IN THE MATTER OF THE PRUDENTIAL STAFF PENSION SCHEME
Royal Courts of Justice
Strand, London, WC2A 2LL
Before :
MR JUSTICE NEWEY
Between :
PRUDENTIAL STAFF PENSIONS LIMITED | Claimant |
- and - | |
(1) THE PRUDENTIALASSURANCECOMPANY LIMITED (2) WILLIAM ANTHONY CHARLES ARTHUR COPP (3) HUGH NORMAN (4) MALCOLM LLOYD (5) TERENCE ROBERT CLADINGBOEL | Defendants |
Mr Andrew Simmonds QC and Mr Joseph Goldsmith (instructed by Mayer Brown International LLP) for the Claimant
Mr Michael Tennet QC and Mr Rupert Reed (instructed by Allen & Overy LLP) for the First Defendant
Mr Keith Rowley QC and Miss Elizabeth Ovey (instructed by Sacker & Partners LLP) for the Second to Fifth Defendants
Hearing dates: 17-21, 24-28 and 31 January and 1-3 and 9-11 February 2011
Further written submissions: 21 and 25 March 2011
Judgment
Mr Justice Newey:
Introduction
The Prudential Staff Pension Scheme (“the Scheme”) provides retirement and other benefits for employees and former employees of the First Defendant, the PrudentialAssuranceCompany Limited (“PAC”), and other companies in the Prudential group. For convenience, I shall refer to the employer companies simply as “Prudential”.
The present proceedings have their origins in a decision which Prudential took in November 2005 as to the policy which it would in future adopt in relation to increases to pensions in payment to members of the “DB Section” of the Scheme (as to which, see paragraph 11 below). There is an issue between the parties as to precisely what the policy was, but, in general terms, it was to the effect that increases would in future be “in line with RPI subject to a normal maximum of 2.5%pa” (to quote from board minutes). In the years which have followed, pension increases have failed to keep up with the retail prices index (“RPI”). Prudential had previously awarded pension increases on a more generous basis.
What is before me is an application for directions brought by the trustee of the Scheme, Prudential Staff Pensions Limited (“the Trustee”). I am asked, specifically, to determine questions set out in an agreed list of issues (“the List of Issues”).
The Second to Fifth Defendants are intended to represent various categories of Scheme member. The Second Defendant, Mr William Copp (“Mr Copp”), is intended to represent members of the DB Section of the Scheme generally; the Third Defendant, Mr Hugh Norman (“Mr Norman”), members of the DB Section who have made additional voluntary contributions (or “AVCs”) to the Scheme; the Fourth Defendant, Mr Malcolm Lloyd (“Mr Lloyd”), members of the DB Section who have transferred other pension rights to the Scheme; and the Fifth Defendant, Mr Terence Cladingboel (“Mr Cladingboel”), members of the DB Section whose pensions have been augmented as a result of decisions by Prudential that they should receive additional benefits as part of severance packages (or otherwise). I shall refer to the Second to Fifth Defendants collectively as “the Beneficiaries” and to the classes of member represented by the Third, Fourth and Fifth Defendants as respectively “the Category I Members”, “the Category II Members” and “the Category III Members”.
The issues raised by the proceedings can be summarised as follows:
whether the decision which Prudential took in November 2005 as to its policy in relation to pension increases (“the 2005 Decision”) and/or subsequent decisions on pension increases breached what Browne-Wilkinson V-C in Imperial Group Pension Trust Ltd v Imperial Tobacco Ltd [1991] 1 WLR 589 called “the implied obligation of good faith” as regards members of the DB Section generally or Category I, II and III Members respectively (“the Good Faith Issues”);
whether Prudential is estopped from denying that members of the DB Section generally (or at least Category I, II and III Members) are entitled to have pensions in payment increased on the basis of what the Beneficiaries have termed “RPI with the proviso” (in other words, in line with RPI except in times of high inflation, when lower rates of increase might be awarded but on the basis that there would later be a “catch-up” exercise) (“the Estoppel Issues”);
whether Category I, II and III Members respectively are contractually entitled as against the Trustee to annual or other periodic increases to pensions in payment (“the Contract Issues”);
whether, as regards Category I and II Members, the Trustee has power to grant pensions which carry an automatic right to annual or other periodic increases (“the Construction Issues”);
whether decisions to grant pensions to Category I and II Members which did not carry an automatic right to annual or other periodic increases were valid and, if not, with what consequences (“the Hastings-Bass Issues”).
The Good Faith Issues are addressed in paragraphs 118-196 below, the Estoppel Issues in paragraphs 197-219 below, the Contract Issues in paragraph 220 below, the Construction Issues in paragraphs 221-227 below and the Hastings-Bass Issues in paragraphs 228-239 below.
Witnesses
The Trustee called Mr Michael Abrahams (“Mr Abrahams”), who has been the chairman of the Trustee’s board since 1991; Mr Graham Clay, who was a director of the Trustee between 1989 and 2000; Mr Bernard Dawkins (“Mr Dawkins”), who was the Staff Pensions Manager from 1986 to 1999; Mr David Linnell (“Mr Linnell”), who was a director of the Trustee from 1984 to 1997; Mr Andrew Parncutt (“Mr Parncutt”), who was the Staff Pensions Manager from 1999 to 2010; Mr Graham Robilliard (“Mr Robilliard”), who was the Actuary to the Scheme between 1995 and 1998; and Mr Colin Singer (“Mr Singer”), who has been the Scheme Actuary since 2006 and had previously assisted a colleague at Watson Wyatt with matters relating to the Scheme. Prudential’s factual witnesses comprised Mr John Betteridge (“Mr Betteridge”), the Director of Investments for Prudential’s Portfolio Management Group; Mr Alan Cook (“Mr Cook”), who was a director of the Trustee between 1997 and 2000; Mr Andrew Jones (“Mr Jones”), who was formerly a Director of Group Reward and Employee Relations for Prudential; and Mr Geoffrey Keeys, who was a director of the Trustee from 1988 to 1995. The Beneficiaries (Mr Copp, Mr Norman, Mr Lloyd and Mr Cladingboel) gave evidence themselves and also called Mr Robert Bridges (“Mr Bridges”), who was a director of the Trustee from the mid-1980s until 1994; Mr John Gould (“Mr Gould”), who prior to retirement was a senior client relationship manager with Prudential (and a director of the Trustee from 1990 to 2002); Mr Malcolm Hall (“Mr Hall”), who was formerly a senior administration manager with Prudential; and Mr David Metcalfe (“Mr Metcalfe”), another retired senior client relationship manager.
All the witnesses seemed to me to be truthful. That is not, of course, to say that their evidence was invariably correct. Understandably, given the lapse of time, witnesses’ recollection of events was not always perfect. There were also, unsurprisingly, some differences in the witnesses’ interpretations of events.
Mr Peter Fudge (“Mr Fudge”), who was the Scheme Actuary from 1985 to 1994, provided a witness statement. He was not, unfortunately, well enough to give oral evidence. Mr Ronald Dougall, who until his retirement was a customer service manager with Prudential, provided a witness statement too.
I also had the benefit of expert actuarial evidence from Mr Gordon Pollock (“Mr Pollock”), who was called by Prudential, and Mr Ronnie Bowie (“Mr Bowie”), who was called by the Beneficiaries. I found the evidence of both helpful.
The Scheme
The Scheme was established in 1918. In its present form, it has two parts. One of them, the “DB Section”, provides final-salary benefits, the other, the “DC Section”, money-purchase (or defined-contribution) benefits. The present proceedings relate exclusively to the DB Section, members of which are referred to as “DB Members”.
The DB Section closed to new members in July 2003 and the number of active members has fallen substantially since then. At 5 April 2003, the DB Section had 5,260 active members. By 5 April 2010, the effective date of the Scheme’s most recent annual report, there were only 1,152 active members left. There were much larger numbers of deferred members (20,929) and pensions in payment to members or dependants (18,554).
The Scheme is very large. As at 5 April 2010, the DB Section alone had net assets in excess of £5 billion.
The Rules
The current Rules
The current version of the rules governing the DB Section (“the Rules”) was introduced with effect from 1 July 2005 by a deed of variation dated 23 June 2005.
The Rules provide for members to receive a range of benefits. A member retiring on or after “Normal Pensionable Date” is entitled under rule 3.1(1) to an immediate pension, the annual amount of which is pursuant to rule 3.1(3) to be ascertained in accordance with a schedule. In respect, for example, of members entering eligible service from 1 April 1980 who were not “Services Staff Members”, the first schedule gives the scale of retirement pensions as:
“In respect of each completed month (subject to a maximum of 480 months) of Pensionable Service pension shall accrue at the rate of 1/720th part of the DB Member’s Final Pensionable Earnings.”
Pension increases are addressed in rule 7.1. Rule 7.1.1 states:
“(1) The Employers shall make regular reviews of each pension and annuity currently in payment.
(2) That part of a pension or annuity currently in payment which is attributable to Pensionable Service on or after 6th April 1997 will be increased each year by the amount required under Sections 51, 52, 53, 54 and 55 of the Pensions Act. No additional increases shall apply unless the Employers decide otherwise.”
Rule 7.3 (which lies at the heart of this case) provides:
“At the request of an Employer and upon payment by the Employer to the Fund of such sum or sums (if any) as the Actuary [i.e. the person appointed as Actuary to the Scheme] shall certify to be necessary (after taking account of any surplus disclosed that the last proceeding Valuation) the [Trustee] shall provide such additional benefits under the Scheme (consistent with Inland Revenue Approval) as the Employer shall determine subject to any condition or qualifications which the Employer may require.”
(Sections 51 to 55 of the Pensions Act 1995, to which there is reference in rule 7.1.1(2), provide for limited price indexation (or “LPI”) of pensions attributable to service after 1997. To the extent that the provisions applied to a pension at the material times, it had to be increased in line with RPI, subject to a cap. The cap used to be 5% but was reduced to 2.5% from 6 April 2005.)
Members are not required to make any contributions (Footnote: 1), but rule 2.4 provides for Prudential to do so as employer. Rule 2.4.1 stipulates that the employers are to make periodic contributions of “amounts ascertained on the basis determined by the Principal Employer [i.e. PAC] and notified to the [Trustee] and the Associated Employers”. Employers’ contributions can be reduced if a valuation reveals a surplus, but they cannot be less than, in broad terms, 12.5% of DB Members’ salaries.
Rule 2.2 makes provision for members to make AVCs to the Scheme. Under rule 2.2.3, voluntary contributions are to be “applied by the [Trustee] to provide additional pension under the Scheme in respect of the DB Member”. Rules 2.2.4 and 2.2.5 deal with the value of the additional pension. They are in these terms:
“2.2.4 The amount of the additional pension to be provided by the DB Member’s Voluntary Contributions shall in each case be determined by the [Trustee] on a money purchase basis which is directly referable to the amount of the DB Member’s Voluntary Contributions.
2.2.5 The value of the additional pension shall be reasonable having regard
(a) to the amount of the DB Member’s Voluntary Contributions and
(b) to the value of the other benefits under the Scheme.”
Rule 6.1 deals with commutation (by which a member exchanges pension for a cash payment). Under rule 6.1.1, when a DB Member becomes entitled to a pension:
“… on the request of the DB Member the [Trustee] may commute subject to Revenue Limitations the whole or part of such pension for a cash payment payable on the day on which the pension was due to commence.”
The amount of such a payment is (pursuant to rule 6.1.1(4)) to be:
“determined by the [Trustee] in accordance with the table of conversion factors currently agreed with the Board of Inland Revenue or such other factors as have been prescribed or specifically agreed by the Board of Inland Revenue.”
