1. When is it acceptable for pension plan expenses to be paid from a pension fund?
2. After a plan conversion, is it permissible to use surplus assets in the DB part of the plan to pay for contributions to the defined contribution(DC) part of the plan?
3. What constitutes proper notice of an adverse amendment?
Facts
The pension plan at issue in the Kerry case was a DB plan established in the 1950s and funded pursuant to a trust. The original trust agreement stated that contributions were to be used for the exclusive benefit of plan members. Initially, the employer paid all plan expenses, but the plan was amended over time to permit actuarial and other third-party expenses to be paid from the plan fund.
The plan was also amended in 2000 to introduce a DC component. In 1985, the employer began taking contribution holidays. After the DC component was implemented, the surplus in the DB component was also used to cross-subsidize the employer’s funding obligations under the DC component.
Plan members challenged the payment of plan expenses from the plan fund and the taking of contribution holidays(including the crosssubsidization) arguing that such practices constituted a breach of trust. The Superintendent of Financial Services made orders regarding some of the member complaints. A series of appeals followed, with the Financial Services Tribunal rendering a decision that was favourable to the employer and the Ontario Divisional Court overturning that decision in favour of the plan members.
Court of Appeal Findings
The Court in Kerry answered these questions as follows:
Expenses – Third-party plan administration expenses could be paid from the pension fund, as plan amendments enabling such payment were not inconsistent with prior plan and trust documentation in this case. However, expenses incurred by the employer for advice in connection with adding a DC component to the plan could not be charged to the fund, nor could trustee expenses as the original trust documents required such expenses to be paid by the employer.
Contribution holidays – The employer could take contribution holidays with respect to the DB component of the plan, as there was nothing stated otherwise in the original plan text and trust. The surplus in the DB portion could similarly be used to cross-subsidize the contribution obligations under the DC component, provided that the plan was properly structured so as to make the members of the DC component beneficiaries of the DB fund.
Notice of plan amendments – The conversion of a pension plan from a DB plan to a DC plan creates uncertainty and risk for the plan members. Accordingly, it is an “adverse amendment,” and as such, prior notice of the amendment must be givenin accordance with Ontario’s pension legislation. The notice provided in this case was insufficient.
What Kerry Means
Largely because the Court of Appeal decided the first two questions in favour of the employer, Kerry has been heralded as good news for employers. But employers take note: the Kerry decision does not generally validate charging expenses to a pension fund and using DB surplus to cross-subsidize DC contribution obligations.
In fact, the result was very much dependent on the particular wording of the plan and trust documentation in that case, and Kerry really stands for the proposition that an employer’s ability to use surplus in an ongoing plan is to be determined based on the wording of the historical plan and trust documents in question.
Moreover, the Kerry decision raises additional issues. For instance, the Court found that the communications provided to members in connection with the plan conversion did not properly describe the legal effects of the conversion. In this regard, the Court appears to have placed an onus on employers to communicate plan changes clearly and accurately with plan beneficiaries or risk having those amendments declared invalid.
Yet there is reason for optimism following the Kerry decision, not so much in the result, but mainly because the Ontario Court of Appeal has provided a helpful analytical framework with which to resolve issues over the use of surplus in an ongoing plan.
The Trust Law Problem
In its 1994 decision in Schmidt v. Air Products of Canada(1994)(“Schmidt”), the SCC determined that pension trusts were subject to “all applicable trust law principles,” just like any other trust. Using the Schmidt approach, an employer could only gain access to surplus assets held in a pension (trust)fund in very limited circumstances; for instance, if it reserved an express power to revoke the trust at the time of its creation.
Since then, however, Canadian courts have struggled to properly apply classic trust law principles to pension plans and to other uses of surplus. In Kerry, the Court of Appeal gives insight to reconcile past cases on this issue and provides a rational framework in which to apply the law of trusts to other uses of pension surplus.
This is a significant legal development. For years, lawyers for unions and plan members have argued that the strict Schmidt approach should be applied to all surplus issues. That is, once a plan is funded pursuant to a trust, it would be a breach/ revocation of trust to use those funds for any purpose not expressly permitted in the original trust documents. Counsel for the members in Kerry argued that any attempt to amend a pension plan to permit expenses to be paid from the pension fund would be invalid unless the power to charge expenses to the fund was reserved at the time the plan was created.
But the Court in Kerry(thankfully)rejected that approach, noting that even classic trusts “operate on the basis that expenses of the trust fund are paid from the trust unless the trust agreement provides otherwise” and that an amendment to permit third-party expenses to be paid from the pension fund is not a revocation of trust as it does not involve the return of money to the employer. According to the Court, “Silence does not create a legal obligation on the company to pay.”
Similarly, the Court rejected a strict application of trust law principles to the cross-subsidization issue, observing that pension plans(unlike typical trusts)are open to have new beneficiaries added over time, as new employees become eligible to join the plans. As a result, using surplus to pay contributions for a new class of DC members was not a breach of the “exclusive benefit” restrictions in the original trust so long as both DB and DC members were part of the same pension plan and beneficiaries of the same fund.
While this reasoning does not lead employers out of the woods on these issues, the Court of Appeal’s analytical approach to pension trusts is compelling. It is rational, practical and consistent with recent SCC decisions in recognizing the differences between modern pension plans and common law trusts.
Paul Litner is a partner in the pension and benefits department at Osler, Hoskin & Harcourt LLP in Toronto. plitner@osler.com
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