LITIGATION HAS COME TO THE DEFINED CONTRIBUTION(DC)world in the form of a case that is currently pending before the divisional court in Ontario. The case is Nolan et al v. Superintendent of Financial Services and Kerry (Canada)Inc., in which surplus from a defined benefit(DB) plan was used to fund a new DC plan.

The case concerns a DB pension plan that was first established in 1954 by the Canadian Donut Company. Over decades, various amendments concerning administration expenses and contribution holidays were made to the plan documents. In 2000, the plan was converted into a DC arrangement.

DC plans have been promoted to employers as mechanisms that require fewer and simpler employer
contributions than DB plans. Unlike DB plans, DC plans do not generate funding deficiencies for the employer, and are less regulated.

On the other hand, DC plans provide no predictable level of retirement benefit to plan members, and displace all investment risk onto them. They enhance employee mobility and decrease employee loyalty through the deterioration of the employer pension commitment. Perceived jeopardy to retirement income security can thus attract negative employee attention, and can lead to litigation.

In the Kerry case, the introduction of a DC arrangement coincided with the existence of a surplus in the DB plan. The employer wished to apply the DB surplus to their contribution under the DC plan, eliminating all employer costs, funding risk and investment risk.

The employer did this by amending their DB plan to create a new “Part II” DC component. The DB plan was then governed by Part I of the plan, while the DC component was governed by Part II. The DB plan members were given the option of converting their DB entitlement into a DC account, and all new employees were automatically enrolled in the Part II DC plan.

Until the creation of Part II, the plan had been a DB plan, and its assets had been held by a trustee in accordance with traditional trust arrangements. On the DC side, however, the funding arrangements were different—but also typical. The company contracted with the Standard Life Assurance Company, which was the “funding agency” for the DC plan.

The litigious issue that arose when the Kerry Plan was converted from a DB plan to a plan with both DB and a DC components, stemmed from the different “funding” approaches to them and the different “funding agents” and funding mechanisms used.

The members of the DB plan were, by definition, not members of the DC plan. Indeed, there was no overlap between the memberships. Similarly, the assets in the DB plan were held under a standard form of trust agreement, while the assets in the DC plan were held under the terms of an insurance policy. As well, the rights, risks and contingencies attaching to the two pools of assets were quite different.

The Kerry case was pursued before the Financial Services Tribunal of Ontario by members of an employees’ pension committee, primarily without counsel. The Tribunal rejected the employees’ claims on most counts, but concluded the trust document governing this arrangement did not permit assets held for the beneficiaries of a DB plan to be used for DC contributions. It suggested amending the plan documents to make DC members “beneficiaries” in respect of the DB plan. An appeal hearing is currently in progress before the divisional court, as to, among other things, the propriety of any such amendment.

The Kerry case, regardless of outcome, sends a message to plan sponsors. It shows that using the surplus of an existing DB plan to fund a DC plan can be a path fraught with challenge and legal consequences.

Murray Gold is a partner with Koskie Minsky in Toronto.

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