Section 8 of the Rules is concerned with transfers into and out of the Scheme. Rule 8.2 allows a DB Member to transfer into the Scheme “subject to Revenue Limitations and to the approval of the [Trustee] a sum representing benefits applicable to the DB Member under any other retirement benefits scheme”. Under rule 8.2.2, the sum so transferred is, subject to certain restrictions, to be:
“applied to provide such additional benefit in respect of the DB Member under the Scheme (consistent with Inland Revenue Approval) as the [Trustee] shall determine ….”
Previous Rules
Certain provisions of previous versions of the Rules should be noted.
Up to 1995, the regime relating to AVCs was somewhat different. Rule 10(A)(ii) of the 1984 Rules allowed a member to pay additional contributions subject to, among other things, “the consent of the [Trustee]” and provided for such contributions to be “applied by the [Trustee] to augment the pension under the Scheme in respect of the Member”. The amount of additional pension was in each case to “be determined by the Actuary” but was not to “operate to increase the amount of the contributions by the Employers”.
As was pointed out by Mr Andrew Simmonds QC, who appeared with Mr Joseph Goldsmith for the Trustee, this regime differed from the present one in four respects. First, an AVC required the consent of the Trustee under the 1984 Rules. That is no longer the case. A second point is that there has been a slight change of wording as regards the application of AVCs. The 1984 Rules provided for AVCs to be applied “to augment the pension under the Scheme in respect of the Member”, the current version for AVCs to be applied “to provide additional pension under the Scheme in respect of the DB Member”. Thirdly, the amount of additional pension was formerly determined by the Actuary rather than, as now, the Trustee. Finally, whereas the 1984 Rules stipulated that the additional pension should “not operate to increase the amount of the contributions by the Employers”, the present Rules provide for the amount of the additional pension to be determined “on a money purchase basis which is directly referable to the amount of the DB Member’s Voluntary Contributions”.
Just as the amount of additional pension payable for AVCs was in the past to “be determined by the Actuary”, so the size of the cash payment made on a commutation was fixed by the Actuary. Rule 19 of the 1984 Rules stipulated:
“The amount of any cash payment … shall be determined by the Actuary and if the cash payment is payable on or after the 1st April 1980 such determination shall be made in accordance with the table of conversion factors currently agreed with the Board of Inland Revenue or such other factors as have been specifically agreed by the Board of Inland Revenue.”
Pension increases up to 2005
For many years pensions in payment have been increased periodically to compensate for inflation.
The available evidence begins in 1950, when the board of PAC approved increases to pensions with effect from 1 January 1951. Pensions were further increased on at least two occasions during the 1950s, in 1953 and 1959. There is also reference in the papers to pensions having been increased in accordance with a resolution dated 1 September 1955, but I have not seen the relevant minutes.
From 1961 onwards, pensions were increased on an annual basis, but not necessarily in line with inflation. In the first place, a sliding scale was applied, with the oldest pensioners enjoying the highest increases. In 1967, for example, the pensions of those who had retired in 1947 or earlier were raised by 10%, but there was no increase at all for anyone who had retired since the end of 1965; those who had retired in the intervening years had their pensions increased by 2.5%, 5% or 7.5%, depending on when they had retired. Those who had retired during 1965 had their pensions increased by the change in RPI that year (2.5%), but everyone else received either more or less than the increase in RPI.
When inflation was particularly high in the 1970s, no pension kept pace with RPI. In 1975, for instance, RPI rose by 24.2%, but all pensions were raised by just 7.5%.
In subsequent years, steps were taken to restore pensions’ purchasing power. For example, in 1979 those who had retired by 1972 had their pensions increased by 30% even though RPI had gone up by only 13.4%, and everyone who had retired by the end of 1976 enjoyed an increase above the 13.4%. By 1992, Mr Dawkins, the Staff Pensions Manager, was able to report that increases had “resulted in pensions from 1 July 1991 equal to 100% of their real value at commencement for more than 97% of pensioners”. However, no one was compensated for the diminished purchasing power of their pensions in previous years.
From 1991 to 1996, pensions were increased by reference to changes in RPI, but subject to the figures being rounded to the nearest 0.5%. Mr Dawkins had explained what was proposed in a 1991 report to the Prudential’s “Group Executive Committee” (“the GEC”) in these terms:
“Having reached the Company target of 100% linkage for most of our pensioners, it is proposed that the opportunity should be taken to determine future scales of increase in relation to actual RPI increases for the year ending 28 February but rounded to the nearer ½%, to maintain the approach of a discretionary scale.”
In the event, the rounding resulted, overall, in increases marginally in excess of inflation.
Rounding was discontinued in 1997 with the coming into force of statutory provisions requiring pensions attributable to service after that date to be increased by a minimum amount each year (see paragraph 17 above). Between 1997 and 2005, the pension increase for each year accorded exactly with the change in RPI in the year to the preceding 30 September.
What members were told about pension increases
The earliest communication to members I have seen referring to pension increases dates from 1979. In August 1979, a supplement to “PruNews”, the then staff newspaper, carried an article with the title, “Substantial increases awarded to our pensioners”. This included passages in these terms:
“Notwithstanding the increases which have been awarded, staff who retired before the period of hyperinflation of the mid-1970’s have had the purchasing power of their pension eroded. Now, from July 1979, the Company have gone a considerable way towards bringing the pension closer to its commencing value increased by the retail prices index ….
As we have emphasized on previous occasions, future pension increases cannot be guaranteed. Their maintenance depends on the future prosperity of the Company and the financial resources of the pension fund.”
Some 13 years later, in 1992, “PruNews” contained an article written by Mr Dawkins which stated:
“The Prudential uses its best endeavour to cushion retired staff against increases in prices, using RPI as the measure. There have been instances in the past, during periods of very high inflation, when the discretionary increases have failed to fully maintain the pensions’ purchasing power. However, these occasions have been followed by ‘catching-up’ years when the increase awarded to those who have suffered a loss of purchasing power is greater than price inflation.
Today, as the Trustee’s Annual Report to Members demonstrates, all pensions have been restored to that full purchasing power. The Prudential hopes to maintain this 100% linkage, but there might be some slippage if we were to experience another period of prolonged high inflation. This message is given at pre-retirement seminars for Prudential staff.”
A “Member’s Booklet” with which members of the Scheme were provided also made reference to pension increases. A 1988 version said:
“The Company has discretion under the Rules to increase your pension from time to time. It has been the Company’s practice to grant such increases to pensions in payment to give some protection against the effect of inflation ….
The Company expects (but does not commit itself) to continue the practice of granting discretionary increases ….”
A 1996 version said:
“The Company will normally try to cushion retired staff against the effect of inflation, but does not guarantee to do so, particularly in times of high inflation.
Pension increases (when granted) come into effect on 1 July each year. The increases are at the Company’s discretion. In recent times, increases have been roughly equal to the increases in the Retail Prices Index.”
A 2001 version stated more tersely, “the Company may choose to award discretionary increases to pensions in payment”.
An introduction to the 1988 booklet explained that it was issued on behalf of both the Trustee and the employers and that its aim was “to give an outline of the provisions of the Scheme and the benefits available to you”. It went on to point out that the booklet was “not an absolute authority” and that the “full provisions of the Scheme are contained in the Scheme Rules”. Similarly, the 2001 booklet said, “This guide is a summary of the Scheme and does not cover all the detailed provisions”.
Annual benefit statements also referred to pension increases. That dating from 2000 stated, under the heading “Discretionary increases to pensions in payment”, “The Prudential will normally endeavour to cushion retired staff against the effects of inflation, but does not guarantee to do so, particularly in times of high inflation”. The 2005 version was less guarded, stating in positive terms that “pensions are increased each year once in payment to protect your income from the effects of inflation”. It is to be noted, however, that the statements were issued by the Trustee rather than Prudential. Further, the 2000 statement warned that it was “not binding on the Trustee” and the 2005 version noted that “the Trust Deed and Rules is the legal document governing the Scheme”.
From at least 1985 (when Mr Dawkins was first involved) until 1998, all active members of the Scheme were also sent copies of its annual reports. Over this period, each report contained a bar chart showing how pensions had grown since 1950 and drawing a comparison with inflation. By 1991, the report showed pensions to have more or less caught up with inflation, and the 1992 report indicated that pensions had by now slightly outpaced inflation. The reports emanated from the Trustee.
In 2002, following a review by Prudential of its staff pension arrangements, Mr Parncutt, who had succeeded Mr Dawkins as Staff Pensions Manager, sent members of the Scheme on behalf of the Trustee a letter in which he said:
“The review is now complete and Prudential has confirmed that the final salary benefits provided to existing staff will be retained and that the Company has no intention of withdrawing them. Prudential has also confirmed to the Trustee that the review will not reduce the benefits for those who have already retired or left the Company’s employment, nor affect the Company’s attitude to discretionary pension increases.”
On retirement, a member was sent a letter on behalf of the Trustee about his pension rights. Notes enclosed with the letter explained:
“When exercising your options you should bear in mind that from time to time the Directors of the Companies participating in the Scheme have made ex-gratia increases to pensions ….
This paragraph must not be taken as any kind of guarantee that increases in pensions will be made in the future, although the Directors intend that pensions shall continue to be reviewed.”
Members drawing pensions were also sent letters on behalf of the Trustee on an annual basis giving details of pension increases. The 1997 version stated:
“As you will know, pensions payable under the Prudential Staff Pension Scheme are regularly increased once in payment, as a cushion against increases in prices. Prudential uses its best endeavours to maintain the purchasing power of the pension throughout retirement, using the Retail Prices Index (RPI) as a benchmark, but does not guarantee always to do so, particularly in times of high inflation. The Scheme’s Annual Report shows how these discretionary pension increases have historically related to increases in prices ….”
The next year’s version announced more shortly that the employers had decided on specified pension increases “to cushion against increases in prices”. In Mr Parncutt’s time, pensioners were told for several years:
“The percentage increase is based upon the Retail Price Index (RPI) for the year ending September … and is in line with the long standing practice of Prudential staff pensions being kept in line with retail prices.”
Retired members were supplied with a half-yearly publication called “Prulink”. In 1990 a supplement to “Prulink” said that it had been the “Prudential’s aim … to provide retirement benefits for its employees that fairly reflect the member’s age, earnings and years of service and, so far as possible, to maintain the purchasing power of the pension during retirement in the light of changes in the Retail Prices Index”. It also explained:
“Prulink readers who retired in the early 1970s or earlier will, no doubt, recall the high inflation era of the 1970s, when the increases awarded to Prudential pensioners were sometimes 15% or more per annum but were still insufficient to maintain the full purchasing power of the pension. In recent years, however, when inflation has been at lower levels, the Company has been able to gradually restore pensions to their full purchasing power at retirement.”
In 1992, an article in “Prulink” said that “the Company uses its best endeavours to cushion pensioners against increases in prices so that the ‘purchasing power’ of the pension is maintained throughout retirement” and observed that pensions had now “been restored to their full purchasing power”. In 1996, an article stated, “It is the Prudential’s policy to try to cushion retired staff against the effect of inflation, but it does not guarantee to do so, particularly in times of high inflation”. A 1997 article contained a passage in almost identical terms. A 2000 article on pension increases written by Mr Parncutt rather than Mr Dawkins (who had by now retired) stated, however, “Any award is made at the complete discretion of the Prudential”.
There were also occasions when members would be told about the Scheme orally. Seminars were held for employees when they were 10 years from retirement and again when they were close to retirement. Mr Dawkins would attend both sorts of seminar, and he was also sometimes invited to union or divisional meetings. Mr Dawkins would refer on such occasions to the pension increases which were awarded. He would make clear too, however, that increases were not guaranteed.
It is additionally to be noted that the Scheme’s three-yearly actuarial valuations made reference to pension increases. The 1990 report by Mr Fudge, who was Actuary to the Scheme between 1985 and 1994, noted that “the Company normally makes annual increases to pensions in payment”. In his next (1993) report, Mr Fudge stated:
“whilst not guaranteeing to do so, the Employers normally arrange for discretionary annual increases to pensions in payment to be made under the Scheme, to offset rises in prices.”
