Pensions Update: Fancy Dancing - Caribbean Style

This month has seen reports of a £350m settlement being offered by the Government in the National Bus dispute. Only two months ago the Privy Council decided that the Jamaican Government could retain half of the $400 million surplus it had taken on the privatisation of Air Jamaica. The Department of Transport must be considering this with real envy. However, the decision is interesting not only on a political level. The Privy Council is still the final court of appeal for a number of former Commonwealth countries. Although Privy Council decisions are not directly binding on courts in the UK, the majority of its judges are drawn from the same panel that provides members of the House of Lords Judicial Committee. Its decision here gives an indication of how some of the most senior British judges consider the nature of pension schemes.

Air Jamaica is the national airline for Jamaica and was initially set up with the Jamaican Government owning a controlling interest. It operated a contributory final salary scheme providing benefits for members, their spouses and “designated beneficiaries”. Members paid contributions which the employer was obliged to match. The employer was also liable for any balance of costs. In the event, the matching contributions had always been sufficient to provide for benefits and no balance of costs payment had ever been made. Indeed, in 1994, a surplus existed of some $400 million.

After a period of heavy losses, Air Jamaica was privatised in 1994. All employees apart from the four trustees were made redundant in June (with offers of employment from the new owners on different terms). The stay of execution for the trustees was not long - they were made redundant in September 1994. In the intervening period, the employer, which had a unilateral power of amendment, made amendments to the Scheme.

Prior to these changes, the winding-up rule provided that any surplus remaining after securing promised benefits would be used to provide additional benefits. Clause 4 of the rules stated that no money paid by the employer could be repaid to it and there was a restriction on the power of amendment and discontinuance preventing its use to allow funds to be applied other than for benefits.

The changes in 1994 removed restrictions on the discontinuance power and the prohibition on returning funds to the employer and then replaced the existing rule on surplus on a winding-up with a rule providing that all such surplus should be paid to the employer. Although the employer was now in effect the privatised company, any such repayment would benefit the Jamaican Government by reducing its obligations under the privatisation agreement.

The same trust law principles apply in Jamaica as in the UK. One of these is a public policy principle preventing property being tied up in trusts forever - the “rule against perpetuities”. In brief, this prevents a trust being set up unless someone will become fully entitled to the assets within 21 years of the death of a person alive when it was set up. In the UK, this has been the subject of legislation exempting most occupational pension schemes (Pension Schemes Act 1993 section 163). No such legislation has been passed in Jamaica.

The Privy Council analysed the Air Jamaica pension scheme as a collection of individual trusts set up in relation to each member. Although this does not sit easily with the collective nature of a typical defined benefit pension fund, it did allow the basic benefits of the Scheme to be retained. For each sub-trust, the benefits would be settled either during the member’s lifetime, in the form of his pension, or on his death as a widow’s entitlement to a pension arises immediately even though the pension itself may last longer than 21 years. The only benefit provision which offended against the rule was a power for widows to nominate a designated beneficiary to receive a possible lump sum on her death.

However, the amendment power as drafted would have allowed the terms of a widow’s pension to be changed more than 21 years after the death of the member. The Privy Council decided it failed the rule against perpetuities and so could not be applied over benefits of existing members. As there would be no new members after June 1994 (when the main redundancies occurred), the 1994 amendments were completely ineffective.

Despite the decision that the power of amendment would fail in any event, the Privy Council made some more general comment on the employer’s purported amendments in 1994. It was felt that these changes would in any case have breached the employer’s duty of trust and confidence to employees. Such a fundamental change to the arrangements for the distribution of surplus under the winding-up rule “once it became likely that the Plan would be wound up” would not be allowed. Few in the UK would have advised that these types of changes could be made safely where a winding up had become a strong possibility, particularly after the Pensions Ombudsman’s decision in the National Bus case.

Unfortunately for the members, the Privy Council decided that the original rule giving the trustees the power to use surplus to augment members’ benefits was also invalid because of the rule against perpetuities. It was therefore faced with a question of how to deal with these assets - some $400 million. To resolve the problem, the Privy Council applied the doctrine of resulting trusts: where a person tries to provide money for a purpose and that purpose fails, a trust arises in favour of the original owner.

The Privy Council had to consider an earlier UK authority from 1973 - In Re ABC Television Limited Pension Scheme. There, wording similar to Clause 4 of the Air Jamaica rules (that no benefit should be given to the employer) had been taken to imply that a resulting trust could not arise, the company having waived any rights to the assets. The Privy Council did not accept this argument. If, as here, the trusts failed because of perpetuity problems, wording in the trust deed was not relevant. A person does not cease to own property until he succeeds in giving it away.

In Davies v Richards & Wallington, Mr Justice Scott had had to consider an argument that employees in a balance of cost scheme who are paid their promised benefits have received all they bargained for. On the facts of that case, he accepted the argument and so decided members had no right to any surplus which may exist. The Privy Council overruled this approach too, in a scheme where the winding-up rule provides for any surplus to be used for augmentations. This expectation is part of the bargain members strike in return for their contributions and the work they perform.

Undoubtedly, the fact that no balance of cost contributions had ever been required from the employer assisted the court in its decision. The contributions that members and the employer had paid in return for their standard benefits had achieved their purpose and would not be disturbed. The surplus consisted of contributions which had not been used to provide benefits and which, because of the failure of the rules on the use of surplus on a winding up, could not be used under the Scheme rules. The Privy Council decided that this surplus should be split in proportion to the contributions. This meant that half would be returned to the employer and half to members (in proportion to their contributions, rather than their benefits).

The Privy Council judgment may well be raised by either members or companies in negotiations over surplus. The background is however important. Because of the rule against perpetuities, the trust deed and rules did not operate in the most crucial areas dealing with surplus. The decision therefore concerns itself with what happens when a pension scheme fails, rather than how surplus should be dealt in the context of an existing trust. It would be almost unthinkable, under UK law, for a part of a pension scheme to fail in the same way as occurred with the Air Jamaica Scheme.

The decision provided half of the surplus to the employer and half to members. In the circumstances in which the Jamaican Government found itself in 1994, this must be seen, in the words of John Prescott, as fancy dancing indeed. It must however be remembered that the decision turned on the technicality of the rule against perpetuities. Had this not intervened, the decision would have reinstated the pre-1994 winding-up rule providing, on the terms of the Scheme, all of the surplus to members.

Mark Atkinson