of Appeal's view, ‘rectification should be difficult to prove'. This potential raising of the evidential bar reflects that strict view taken by the court."
Egerton noted that the court drew a key distinction between the requirements for rectifying contracts and the test for rectifying pension scheme amendments. In this case, the Court of Appeal has now confirmed that in seeking to rectify an amendment there is no need to prove an outward expression of accord of the parties' intentions.
Egerton said the requirement for common intentions to be proven by reference to subjective intentions remains a significant evidential hurdle but not having to establish the other limb of an outward expression of mutual understanding makes rectification of scheme amendments slightly easier to obtain than in other contract cases.
"This is because an amendment power usually requires one party to exercise the power and the other party to consent to that exercise," he said. "This is distinguished from a contract where both parties must agree to the terms of the contract.
However, in contract cases, such as where there is a mistake in an agreement between trustees and a third party, trustees would need to meet the "full evidential hurdles" set out in the FSHC case.
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