In 1996 Mr Robilliard, the Scheme Actuary between 1995 and 1998, said in his report:
“Pension increases in excess of the statutory requirements are considered annually by the employers. Whilst there is no obligation to pay increases, for many years the employers have granted increases to pensions in line with inflation. For the purposes of this valuation, I have assumed that this practice will continue.”
Later reports prepared by Mr Paul Thornton (“Mr Thornton”) of the actuarial consultants Watson Wyatt, who was the Scheme Actuary between 1999 and 2005, stated:
“Consistent with the previous valuation, we have allowed for future pension increases to be granted fully in line with inflation on the whole of the excess over the GMP [i.e. the ‘guaranteed minimum pension’ which broadly replicated the ‘SERPS’ benefits that members of a pension scheme gave up when it contracted out of ‘SERPS’] and in line with statutory increases on the GMP in payment.”
It is fair to say, however, that the actuarial valuations were not prepared on Prudential’s behalf and that they are most unlikely to have been read (or even seen) by more than a tiny number of members of the Scheme.
The expectations of members of the Scheme
The DB Section now has some 20,000 active or deferred members, and pensions are being paid to, or to dependants of, getting on for 20,000 further members. It is inherently improbable that all these members had exactly the same understanding of the position in relation to pension increases.
Many of those who gave evidence before me were members of the Scheme. They were uniformly very knowledgeable about the Scheme. Quite a few of them had actuarial qualifications, and some of the others had been closely involved with the Scheme. There will have been other members with less reason to know about the Scheme and less well-qualified to assess its affairs. When it was put in cross-examination to Mr Cook, who worked for PAC from 1970 to 2002, that there was a “pretty sophisticated scheme membership”, he said:
“Not particularly, no. Some people might have been. But we used to have a thing called the engineers and works department, and they were mechanics, they were lift engineers; the Prudential did everything at that time, they would not be pensions familiar at all.”
There will have been variations in knowledge not only as between individuals but over time. Unsurprisingly, more than one witness spoke of having known relatively little about the Scheme when young. Mr Dawkins said that “as a young man [he] paid less attention to the practice and the levels of increase granted to pensioners than certainly when [he] was appointed as Pensions Manager and became closer to retirement age [himself]”. Mr Robilliard referred to a period when he was not taking much notice of the Scheme “because [he] was in [his] 20s”. Asked about his understanding in relation to pension increases in the 1970s and 1980s, Mr Cook said:
“I wouldn't have been aware at all, to be perfectly honest. I was young.”
It was Mr Dawkins’ view that Prudential had a discretion in relation to pension increases, but that this was exercisable only within certain limits. He said in cross-examination:
“it has been my understanding that the company's discretion was within limits having regard to – ‘promises’ may not be the right word, but communications to members and statements made to members with the associated funding policy.”
Even he, however, had been concerned that members of the Scheme should understand pension increases to be discretionary. He explained that he had had the idea of the rounding factor “to reinforce to members that the increases were discretionary, but albeit linked in a fairly close way to RPI”. He also said:
“… I never gave anybody the impression the increases were guaranteed, and I do not believe the members had an expectation that the increases were guaranteed.”
Mr Dawkins thought that members of the Scheme would have shared his view that Prudential’s discretion was subject to limits. He said, for example:
“I believe the members had an expectation that future increases would be in line with the company policy that is discretionary, but within the limits and parameters that we spoke about yesterday ….”
Mr Dawkins’ view receives support from the evidence given by Mr Copp, the Second Defendant. It is apparent from that evidence that Mr Copp considered that Prudential had committed itself to paying RPI increases other than in times of high inflation and to pensions catching up with inflation after periods of high inflation, although he took the view that it was “left to the company” to decide what represented “high inflation”.
Other members of the Scheme, however, did not regard Prudential as having given any commitment as to pension increases. Evidence to this effect was given by many witnesses, but it suffices, I think, to cite evidence given by or on behalf of the Beneficiaries. Thus, Mr Norman, the Third Defendant, said:
“there was a general expectation that an increase would be paid at RPI, as we have called it now, with the proviso. I don't think there was any guarantee that that would happen, I think it is an expectation, and I think my view is that everyone expected that that would be the position.”
Mr Lloyd, the Fourth Defendant, said:
“I had always had the understanding that any increases with regard to what I would refer to as the basic pension were at the discretion of the employer. My understanding, however, had been that except in periods of high inflation, it was the employer's intent to ensure that the purchasing power of the pension was maintained.”
When Mr Cladingboel, the Fifth Defendant, was asked in cross-examination whether it had been his understanding that Prudential had guaranteed to give RPI increases, he said:
“They hadn't guaranteed; the way it was put to me was that increases were discretionary, but they had always paid at RPI in the past and there was no anticipation of that changing in the future.”
Likewise, Mr Gould, one of the witnesses called by the Beneficiaries, said that he did not understand a promise to have been given; the position was rather, Mr Gould said, that:
“it had been custom and practice that those increases had been paid and the assumption was that that would continue into the future.”
Mr Hall, another of the Beneficiaries’ witnesses, said:
“I guess we all knew that it wasn't guaranteed, it was said a number of times over the years that it was not a guarantee that the cost of living would be maintained, et cetera, but there was this feeling, and this -- from history, that whenever they could, and depending on factors such as the state of the scheme and the state of the company, the company would do its best to bring pensions back up to cost of living.”
Mr Bridges, who also gave evidence for the Beneficiaries, confirmed that there had been an expectation that increases would continue but accepted that “no promise was given”.
Overall, it seems to me that there was a general understanding among members (or at any rate those taking a significant interest in the Scheme) that, except when inflation had been particularly high in the 1970s, pension increases had fully compensated for inflation, and there was a widespread expectation that that pattern would continue. On the other hand, Prudential was not thought to have guaranteed or committed itself to such increases. Nor, more specifically, did the evidence, taken as a whole, bear out Mr Dawkins’ view that members generally understood Prudential’s discretion to be subject to particular limits.
Conversion factors
Like other pension schemes, the Scheme applies conversion factors when money or other rights are injected into or taken out of the Scheme.
“Commutation factors” (i.e. the factors used to determine the amount of money that a member is to receive if he gives up pension rights) have been of particular importance. It is common ground that the factors applied to the conversion of AVCs into pension have been the converse of those applied to the commutation of pension rights; as Mr Fudge said in a 1991 memorandum, “For convenience and consistency with the conversion of Scheme pension to cash, the cash option factors have been used in reverse to convert AVC proceeds into pension”. Factors used for other purposes have to an extent also been driven by commutation factors.
Before 1992, commutation factors were set at the maximum the Inland Revenue would allow for non-increasing pensions. In his 1991 memorandum, Mr Fudge commented that the factors “would be regarded as falling short of a fair value in commutation of a pension which was subject to discretionary increases in payment at a level expected to be at or near the level of increases in RPI, such as is the case for [Scheme] pensions in payment”. The flip side would be that the rates at which AVCs were converted into pension were (in Mr Fudge’s words) “too generous to AVC payers”. Calculations undertaken by Mr Bowie, the expert witness called by the Beneficiaries, suggest, however, that the AVC conversion factors were not vastly “too generous”.
In 1992, the Inland Revenue agreed to the introduction of new commutation factors which were intended to be fairer to those giving up pension rights. The new factors were based on the assumption that the net return on investments would be 5%. In arriving at the 5% figure, Mr Fudge appears to have made an allowance of ½% less than RPI for pension increases.
As I have mentioned, Mr Fudge was not able to give evidence in person, but he provided a witness statement. He explained in this that it was his understanding that “it was the Company’s intention to maintain the purchasing power of pensions throughout retirement, using RPI as a benchmark, but that it did not guarantee always to do so, particularly in times of high inflation”. Mr Linnell, who was Mr Fudge’s line manager, said (and I accept) that the “primary risk” which Mr Fudge would have had in mind was that of “another period of high inflation” and that he (Mr Linnell) could not “recall that we would have thought in any detail about anything else”. Even so, I have not been persuaded that the ½% deduction from RPI was intended to relate exclusively to the risk of pension increases falling behind RPI in times of high inflation. The likelihood is, in my view, that Mr Fudge approached the matter in a somewhat broader-brush way and made the deduction to take account of the risk of pension increases failing to match RPI for any reason. That is consistent with his witness statement where he refers to Prudential not guaranteeing always to maintain the purchasing power of pensions “particularly” (but not exclusively) in times of high inflation. It is also consistent with the fact that Mr Fudge’s 1991 memorandum spoke simply of “the discretionary nature of these increases”, with no mention of high inflation. It is consistent too with evidence given by Mr Pollock, Prudential’s expert witness, suggesting that ½% would have been on the high side as a deduction for the risk of high inflation alone.
The same approach was taken to augmentations (by which members of the Scheme were granted enhanced retirement terms). This is apparent from a passage from Mr Fudge’s 1991 memorandum in which he said:
“It is my understanding that the Employers intend that, in normal circumstances, future increases to pensions in payment should be made at or near the level of increases in RPI. Bearing in mind the discretionary nature of these increases, however, I believe that the basis on which they were valued for the last actuarial review of the Scheme would represent a fair value for the pension relinquished. The same basis is used when calculating the capital cost of augmentations to pensions, under Rule 27.”
(The emphasis has been added.)
Until the late 1990s, pension rights transferred into the Scheme would be converted into additional years of service. The evidence indicates that, when determining the years to be added, account would be taken of the prospect of pension increases. From August 1997, increases at “LPI/5%” (i.e. RPI subject to a maximum of 5%) were allowed for. It is not clear whether, before this, it was assumed that the additional pension would increase in line with RPI. It was Mr Robilliard’s recollection that, for the purposes of calculating added years, he “assumed that pension in payment would receive full RPI increases in the same way that transfers out assumed full RPI increases”. In contrast, Mr Dawkins thought that “it was assumed that the member would be granted discretionary increases on his pension broadly in line with RPI, save for in periods of high inflation”. On balance, I do not think I would be justified in concluding that the allowance made for pension increases was greater with transfers in than with commutation or AVCs.
The various conversion factors were reviewed by Mr Robilliard in 1998. He approached matters on the basis that pensions in payment would receive full RPI increases, but his room for manoeuvre was limited by Inland Revenue restrictions on commutation factors. The upshot was that the new commutation factors Mr Robilliard recommended “did not fully reflect RPI”. AVC conversion factors could correspondingly be considered not to have allowed fully for pension increases in line with price inflation.
With respect to transfers in, from 1998 a member transferring pension rights into the Scheme would be deemed to have transferred a cash amount of equivalent value, and the sum so calculated would be treated in the same way as AVCs. As regards transfers out, allowance was made for pension increases in line with inflation, but subject to a cap of 5%. A similar approach was taken to augmentations.
There was a further review of factors in 2000. In line with recommendations made by Watson Wyatt, factors were revised to allow for pensions being increased “in line with full price inflation”.
Until 1995, the amount of additional pension to be provided for AVCs was determined by the Scheme Actuary and did not strictly require the approval of either the Trustee or Prudential. From 1995, the conversion factor fell to be fixed by the Trustee.
What members were told about AVCs
The “Member’s Booklet” referred to the possibility of making AVCs. The 1988 version stated:
“If you are in Pensionable Service you may, with the agreement of the Trustee, pay voluntary contributions to the Scheme. Your voluntary contributions, which are subject to Inland Revenue limitations, will be accumulated year by year with interest and at retirement the total sum will be applied in order to increase your benefits under the Scheme.”
The 1996 version included this:
“If you are in Pensionable Service you may make voluntary contributions by deduction from pay through the payroll system ….
Voluntary contributions provide pension benefits in a different way from the main Scheme benefit. Contributions will be added together with interest in the same way as a savings account. At retirement, the total fund is used to buy extra pension.”
