Trust Law and Pension Plans—An Evolution in Progress
June 23, 2008 | Ian McSweeney and Douglas Rienzo

As all pension practitioners know, the provision of pension benefits is a complicated business, with layers of legislation, regulation, policy, and case law to consider, on top of the various employee relations and business strategy considerations that come into play.

One variable that has often caused problems for plan sponsors is the application of trust law to their pension plans. Although in some cases pension plans may be funded through an insurance policy, in the majority of cases—at least with respect to traditional defined benefit plans—the funds are held in trust.

Once a trust fund is established to hold pension plan assets, then trust law concepts come into play. Unfortunately, trust law principles, which have evolved over hundreds of years, often cause surprising and troublesome results when applied to a modern pension plan.

Trust law evolved in the common law world starting in England, where for the most part the cases that were decided by the courts involved trusts set up in a will, for example a family trust set up by a grandfather for the education of his grandchildren. The principles that evolved in those cases are now being applied to modern pension plans, and the fit is often not a good one.

There have been some recent positive developments in the courts, however, which should give pension plan sponsors some cause for hope. The Supreme Court of Canada itself recently recognized, for example, that the application of classic trust law principles in the modern pension context may not always lead to the best result.

Pension Trusts are “Classic” Trusts

The story starts in 1994 with the first surplus entitlement case to reach the Supreme Court, Schmidt v. Air Products. In Schmidt, the Supreme Court had to decide a fundamental issue that up to that point had been the subject of conflicting lower court decisions: namely, what sort of trust a pension trust really is.

• Some lower court decisions had found that a pension trust is a special kind of trust called a “purpose trust.” This kind of trust is just what the name would suggest: the trust is set up for a specific purpose, and once that purpose is fulfilled, the trust expires. An example of this would be a trust set up to fund the building of a hospital. Once the hospital is built, then the trust would expire, and any funds left over—the surplus if you will—would no longer be subject to the restrictions found in the trust document.

• Other lower court decisions, on the other hand, had decided that a pension trust is a “classic” trust, just like the trust set up by the grandfather for his grandchildren. In the pension context, this would mean that any funds left over once members’ pensions are paid—the surplus—would still be subject to the terms of the trust, and the trust would live on.

The Supreme Court decided that pension trusts are classic trusts, and not trusts for a purpose. These trusts hold funds for the benefit of specified persons, and not for a general purpose like building a hospital. That decision had profound implications, some of which were likely not foreseen by the court at the time. In deciding that pension trusts were like classic trusts, the Supreme Court required that the law of trusts, which as mentioned above had developed over hundreds of years mostly in the context of trusts set up by will, would apply to all pension trusts.

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