I was also referred to several leaflets concerning AVCs. The earliest of these, dating from about 1993, included tables illustrating potential benefits. Notes to the tables included passages in these terms:
“It is emphasised that the future interest rates cannot be guaranteed and the actual benefits may be significantly different (greater or smaller) from those illustrated.
You should also remember that the purchasing power of the pension secured by the sum available at retirement will depend upon future rates of inflation ….
At retirement, the total sum will be converted to pension using rates determined by the Actuary. These rates are not guaranteed and may be changed at any time.”
The next leaflet, dating from 1996, included similar illustrations and notes in identical terms. In addition, a section headed “Benefits” explained as follows:
“Each year interest will be added to the voluntary contributions you have paid at a rate determined by the Actuary to the Scheme. At retirement the total sum will be available, as described below, to provide you with pension ….
Pension secured by voluntary contributions will qualify for increases granted at the discretion of the Company ….”
The final leaflet, dating from about 2001, dealt with the benefits which could be obtained from AVCs in these terms:
“When you retire, your accumulated Voluntary Contributions will be used by the Trustee to fund extra pension benefits on your behalf.
The Trustee does this by converting your accumulated funds into an annual pension, or ‘annuity’. This involves the use of a ‘conversion factor’, which relates to your age at retirement.
The Trustee takes advice on this process from the Scheme Actuary, and the factors used are subject to change depending on this advice. You will be contacted with details of the rates in use at the time you retire ….”
The leaflet also stated, “The pension you receive from your Voluntary Contributions may be increased, at the Company’s discretion”.
An announcement relating to AVCs was issued to members in 1992. This explained that the rates at which sums accumulated by the payment of voluntary contributions were converted to pension on retirement were being revised. It also stated:
“Pension secured by voluntary contributions will qualify for increases granted at the discretion of the Company.”
I was referred, too, to a booklet concerned, as I understand it, with the sale of AVCs and “FSAVCs” (i.e. “Free-Standing Additional Voluntary Contributions”). One section of this dealt with the Scheme. This began by stating:
“You may come across a member of Prudential’s staff who requires advice and guidance about retirement provision. Whilst you have the opportunity to sell the FSAVC, you should also make the client aware of the in-house scheme and its main features.”
The text which followed included this:
“The AVC fund is usually used to purchase a single life pension on which future increases will be granted at the same rate as the rest of the member’s pension under the scheme. Whilst purely discretionary, such increases in recent years have tended to follow the movements of the RPI. This is a major advantage of the in-house AVCs over the free-standing alternative.”
It is relevant, finally, to note the benefit statements supplied on an annual basis to those who had paid AVCs. The example I have seen, dating from 2000, stated:
“Pension secured by voluntary contributions will qualify for increases granted at the discretion of the Company.”
Events leading to the 2005 Decision
For many years, the Scheme’s assets were predominantly invested in equities and, to a much smaller extent, property. On, for example, 5 April 1999, the date of the 1999 valuation, equities accounted for 86.6% of the Scheme’s investments and property another 11%.
The Scheme’s investment strategy had served it well. Successive triennial valuations showed the Scheme to have large surpluses even though pensions in payment were being increased in line with inflation. The valuation as at 5 April 1999, for example, reported that “the assets held by the Trustee at the valuation date exceeded by £464m those calculated to be required to finance the benefits earned to the valuation date”.
As a result of the Scheme’s financial strength, Prudential’s contributions were reduced to 12.5% of members’ salaries following the 1990 valuation. The then Scheme Actuary, Mr Fudge, had recommended in the 1990 actuarial report that Prudential’s contributions should be reduced to the minimum, observing that the ratio of assets to liabilities was “uncomfortably close to the 105% threshold above which remedial action has to be taken” (because of Inland Revenue requirements). Prudential continued to contribute at the minimum rate (which was less than the rate of ongoing accrual) until 2006.
The Scheme’s financial strength was also such that augmentations could be funded from the Scheme without Prudential making additional contributions. Mr Dawkins estimated that Prudential would have paid an extra £149.6 million into the Scheme had it had to meet the cost of the augmentations granted between 1992 and 2005. With the Scheme’s ample funding in mind, Mr Fudge had recommended in the 1990 actuarial report that the cost of augmentations should be met from the surplus in the fund rather than by additional employer contributions.
Despite the success which the Scheme’s investment strategy had enjoyed, the question came to be asked whether the Scheme should invest less in return-seeking assets and more in bonds. Equities can be expected to produce higher returns than bonds in the long term, but at a price in terms of risk. Shifting a pension scheme’s investment strategy towards bonds thus “de-risks” the scheme.
In 1999, Mr Thornton of Watson Wyatt was appointed as the Scheme Actuary. At a meeting of the Trustee board in November of that year, Watson Wyatt recommended that the Trustee “reviews its investment policy in the light of the results of an asset liability modelling study”, Mr Singer of Watson Wyatt noting that the Scheme was “now mature”. In February 2000, Mr Singer reported to the Trustee board that the asset liability modelling study had indicated that “an investment strategy … of between 60%-90% in equities could be justified”, although “an argument could be made for a far lower equity content”. The board “agreed in principle to allocate 10% of the UK Equity portfolio to bonds”.
Mr Singer explained in a witness statement that it was Watson Wyatt’s view that the Trustee’s previous investment strategy “did not match the liabilities of the Scheme (i.e. the proceeds – in terms of amount and timing – from the Scheme’s assets were not expected to be the same as the liability outgo from the Scheme) as well as some other strategies, for example, a bond driven strategy”. When giving oral evidence, Mr Singer said:
“the way I, as an actuary, think is not necessarily driven by market sentiment from time to time. It's much more in the nature of do the assets match the liabilities or do they not …. And if they do not, what is the extent of the mismatch and what else can be done about it.”
Other pension funds also reduced their investment in return-seeking assets at about this time. Asked about the position in 2000, Mr Pollock commented that “large pension funds were beginning to move more to bonds and more quickly to bonds than The Prudential did”, albeit that a high equity content remained common. Mr Singer similarly said that over the 1980s and 1990s there had been an increasing recognition of matching issues. Mr Bowie agreed that the principle of matching assets and liabilities had become increasingly popular with pension trustees in recent years, though he thought that that was “principally from 2004/2005 onwards”.
As the 1990s ended, so did the boom in share prices which had taken place during that decade. At the end of 1999, the FTSE index stood at 6930.20. By the end of January 2000, it had dipped to 6268.50, and by January 2003 it had dropped to 3567.40. The index then gradually recovered, reaching 4852.30 in January 2005, the year of Prudential’s decision to adopt the new policy in relation to pension increases.
Stock market performance will have been one of the factors influencing a graph Mr Bowie prepared charting the Scheme’s funding level. The graph shows the Scheme as having had a funding level of about 120% at the beginning of 2000, but that this had fallen to roughly 80% by January 2003. The funding level is depicted as climbing back to just less than 100% by 2006.
In September 2001, the Trustee board discussed the extent to which it should further increase the Scheme’s exposure to bonds, the question having “arisen due to equity movements causing an erosion of the fund”. No decision was taken at this stage, but in November of the following year the board agreed that asset allocation should be considered by a working party. At a board meeting in July 2003, it was reported that the working party had “recommended 55% equity exposure as an appropriate allocation into equities”, and the board resolved that “the equity asset allocation of the Scheme’s funds be set at a strategic weighting of the fund (inclusive of Private equity) of 55% over a period of two years with a review in 12 months time”. This did not wholly accord with Prudential’s wishes. The minutes record:
“Mr Betteridge for the employer supported the broad thrust of the working party’s recommendations, however he felt the level of equity was too high and expressed the employer’s preference for an equity level of 45%. In addition to this, he felt the switch to 45% should be executed over a shorter period of time than two years proposed in the report.”
The minutes also state:
“In reply to a question from the Chairman, Mr Singer [of Watson Wyatt] stated that if the employer were to adopt a risk averse stance then this would have an impact on employer contributions. Mr Singer explained that the employer has a wide discretion with regard to pension increases and, if funding pressures became too great, it need not agree to any discretionary increases, which represent 30% of the fund’s liability. He went on to say that in theory a risk averse employer’s preference for a high bond allocation would consequently require larger contributions from the employer to compensate for relatively low returns.”
When giving evidence about the Trustee board’s 2001 meeting, Mr Abrahams, the chairman, said:
“… at that time all pension funds were really becoming concerned about the volatility that was taking place, about whether equities had really had a very good run and were in for a much less good run and this is the whole background to the matters that we were considering ….”
In January 2004, the Trustee board decided that Mr Betteridge should be invited to attend board meetings at which investment items were to be discussed. This he subsequently did.
Mr Singer remembers thinking during the course of 2004 that there was a serious chance that the Scheme might be moving from surplus into deficit. Mr Parncutt has a recollection of speculation in the latter part of 2004 that the Scheme was likely to be shown as in deficit in the next valuation (which was due in the following year).
In July 2004, Mr Singer wrote to Mr Philip Broadley, who was Prudential’s Group Finance Director as well as being a member of the Trustee board, warning him that he (Mr Broadley) might “wish to budget for an increased level of contribution to the DB Section of the Scheme from 2005”. The letter included three estimates, on different assumptions, of the Scheme’s funding level as at April 2004. On the most prudent of the three, the Scheme had a £214 million deficit and a funding level of only 94%. Mr Singer spoke of “deficiency contributions of, perhaps, £40m pa” being potentially required.
In November 2004, after Mr Mark Wood, the Chief Executive Officer of Prudential UK, had written “to express his views on the current level of equities and the pace of the movement of equities into bonds”, the Trustee board agreed that asset allocation should be reviewed by a working party. The asset allocation and valuation assumptions working party met for the first time in December 2004. Those present included representatives of the Trustee board and Watson Wyatt. Mr Betteridge was also there. Explaining Prudential’s position, Mr Betteridge said that the company “recognises that asset values and the Scheme’s funding level have fallen since the last valuation and that the Scheme is likely to be in a worse financial position as compared with that as at 5 April 2002”. He said that Prudential “would probably wish to reduce the volatility in the future funding requirement, although the cost of doing so would need to be considered and the Company are continuing its work to assess a preferred policy in this regard”. Mr Broadley, who was attending as a director of the Trustee, “suggested that the Trustee might also want to consider adopting a 1 in 200 year approach when setting the appropriate funding policy and asset strategy for the Scheme”. As regards pension increases, the minutes include this:
“The working party noted that a significant issue in developing the funding and investment strategy was the high level of discretionary benefits currently funded for under the Scheme. [Mr Betteridge] noted that the Company’s view was that according to the Scheme’s formal documentation, these discretionary pension increases were certainly discretionary, not guaranteed, but the Company acknowledged that communications provided to members meant that members had strong expectations that these increases would be granted indefinitely. It was noted there have been periods in the past when increases have not matched RPI but catch up exercises mean that pensions are now virtually fully index-linked. It was recognised that the Company might have a ‘nuclear option’ of discontinuing, reducing or suspending such pension increases but members’ expectations may make it difficult.
[Mr Abrahams’] view was also that there was no guarantee to provide such increases but there was a strong expectation. [Mr Pete Davis] also noted that unions had strong expectations of such increases.”
The asset allocation and valuation assumptions working party met again on 25 January and 23 March 2005. In advance of the January meeting, Watson Wyatt prepared a note on “Illustrative funding objectives”. This explained that the Scheme had a sizeable shortfall if its position was assessed on a “buy out” basis or in accordance with FRS17 (an accounting standard whose purpose, as Mr Singer said, was “enabling investors to make cross-company comparisons”). On a gilts-matching basis, the Scheme had a funding level of almost 100% if discretionary pension increases were ignored, but had a large shortfall if allowance was made for such increases. Applying an approach consistent with that adopted for recent valuations (i.e. by reference to “cautious estimates of the long term returns expected on a notional portfolio of assets that closely matched the actual assets held by the Scheme”), Watson Wyatt considered that “the estimated funding level as at 30 September 2004 … might fall in the range 90% to 100%, depending on the assumptions and the level of caution adopted”.
The Trustee board met on 9 February and 6 April 2005. At the February meeting, it was reported that the asset allocation and valuation assumptions working party was “in the midst of its review”. For the April meeting, Mr Parncutt provided a progress report in which he said that an analysis presented to the working party had “suggested that the likely level of discretionary increases and corresponding contributions would be a significant factor in the funding of the Scheme going forward”. The report continued:
“It was agreed that the Company should be asked to consider its preferred contribution pattern and likely policy on discretionary increases. In particular, the Company will need to consider the Trustee’s desire for security for the existing guaranteed level of benefits (ie excluding discretionary increase) to be maintained.”
The minutes of the meeting include a passage in these terms:
“Mr Singer reported that a shortfall in the region of £1 billion would be easy to justify were the Board to take into account the full funding of future discretionary increases. He commented that the world of pension schemes was becoming increasingly risk averse and that reporting in this manner would be the most risk averse approach. Mr Singer further commented that the Board should not unduly worry themselves regarding this £1 billion figure as, in relation to other schemes, this scheme was well funded. Mr Ford [of Watson Wyatt] commented that without the discretionary increases the Scheme would be virtually fully funded.”
During this period, Prudential’s “Portfolio Management Group”, of which Mr Betteridge was Director of Investments, carried out work to model the impact of adopting various investment strategies, levels of Prudential contributions and levels of pension increases. Mr Betteridge and Mr Jones were looking for a combination of measures which was expected to have a less than 50% chance of the Scheme’s funding level being less than 100% after 10 years and a less than 20% chance of the funding level being less than 80% after 10 years. Eight of the permutations modelled satisfied these criteria, but only two allowed for discretionary pension increases. One of the two provided for pension increases at a maximum of 2.5% each year. The other imposed the further condition that the Scheme had to be over 80% funded for there to be pension increases.
Mr Betteridge updated the Trustee board at its meeting on 15 June 2005 and in a paper circulated in advance of the meeting. The paper explained:
“[W]e are therefore looking at the degree of flexibility in the liabilities, particularly the issue of inflation linked payments, which are entirely at the discretion of the Company. In return for a very meaningful increase in Company contributions, the Trustee will be asked to consider whether we might introduce some conditionality in the payment of those increases ….”
The asset allocation and valuation assumptions working party met on 15 July 2005. A Watson Wyatt presentation explained that Prudential wished “to seek the Trustee’s view” on the following proposal:
“• Contributions of the order of £75m pa for 10 years, including minimum contributions (currently around £15m pa),
• Include allowance in funding for discretionary pension increases in line with post 2005 guaranteed pension increases (LPI, max 2.5%), but
• Adopt a more formal process at the time each discretionary increase is considered, to consider whether further funding is required or whether a higher or lower increase should be awarded”.
Watson Wyatt went on:
“This additional funding is expected to allow the Trustee to reduce the reliance on equity returns to fund the Scheme benefits. We have modelled a 50% and 60% allocation to bonds. (The current bond allocation is 32.5% from September 2005.)”
The minutes record that it “was generally accepted by the working party that [the proposal] was a reasonable starting point”.
The Scheme was on the agenda at a PAC board meeting on 25 July 2005. Mr Betteridge attended the meeting, and a paper he and Mr Jones had prepared had been circulated in advance of the meeting. The paper began by stating that the forthcoming valuation of the Scheme by Watson Wyatt would “show a meaningful deterioration in its funding status, or financial health”. It was explained that the previous, 2002, valuation had shown assets of 110% of the estimated liabilities and that “[i]f a gilts discount rate had been used, the scheme would have been 96% funded at that point”. Watson Wyatt now estimated (the paper said) that, using a gilts discount rate, the Scheme would be 75% funded, “equivalent to a capital shortfall of £1.2bn”. The funding of the Scheme “on this basis” had deteriorated because:
“• A much more conservative discount rate has been used.
• Markets have delivered nearly 20% less than what was expected in 2002.
• Contributions since 2002 have been insufficient (by half) to fund ongoing service accrual.”
It was observed that this was “the first time in living memory that the pension fund has shown a deficit” and that there was “no prospect of continuing with the current policy of minimal company contributions and the current heavily equity-oriented investment strategy”. The “saving grace” was that there was “a large degree of flexibility in the liabilities in that annual payments from the Scheme to pensioners to compensate them for the effects of inflation are at the company’s discretion” and, were no such increases to be assumed, “the deficit would fall to zero”. “[S]topping [discretionary inflationary increases] altogether would come as a massive shock and be seen as a breach of commitments previously given” and so had been “ruled … out as an option”. However, “it should be possible to agree with the Trustees a more modest and affordable funding schedule on the basis that [discretionary inflationary increases] are capped or suspended in difficult solvency scenarios”. After extensive discussion, the PAC board decided that further modelling should be carried out and that the subject should be revisited in September.
In the first half of September 2005, the Scheme was considered by both the GEC and PAC’s board. A paper which Mr Betteridge wrote for the GEC meeting noted that it was necessary “to steer a course carefully between a number of stark alternatives, taking decisions on the extent to which we will honour discretionary inflationary increases, enhance company contributions and attempt to persuade the Trustee to shift investment strategy”. A presentation which Mr Betteridge and Mr Jones gave at the GEC meeting showed that, making allowance for discretionary increases, the Scheme had a funding level of 102% if this was calculated in the same way as 2002, but funding levels of only 95% and 75% respectively if the position was assessed on the basis of FRS17 or “Gilts enhanced mortality”. The minutes of the meeting record that “[t]he proposal included the Company exercising its rights to determine any inflation linked increase by reference to fund performance whilst working towards an inflation increase cap of 2.5% as recommended by the Government”, that it was “agreed that the proposal should be put to the Trustees on the basis that it would remain in place until the next valuation in approximately three years time” and that it was “also agreed that a more conservative investment policy should be followed to protect the Fund from a further downturn in the market”.
The PAC board met a few days later. The minutes record that Mr Jones explained that the “proposal was to limit payments to the statutory maximum (2.5%) and making explicit the option in the future to suspend [discretionary inflationary increases] when fund solvency was poor and to have the ability to pay higher inflation if the fund would stand it”. The minutes go on to state that the board “confirmed that it was happy with the proposed [discretionary inflationary increases] policy” and “would confirm its final approval at the next meeting”.
There was a meeting of the Trustee board on 14 September 2005, for part of which Mr Betteridge and Mr Jones were in attendance. Mr Jones explained that Prudential was proposing “to increase the level of contributions by £75 million per year for 10 years in addition to an asset allocation strategy that would be more matched to the liabilities of a mature scheme”. The minutes state:
“The Chairman commented that the strategy outlined by Mr Jones was accompanied by a hugely increased funding proposition from the Company. It would be necessary for the Trustee to arrange a working party to consider this proposal, and put any issues to the Board for discussion. He noted that on the surface it would seem that the Trustee would approve such a proposal as it produced certainty where there was none. He further noted that in normal foreseeable circumstances the discretionary increases should be paid.”
According to the minutes, Mr Jones had told the board that “if inflation were to rise above 2.5% then increases above this figure should be able to be paid”. Mr Jones explained in evidence that he did not recall making a statement in exactly those terms; he thought that what he had been saying was that Prudential would reserve the right to pay increases of above 2.5% if inflation exceeded this level but without committing it to the circumstances in which it might exercise that option. Mr Keith Rowley QC, who appears with Miss Elizabeth Ovey for the Beneficiaries, pointed out that the minutes had been approved as they stand at a subsequent meeting of the Trustee board, but (a) Mr Jones was not present at the time and (b) it is not uncommon for details in minutes of meetings to contain minor inaccuracies. That that is true of these particular minutes is perhaps indicated by the fact that they refer to contributions being increased “by” £75 million when what was in prospect was surely an increase to £75 million. In any case, Mr Jones confirmed what Prudential was envisaging in writing, in a letter to Mr Abrahams dated 5 October 2005. This included the following:
“We … have taken the latest UK government standard as being appropriate. This is Limited Price indexation for pensions with a ceiling of 2.5%. Unlike the government standard, Prudential’s policy would be to apply this to the total pension in payment and not just the pension accrued since LPI was introduced. This would form the employer’s policy. The decision to apply this increase would be approved every year but it would be departed from only in exceptional circumstances. If the solvency of the fund became weakened to a level where it would be imprudent to apply the increase, it would be suspended for one or more years as appropriate. If, on the other hand, inflation were to rise above 2.5% and the strength of the fund supported [discretionary inflationary increases] at a higher level, the employer would ask the trustee to pay a higher level of increase.”
The asset allocation and valuation assumptions working party once more met on 11 October 2005. The Scheme was again considered by the PAC board at a meeting on 7 November 2005. A paper from Mr Betteridge and Mr Jones explained that Watson Wyatt had now calculated that “[o]n an actuarial funding basis, using as discount the 65th percentile of the expected asset return, assuming a shift to a 60% bond strategy, the deficit was £243m at 5 April 2005, a funding level of 94%”. The paper also observed that the Scheme “will be subject to actuarial review at least every three years and there will be ample opportunity to renegotiate the deficit proportion at that time”. The board confirmed its agreement to proposals with, among others, these features:
“(i) DII: it was the Company’s intention to award discretionary pension increases in future in line with RPI subject to a normal maximum of 2.5%pa. Those increases could be suspended for one or more years if the financial position of [the Scheme] deteriorated materially. But higher increases could be paid if RPI exceeded 2.5% in any year and the then financial position of the Scheme supported the award of a higher level of increase.
(ii) Contributions: the valuation had assumed a flat £75m pa from the Company, which, given an amount of £40m pa to service ongoing accrual, implied ten years of deficit-reducing contributions of £35m. It had been made clear to the trustees that the Company would like to contribute an amount for ongoing service accrual plus £35m pa.
(iii) Asset allocation strategy: it had been pointed out to the trustees that the company was tripling its current contribution and requested in response an asset strategy for [the Scheme] which reduced the possibility of having to make substantial extra contributions because of an equity market fall, suggesting at least a doubling of the bond proportion to 60% ….”
Prudential’s proposals were discussed on 9 November 2005 at what is described in notes of the meeting as “a meeting of a number of the trustees and representatives from the company on the funding of the Scheme”. The notes record that one of the Trustee’s directors, Ms Brewer, “asked whether this was the start of the negotiations with the employer in respect of a contribution figure”, to which Mr Jones replied that the employer was “not at the start of the process” and that the £75 million figure was “not intended to be an opening bid in a bartering process”. Mr Jones confirmed the point in an email to Mr Abrahams of 15 November.
The Scheme featured at a meeting of the board of Prudential plc on 10 November 2005. The minutes state shortly:
“It was noted that the trustees of the Prudential Pension Scheme would be meeting the following week when they would be asked to consider increased funding proposals from the company and to effect a change in the investment mix in order to remove the deficit over time.”
The meeting of the Trustee board took place on 16 November 2005. Mr Betteridge told the board that Prudential’s proposal had been “discussed and approved at the GEC, the Prudential plc board, and the PAC board”. The board proceeded to discuss the proposal in the absence of Mr Betteridge and Mr Jones, and then to explore aspects of it with Mr Betteridge and Mr Jones. Mr Betteridge and Mr Jones having left the meeting again:
“IT WAS RESOLVED THAT subject to a couple of minor investment issues to be clarified by John Betteridge the proposal of the employer based around the contribution of £75million per annum over 10 years and the movement into 60% bonds be approved.”
The 2005 valuation
The Scheme’s 2005 valuation was signed off by Watson Wyatt on 3 April 2006. This depicted the Scheme as having as at 5 April 2005 a 94% funding level (or a shortfall of £243 million). In preparing the valuation, Watson Wyatt assumed that 60% of the Scheme’s assets would be invested in bonds (as had by now been agreed between Prudential and the Trustee). The valuation also records that the agreed funding plan “makes allowance for future pension increases on the excess over Guaranteed Minimum Pensions in line with future price inflation” (i.e. for pensions to increase in line with RPI).
The valuation compared the £376 million surplus shown in the previous (2002) valuation with what had become a £243 million shortfall. The following items were listed as contributing to the change:
“- shortfall of employer contributions over the cost of benefit accrual over the intervaluation period (41)
- augmentation of benefits (6)
- investment return achieved relative to the 2002 valuation assumption, net of adjustment to future investment return assumption to reflect changing market conditions, and other miscellaneous items (411)
- effect of change assumed future investment strategy, and corresponding reductions in the assumed future investment return (315)”
In other words, much the largest factors were (a) poor investment performance and (b) the shift from return-seeking investments to bonds.
Pension increases in 2006-2010
2006
In January 2006, Watson Wyatt supplied a note giving an update on the Scheme’s funding position. The note was prepared for the Trustee, but on the basis that it would be made available to Prudential. Watson Wyatt considered the Scheme’s long-term and medium-term funding targets and found that neither provided a reason for the Trustee to decline to agree a 2.5% increase in pensions. Watson Wyatt explained in their note that, were pensions to be increased by 2.7% (in line with RPI) rather than 2.5%, the funding level would fall by 1% (from 94% to 93%) on a medium-term basis and by 0.2% on a long-term basis. At the meeting of the Trustee board on 2 February 2006, Mr Singer “confirmed that the fund could support either level of increase and stated that either 2.5% or 2.7% in relation to the medium-term effect on the fund would be marginal”.
Mr Jones took the view that the increase should be 2.5%, and the GEC endorsed a recommendation to that effect. When, however, Prudential’s decision was discussed by the Trustee board on 2 February 2006, objections were raised. Mr Pete Davis, for example, is recorded as saying that “Prudential would not treat its customers in this way as the FSA would not permit it to do so and the same principle should be applied to Prudential pensioners”. It was agreed that Mr Abrahams, as chairman, should request Prudential to award 2.7% “on the basis that no notice had been given to members of the new policy”. On 13 February, however, the PAC board decided to award a 2.5% increase. The minutes state:
“The Board rejected the request for payment of 2.7%, as opposed to 2.5%, on the grounds that the employer wished to adhere to the agreed policy, which had not been to commit to payment of full RPI. Although the difference between the two alternatives was small in the context of [Scheme] liabilities, it represented a material amount, £4 million.”
When giving evidence about the 2006 pension increase, Mr Parncutt agreed that the Trustee board was as concerned as Prudential about the impact of discretionary increases on the Scheme.
2007
In 2007, the relevant RPI figure was 3.6%. Mr Jones proposed that pensions should be increased by 2.75%, and the GEC agreed. In a paper prepared for the GEC, Mr Jones had said:
“While an increase in line with RPI is not defensible given the state of the fund, an increase of say 2.75% would demonstrate our willingness to act proportionately and exercise our discretion. Some of those who have criticised our policy have said that the company will never pay more than 2.5%. An additional benefit of paying 2.75% is that it demonstrates that the company is carrying out in practice what it said it would do.”
Earlier in his paper, Mr Jones had said:
“The latest funding position of the scheme … shows that the financial strength of the fund has increased since the 2005 valuation and that
(i) on the long term funding target, which includes an allowance for discretionary increases in line with full RPI, the scheme funding level is 100%; and
(ii) on the medium term funding target, which makes no allowance for future discretionary increases, there is a surplus of £114m, which represents a funding level of 103%.”
The Trustee board noted the proposed increase at a meeting on 7 February 2007, and the GEC’s decision was approved by the PAC board on 7 March 2007.
2008
In 2008, the relevant RPI figure was 3.9%. By now, Mr Jones had retired and been replaced by Mrs Hilary Oliver (“Mrs Oliver”). On Mrs Oliver’s instructions, Mr Parncutt prepared a paper for the GEC recommending a 2.75% increase in pensions. The paper explained:
“Taking into account the current funding position of the Scheme, an increase of 3% can be considered. Conversely, the policy that has been announced is to limit increases to 2.5% until the long term funding position is more secure. However, an increase awarded in 2007 was greater than 2.5%. This was because it was decided to share with pensioners the improved funding position by way of an increase slightly above 2.5% i.e. 2.75%. As the fund is currently in a better financial position compared to 2007, it is still able to afford a discretionary increase greater than 2.5%.”
However, the GEC concluded that “the proper decision would be to stand by the 2.5% cap agreed in 2005”, and the PAC board likewise took the view that the pension increase should be limited to 2.5%.
At the request of the Trustee board, Mr Parncutt wrote to Prudential’s Group HR Director to ask for details as to how the proposed increase for 2008 (which the board then understood to be 2.75%) had been determined. Replying to Mr Parncutt’s letter, Mrs Oliver said:
“In conclusion, we believe that the fund should be on a firm financial footing and that the market outlook should be good before we make any discretionary rises above our stated policy.”
When giving evidence about the 2008 pension increase, Mr Parncutt said:
“Without being flippant, my Lord, I was getting confused as to what the policy was. It seemed to be changing -- frequently may be not the right word, but depending on who we had discussions with, whether it's Mr Jones who initially laid out what their policy was, was fairly clear, and it then depended on whether we were talking to John Betteridge or indeed Ms Oliver, so -- which is why the trustee was getting quite concerned about what their investment strategy proposal should be going forward, and were forever seeking clarification as it what the discretionary increase policy would be.”
2009
In 2009, the relevant RPI figure was 5%. By this point, a Group Pension Committee was in being, and it considered the pension increase at a meeting on 15 January 2009. The committee agreed to recommend a 2.5% increase to the GEC. The minutes of the meeting record:
“The policy was to pay discretionary increases at a maximum of LPI 2½%. Traditionally, the RPI figure in September had been used when considering the level of increase. Mrs Oliver advised that the September RPI figure was 5%, although it had fallen considerably since September and was predicted to fall further in 2009.
It was noted that in the current market situation, it was likely that most employees would receive salary increases below 2.5% and that 2009 was not the year to be paying large increases to pensioners, although it was recognised that pensioner inflation had been high in 2009.”
On 28 January 2009, Mr Singer wrote to Mr Parncutt with information about the cost of the proposed 2.5% increase and also, at Mr Parncutt’s request, a 5% increase. Asset cover for guaranteed benefits as at 5 April 2008 was calculated to stand at around 97% (up from 94% in 2005), but Mr Singer warned that “the position appears to have worsened” and that “it is difficult to know the true extent of this worsening given the extreme market conditions currently being experienced”. Mr Singer explained that a 2.5% increase would worsen the funding position by some £50 million and that a 5% increase would result in an increase of double this, approximately £100 million. Mr Singer said that he was “content to certify that there is no immediate need for additional contributions to be made at this stage consequential to the granting of a discretionary increase of 2.5%”. He did not comment on whether the Scheme could support a 5% increase.
The GEC endorsed the proposed 2.5% increase at a meeting on 17 February 2009. It had been provided with a note from Mrs Oliver in which it was said:
“The policy that has been announced is to limit increases to 2.5% until the long term funding position is more secure. Though the valuation to 5 April 2008 indicates that the scheme is very well funded with just a 3% short fall on a solvency basis, C. £140M, the position by 31/12/08 had substantially worsened. The deficit at 31 December is c. £680M on a gilts basis some 14% of the total assets at that date.”
The PAC board adopted the 2.5% figure at a meeting on 24 February 2009.
It is, perhaps, one of the less immediately appealing features of the story that Prudential also sought to reduce its contributions to the Scheme at this stage. Prudential proposed that its annual contributions should be reduced from £75 million to £50 million, and the Trustee agreed after Prudential had confirmed that the “current constraints on capital are such that a saving of £25m pa is sufficiently critical to the business”. In fairness, I should record too that the number of active DB Members, and hence the sums which Prudential was obliged to contribute under rule 2.4 of the Rules, had also fallen since 2005.
2010
In 2010, the RPI figure was a negative one: -1.4%. The Group Pension Committee suggested that there should be either no increase or one of 1%. The GEC preferred the former alternative, and the PAC board approved its recommendation to that effect.
The Good Faith Issues
The Imperial case
The obligation of good faith was first recognised in a pensions context in Imperial Group Pension Trust Ltd v Imperial Tobacco Ltd. In that case, Browne-Wilkinson V-C noted that contracts of employment contain an implied term “that the employers will not, without reasonable and proper cause, conduct themselves in a manner calculated or likely to destroy or seriously damage the relationship of confidence and trust between employer and employee” and said (at 597) that that obligation (which Browne-Wilkinson V-C termed “the implied obligation of good faith”):
“applies as much to the exercise of his rights and powers under a pension scheme as they do to the other rights and powers of an employer”.
Browne-Wilkinson V-C went on to explain that a claim for breach of the obligation of good faith need not be founded “in contract alone” (597). He said (at 597-598):
“Construed against the background of the contract of employment, … the pension trust deed and rules themselves are to be taken as being impliedly subject to the limitation that the rights and powers of the company can only be exercised in accordance with the implied obligation of good faith.”
Browne-Wilkinson V-C explained in his judgment that the obligation of good faith requires an employer to “exercise its rights (a) with a view to the efficient running of the scheme established by the fund and (b) not for the collateral purpose of forcing the members to give up their accrued rights in the existing fund subject to this scheme” (598-599). With regard to (a), Browne-Wilkinson V-C said (at 599):
“it would be a breach of the obligation of good faith if the company were to say that it would never consider whether or not to consent to an amendment increasing benefits. In my judgment the obligation of good faith resting on the company as employer requires that it should consider each proposal for amendment under clause 36 [of the relevant trust deed] put forward by the committee at the time it is put forward in the light of the circumstances that then exist. A blanket refusal by an employer to consider amendments of a kind which are beneficial to the employees and which have for the last 20 years been acceptable to the employer is plainly calculated to undermine the trust of the employees in their employer. Good faith requires the company to consider the proposals each time they are made.”
As for (b), Browne-Wilkinson V-C said (at 599):
“the starting point must be that there is in existence a trust to provide pension benefits for a closed class of employees. In my judgment, the obligation of good faith requires that the company should not exercise its rights for the purpose of coercing that class to give up its rights under the existing trust. The duty of good faith requires the company to preserve its employees’ rights and pensions fund, not to destroy them. If there are financial and other considerations which require the fund to be determined, so be it. But if the sole purpose of refusing to consent to an amendment increasing benefits is the collateral purpose of putting pressure on members to abandon their existing rights, including the right to the surplus on determination, in my judgment the company would not be acting in good faith.”
Elsewhere in his judgment, Browne-Wilkinson V-C said (at 597) that an employer could breach the obligation of good faith if “in purported exercise of its right to give or withhold consent, [it] were to say, capriciously, that it would consent to an increase in the pension benefits of members of union A but not of the members of union B”.
Browne-Wilkinson V-C made clear that the obligation of good faith is not to be equated with an obligation to act reasonably. He said (at 597):
“I can see no necessity to engraft an implied limitation of reasonableness on to the company's right to refuse consent under clause 36 [of the relevant trust deed]. On the contrary, there are many good reasons why such limitation should not be implied …. [I]n all pension schemes, including this one, the company has a direct personal interest in how the scheme is to operate for the future. Any change in benefits may well be reflected in the company having to make increased contributions. What is ‘reasonable’ from the point of view of the company may be unreasonable viewed through the eyes of the pensioners. Which viewpoint would the court have to adopt in testing reasonableness? Would the court have to seek to balance the reasonableness of both viewpoints? In the context of a pension scheme, a test of unreasonable withholding of consent would be unworkable.”
In similar vein, Browne-Wilkinson V-C said (at 598):
“… the relevant question is not whether the company is acting reasonably. As I have said, where the interests of the company and the members are in direct conflict, it is impossible to say, for example, that the company is acting in breach of its obligations just because it would be reasonable to rely on the existing surplus as a basis for consenting to an increase in the pension benefits beyond the guaranteed 5 per cent. minimum. It must be open to the company to look after its own interests, financially and otherwise, in the future operations of the scheme in deciding whether or not to give its consent.”
Subsequent authority
Pension cases
The scope of the obligation of good faith has been the subject of comment in a number of pension cases since Imperial. I do not think I need refer to all of the ones to which I was taken, but I shall mention a few.
The earliest in time is Stannard v Fisons Pension Trust Ltd [1991] PLR 225. In that case, one member of the Court of Appeal, Staughton LJ, said that it might “even be that for [an employer] to make a reduction [in its rate of contribution to a pension scheme] would in some circumstances be a breach of contract with its employees”, citing Imperial as authority.
In National Grid Company plc v Laws [1997] PLR 157, Robert Walker J noted (in paragraph 88) that “the Imperial Tobacco duty does not prevent the employer from looking after its own financial interests, even where they conflict with those of members and pensioners”. When the case reached the House of Lords on other points, Lord Hoffmann observed that the members had accepted that Robert Walker J had been right to take the view that the employer “was entitled to act in his own interests provided that he had regard to the reasonable expectations of the members”: see National Grid Co plc v Mayes [2001] 1 WLR 864, at paragraph 11.
In Hillsdown Holdings plc v Pensions Ombudsman [1997] 1 All ER 862, Knox J noted (at 889) that Browne-Wilkinson V-C had used the expression “obligation of good faith” as a “form of shorthand” for the “implied obligation … that powers should not be exercised so as to destroy or seriously damage the relationship of confidence and trust between the employer and its employees and former employees”. Knox J emphasised that the formulation “does not carry the implication that a failure to observe the implied obligation involved would amount to bad faith in the pejorative sense in which that expression is often used”.
Knox J also said (at 890):
“The other power which Hillsdown [i.e. the employer] had was to suspend or determine its contributions …. Clearly that power was given to it for its own benefit and there can be no question of fiduciary duty being owed in relation to its exercise. But where it does seem to me that the obligation of good faith would have applied to restrain Hillsdown's unilateral pursuit of its own interests without a proper regard to those of its employees and retired employees would have been in a combined operation of the power to adhere further employers while at the same time suspending its contributions which would otherwise have been payable in respect of them for the purpose of running down a surplus certified to have arisen ex hypothesi in relation to the service of the employees of other employers which were in the … scheme before the date as at which the surplus was certified. I say this for two reasons. The first is that the surplus thus certified was in the disposition of the trustees alone under the express terms of r 23(a) [of the relevant trust deed] and Hillsdown had no right to interfere with its exercise and, secondly, because it would in my view constitute a breach of the implied obligation of good faith on the one hand to enlarge the class of employers and so bring in large categories of new members and at the same time to decline to make contributions in respect of such new members for the purpose of running off a surplus which had arisen in relation to other members who were members at the time as at which the surplus was certified. It is one thing for an employer to take a contributions holiday in respect of a category of existing members and quite another to introduce a large class of new members and take a contributions holiday in relation to them so as to accelerate the effect of the contributions holiday in relation to the existing members.”
In Air Jamaica Ltd v Charlton [1999] 1 WLR 1399, Lord Millett, delivering the judgment of the Privy Council, said (at 1411):
“the [employer’s] power to amend the [pension] plan was subject to an obligation to exercise it in good faith: see Imperial Group Pension Trust Ltd. v. Imperial Tobacco Ltd. …. The company [i.e. the employer] was not entitled simply to disregard or override the interests of the members. Once it became likely that the plan would be wound up, the company would have to take this fact into account, and it is difficult to see how the plan could lawfully be amended in any significant respect once it had actually been discontinued. But even if it could, their Lordships are satisfied that it could not be amended in order to confer any interest in the trust fund on the company. This was expressly prohibited by clause 4 of the trust deed. The 1994 amendments included a purported amendment to the trust deed to remove this limitation, but this was plainly invalid. The trustees could not achieve by two steps what they could not achieve by one.”
Browne-Wilkinson V-C’s decision in Imperial has also been considered in a Canadian case with a similar name, Lloyd v Imperial Oil Ltd 2008 ABQB 379. There, Wittmann ACJ concluded that the employer had not acted in breach of a duty of good faith. He said:
“[113] The fact that Imperial [i.e. the employer] may have acted in self interest did not of itself result in a breach of a duty of good faith where the outcome of Imperial’s action was otherwise consistent with the scope of the Pension Plan. Imperial was entitled to amend the Pension Plan under the terms of the Pension Plan itself and under the applicable Ontario and Alberta legislation. Nowhere in the Plan or in the legislation is Imperial precluded from making amendments in its own interests ….
[114] Even if Imperial was motivated by financial self-interest, there is no evidence that Imperial was acting in an underhanded manner or for some collateral purpose. I do not see how Imperial, acting in its capacity as employer and exercising its right to amend in accordance with the terms of the Pension Plan and the applicable legislation, could be said to have been acting in bad faith.”
Employment cases
The employer’s contractual obligation of trust and confidence (from which Browne-Wilkinson V-C’s “obligation of good faith” stemmed) has been considered in an employment context on many occasions since the Imperial case was decided, including in several House of Lords cases.
In the first of the House of Lords cases, Malik v Bank of Credit and Commerce International SA [1998] AC 20, the obligation of trust and confidence was endorsed. Lord Steyn, with whom Lords Goff, Mackay and Mustill expressed agreement, said (at 110) that he regarded “the emergence of the implied obligation of mutual trust and confidence as a sound development”. Lord Nicholls, with whom Lords Goff and Mackay also agreed, said (at 34-35) that “an implied obligation to … employees not to conduct a dishonest or corrupt business” was “no more than one particular aspect of the portmanteau, general obligation not to engage in conduct likely to undermine the trust and confidence required if the employment relationship is to continue in the manner the employment contract implicitly envisages”.
Lord Nicholls and Lord Steyn each favoured an objective approach. Lord Nicholls observed (at 35) that the conduct of which complaint is made must “impinge on the relationship in the sense that, looked at objectively, it is likely to destroy or seriously damage the degree of trust and confidence the employee is reasonably entitled to have in his employer”. Lord Steyn said (at 47):
“The motives of the employer cannot be determinative, or even relevant, in judging the employees’ claims for damages for breach of the implied obligation. If conduct objectively considered is likely to cause serious damage to the relationship between employer and employee a breach of the implied obligation may arise.”
In Gogay v Hertfordshire County Council [2000] IRLR 703, a Court of Appeal case, Hale LJ, with whom the other members of the Court agreed, took it as “now well settled that there is a mutual obligation implied in every contract of employment, not, without reasonable and proper cause, to conduct oneself in a manner likely to destroy or seriously damage the relationship of confidence and trust between employer and employee” (paragraph 53). Turning to the question whether, in the case before the Court, the employer’s conduct amounted to a breach of the implied term, Hale LJ said (in paragraph 55):
“The test is a severe one. The conduct must be such as to destroy or seriously damage the relationship.”
In the next House of Lords case, Johnson v Unisys Ltd [2003] 1 AC 518, Lord Steyn said (at paragraph 24) that the “obligation of good faith” could “also be described as an employer’s obligation of fair dealing”. Some further indication as to the nature of an employer’s contractual duties can perhaps be found in Lord Hoffmann’s speech, with which Lords Bingham and Millett expressed agreement. Lord Hoffmann said (in paragraph 43):
“In Wallace v United Grain Growers Ltd 152 DLR (4th) 1, 44-48, McLachlin J (in a minority judgment) said that the courts could imply an obligation to exercise the power of dismissal in good faith. That did not mean that the employer could not dismiss without cause. The contract entitled him to do so. But in so doing, he should be honest with the employee and refrain from untruthful, unfair or insensitive conduct. He should recognise that an employee losing his or her job was exceptionally vulnerable and behave accordingly. For breach of this implied obligation, McLachlin J would have awarded the employee, who had been dismissed in brutal circumstances, damages for mental distress and loss of reputation and prestige.”
The last of the House of Lords cases is Eastwood v Magnox Electric plc [2004] UKHL 35, [2005] 1 AC 503. In that case, Lord Nicholls (with whom Lords Hoffmann, Rodger and Brown expressed agreement) said this (at paragraph 11):
“The trust and confidence implied term means, in short, that an employer must treat his employees fairly. In his conduct of his business, and in his treatment of his employees, an employer must act responsibly and in good faith.”
In the same case, Lord Steyn referred (in paragraph 40) to a power to suspend being exercised “with due regard to trust and confidence (or fairness)”. In this case, as in Johnson v Unisys Ltd, Lord Steyn’s approach differed somewhat from that of the majority of the House of Lords, but not in a relevant respect.
It is also relevant to note at this stage two cases concerned with the payment to employees of discretionary bonuses. The earlier of these is Clark v Nomura International plc [2000] IRLR 766. In that case, Burton J said (in paragraph 40):
“Even a simple discretion whether to award a bonus must not be exercised capriciously … or without reasonable or sufficient grounds …. I do not consider that either of these definitions of the obligation are entirely apt, when considering whether an employer was in breach of contract in having exercised a discretion which on the face of the contract is unfettered or absolute, or indeed even one which is contractually fettered such as the one here considered. Capriciousness, it seems to me, is not very easy to define …. It can carry with it aspects of arbitrariness or domineeringness, or whimsicality and abstractedness. On the other hand the concept of ‘without reasonable or sufficient grounds’ seems to me to be too low a test. I do not consider it is right that there be simply a contractual obligation on an employer to act reasonably in the exercise of his discretion, which would suggest that the court can simply substitute its own view for that of the employer. My conclusion is that the right test is one of irrationality or perversity (of which caprice or capriciousness would be a good example) ie that no reasonable employer would have exercised his discretion in this way …. Such test of perversity or irrationality is not only one which is simple, or at any rate simpler, to understand and apply, but it is a familiar one, being that regularly applied in the Crown Office or, as it is soon to be, the Administrative Court. In reaching its conclusion, what the court does is thus not to substitute its own view, but to ask the question whether any reasonable employer could have come to such a conclusion.”
The other case is the decision of the Court of Appeal in Keen v Commerzbank AG [2006] EWCA Civ 1536, [2007] ICR 623. In that case, the claim had “not been pleaded, argued or decided on the basis of breach of an implied duty of trust and confidence”, probably because the employee claimant “[wanted] more than adequate reasons to be supplied in respect of the bonuses that he has received” (Mummery LJ, at paragraph 47). However, Mummery LJ, with whom the other members of the Court expressed agreement, commented on the duty of trust and confidence in these terms:
“43 The employment relationship contains implied duties which do not normally feature in commercial contracts sued on by business men in the Commercial Court or in the exercise of public law discretions challenged by citizens in the Administrative Court. Employment is a personal relationship. Its dynamics differ significantly from those of business deals and of state treatment of its citizens. In general there is an implied mutual duty of trust and confidence between employer and employee. Thus it is the duty on the part of an employer to preserve the trust and confidence which an employee should have in him. This affects, or should affect, the way in which an employer normally treats his employee.
44 Consistent with this duty an employer ought to supply an employee with an explanation of the reasons for the exercise of a discretion in respect of additional pay. Unless there is a good reason to the contrary the explanation ought to be given by the person(s) responsible for the decision affecting additional pay.
45 Like the judge, I am concerned about the lack of direct evidence from any person involved in the exercise of the discretion concerning bonus payments. If the parties have agreed that an employer should have a discretion to decide, by reference to certain factors, whether an employee should be paid additional remuneration by way of bonus for work done under the contract of employment and, if so, how much, the employer is under an obligation to treat his employee fairly in explaining the situation. This would involve making known to the employee, quite apart from any duty of disclosure in litigation, the factors which have influenced the decision, by whom the decision was taken and the reasons for the decision taken.”
The scope of the “obligation of good faith”
The parties’ cases
Mr Rowley argued that the “obligation of good faith” involves an obligation to act fairly. In support of this submission, he relied on passages in Johnson v Unisys Ltd and Eastwood v Magnox Electric plc, including those in which Lord Steyn said that the “obligation of good faith” could “also be described as an employer’s obligation of fair dealing” (in Johnson), Lord Nicholls said that the “trust and confidence implied term” required an employer to “treat his employees fairly” and to “act responsibly and in good faith” (in Eastwood) and Lord Steyn spoke of “due regard to trust and confidence (or fairness)” (Eastwood again). Mr Rowley also relied on remarks made by Lord Bingham in Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd [1989] QB 433 and Director General of Fair Trading v First National Bank plc [2001] UKHL 52, [2002] 1 AC 481. In the latter case, which concerned the Unfair Terms in Consumer Contracts Regulations 1994, Lord Bingham said (in paragraph 17):
“The requirement of good faith in this context is one of fair and open dealing. Openness requires that the terms should be expressed fully, clearly and legibly, containing no concealed pitfalls or traps.”
In the Interfoto case, Lord Bingham (as Bingham LJ) said (at 439) of the obligation of good faith which civil law systems recognise in relation to contractual dealings:
“… its effect is perhaps most aptly conveyed by such metaphorical colloquialisms as ‘playing fair,’ ‘coming clean’ or ‘putting one’s cards face upwards on the table’. It is in essence a principle of fair and open dealing.”
Mr Rowley argued that, when assessing whether there had been “fair and open dealing”, the Court should look to both the manner in which a decision was reached and the substance of the decision. In the context of an occupational pension scheme, the Court should, Mr Rowley said, have regard in particular to members’ legitimate expectations. Mr Rowley drew an analogy with the “fair-dealing rule” which applies to fiduciaries. In Tito v Waddell (No 2) [1977] Ch 106, Megarry V-C summarised the fair-dealing rule in these terms (at 241):
“The fair-dealing rule is (again putting it very shortly) that if a trustee purchases the beneficial interest of any of his beneficiaries, the transaction is not voidable ex debito justitiae, but can be set aside by the beneficiary unless the trustee can show that he has taken no advantage of his position and has made full disclosure to the beneficiary, and that the transaction is fair and honest.”
For his part, Mr Michael Tennet QC, who appears with Mr Rupert Reed for Prudential, observed that rule 7.3 of the current Rules (and its predecessors) did not in terms impose any restrictions on the discretion it conferred on Prudential. Mr Tennet recognised that the obligation of good faith meant that Prudential did not have an absolute discretion, and he accepted in particular (by reference to Clark v Nomura International plc) that an irrational or perverse decision could be attacked. He argued, however, that there is no requirement on an employer exercising such a power to have regard to particular matters when making decisions. It is right, Mr Tennet contended, that the restrictions on the exercise of such a power should be less rigorous than those that apply to fiduciary powers. If “fair dealing” is relevant at all, it is not to be taken, Mr Tennet said, as requiring an employer to arrive at a “fair” result or to balance his own interest in a “fair” or “reasonable” way against those of members. Mr Tennet also submitted that, for the obligation of good faith to be breached, the conduct in question must be serious: where a member remains an employee, the conduct must, viewed objectively, be so destructive of the relationship of trust between employer and employee that the employer may be taken to have repudiated the contract of employment.
Discussion
The obligation of good faith is rooted in employment law’s implied duty to preserve trust and confidence. It was by reference to the latter duty that Browne-Wilkinson V-C justified the former, explaining that the duty as to trust and confidence applied “as much to the exercise of [an employer’s] rights and powers under a pension scheme” as to an employer’s other rights and powers. In Johnson v Unisys Ltd, Lord Steyn observed (in paragraph 24) that the Imperial case “did not involve trust law and the employer was not treated as a fiduciary”; the case, Lord Steyn opined, “was decided on principles of contract law”.
Given the origins and rationale of the obligation of good faith, it must be appropriate to have regard to how the duty of trust and confidence has developed since Imperial. Browne-Wilkinson V-C took the view that the duty of trust and confidence applied in a pensions context. If subsequent authority casts light on that duty, there can be no reason to disregard it. It would make no sense to freeze-frame the duty of trust and confidence as it appeared at the date of Browne-Wilkinson V-C’s decision.
As Mr Rowley pointed out, post-Imperial cases have included references to fairness. In Eastwood v Magnox Electric plc, Lord Nicholls said that the trust and confidence implied term meant that an employer must treat his employees “fairly” and Lord Steyn spoke of “due regard to trust and confidence (or fairness)”; in Johnson v Unisys Ltd, Lord Steyn had equated the obligation of good faith with an “obligation of fair dealing”. Even so, I agree with Mr Tennet that the obligation of good faith is not to be taken as requiring an employer to arrive at a decision which is substantively “fair” when exercising a power given to him in apparently unfettered terms by pension scheme rules. No support for such a requirement is to be found in Imperial or the subsequent pension authorities. In Imperial itself, Browne-Wilkinson V-C rejected in terms “an implied limitation of reasonableness”; he would surely have been no more receptive to a submission that decisions had to be substantively fair. Nor, to my mind, do the employment law cases suggest that there is such a rule. So far as I am aware, there is, for example, no indication that decisions made as to discretionary bonuses must be substantively fair. I doubt, moreover, whether Tito v Waddell (No 2) or the passages to which I was referred from the Interfoto and Director General of Fair Trading cases are of any real help with this area of the law; the context is too different.
In the Imperial case, Browne-Wilkinson V-C said that the obligation of good faith could be breached if an employer acted “capriciously”. With discretionary bonuses, the Courts have adopted the slightly different test of irrationality or perversity (see paragraph 135 above). I agree with Mr Tennet that an irrational or perverse decision by an employer in a pensions context is likewise capable of offending the obligation of good faith. If the Courts will interfere on the basis of irrationality or perversity with decisions made by employers in relation to discretionary bonuses, I can see no reason why they should not intervene on the same grounds in relation to decisions made by employers with regard to pension schemes. In Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287, [2005] ICR 402, a discretionary bonus case, Potter LJ, giving the judgment of the Court of Appeal, said (in paragraph 30):
“While, in any such situation, the parties are likely to have conflicting interests and the provisions of the contract effectively place the resolution of that conflict in the hands of the party exercising the discretion, it is presumed to be the reasonable expectation and therefore the common intention of the parties that there should be a genuine and rational, as opposed to an empty or irrational, exercise of discretion.”
In my view, a power to increase a pension similarly requires “a genuine and rational, as opposed to an empty or irrational, exercise of discretion”.
Assessing whether a decision was irrational or perverse is not, however, to be equated with the application of an objective standard of reasonableness. The Court of Appeal distinguished between the two in Socimer Bank Ltd v Standard Bank Ltd [2008] EWCA Civ 116, [2008] Bus LR 1304, where Rix LJ said (in paragraph 66):
“It is plain from these authorities that a decision-maker's discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused. Reasonableness and unreasonableness are also concepts deployed in this context, but only in a sense analogous to Wednesbury unreasonableness, not in the sense in which that expression is used when speaking of the duty to take reasonable care, or when otherwise deploying entirely objective criteria: as for instance when there might be an implication of a term requiring the fixing of a reasonable price, or a reasonable time. In the latter class of case, the concept of reasonableness is intended to be entirely mutual and thus guided by objective criteria …. Laws LJ in the course of argument put the matter accurately, if I may respectfully agree, when he said that pursuant to the Wednesbury rationality test, the decision remains that of the decision-maker, whereas on entirely objective criteria of reasonableness the decision-maker becomes the court itself.”
How far are members’ interests relevant? Mr Tennet disputed that there was any positive obligation on an employer in Prudential’s position to take into account or balance the interests of members. Relying, in particular, on passages from Browne-Wilkinson V-C’s judgment in Imperial and Robert Walker J’s in National Grid Company plc v Laws (as to which, see paragraphs 121 and 124 above), he argued that an employer is entitled to act in his own interests and that it would be nonsensical to expect him fairly to balance his interests against those of members. Mr Rowley, on the other hand, submitted that the interests and expectations of members should be taken into account. He sought support in, among other things, a passage from Hillsdown Holdings plc v Pensions Ombudsman which followed that quoted in paragraph 126 above. After observing that “it may be asked how one reconciles a freedom to negotiate with a duty to observe the implied obligation of good faith”, Knox J said (at 891):
“I see no irreconcilable conflict in the two nor indeed anything out of line with many facets of employment relations where it is common for employers whilst under the implied obligation nevertheless to be free to negotiate with employees or their representatives.”
My own view is that members’ interests and expectations may be of relevance when considering whether an employer has acted irrationally or perversely. There could potentially be cases in which, say, a decision to override expectations which an employer had engendered would be irrational or perverse. On the other hand, it is important to remember that powers such as that at issue in the present case are not fiduciary. As a result, the donee of the power is, as Mr Tennet pointed out, entitled to have regard to his own interests when making decisions (see paragraphs 121 and 124 above). That fact must limit severely the circumstances in which a decision could be said to be irrational or perverse.
Had the power at issue been a fiduciary one, it would have been incumbent on Prudential to have regard to the correct considerations. Edge v Pensions Ombudsman [2000] Ch. 602, for example, illustrates that a person exercising a fiduciary power must do so “giving proper consideration to the matters which are relevant and excluding from consideration matters which are irrelevant” (see 627). I do not think that there is any similar obligation in relation to a power such as the one with which I am concerned. With such a non-fiduciary power, the Court will, as it seems to me, consider whether, overall, a decision was irrational or perverse, not whether regard has been had to particular matters.
It may be, nonetheless, that the manner in which an employer arrived at a decision could be material when deciding whether there has been a breach of the obligation of good faith. Matters relating to internal decision-making may be capable, as it seems to me, of shedding light on whether an employer has acted irrationally or perversely or, to quote from Potter LJ in Horkulak, whether there has been “a genuine and rational, as opposed to an empty or irrational, exercise of discretion”. Put differently, a failure of process, if sufficiently significant, may, once known to members, be likely to undermine trust and confidence.
However, breach of the contractual obligation of trust and confidence which subsists between employer and employee requires conduct of some seriousness: the test has been said to be “a severe one” (paragraph 132 above). It may be, therefore, that irrational or perverse conduct by an employer in a pensions context will not invariably give rise to a breach of the obligation of good faith, derived as it is from the obligation of trust and confidence. An irrational decision by an employer on a trivial matter might not be thought to be “such as to destroy or seriously damage” the relationship between employer and members and so might involve no breach of the obligation of good faith. Where an employer has acted irrationally in relation to a minor matter, it may be that members will have to look for any remedy elsewhere (e.g. in the principle to which Millett J referred in In re Courage Group’s Pension Schemes [1987] 1 WLR 495 that “a power can be exercised only for the purpose for which it is conferred, and not for any extraneous or ulterior purpose”).
Finally, I do not think that the manner in which an employer’s decision is communicated to members can affect its validity. Keen v Commerzbank AG suggests that, where there is a continuing contractual relationship between an employer and a member, a failure by the employer to supply reasons for a decision could potentially give rise to a breach of contract. However, I think Mr Rowley was right to concede that the validity of a decision taken in relation to a pension scheme could not be affected by subsequent events. As Mr Rowley said, “what is good is not subsequently rendered bad by the deficiencies in the employer's communication to its staff”.
Objective and subjective approaches
By the close of submissions, it was agreed on all sides that matters had to be approached on an objective basis. Mr Simmonds, for example, submitted that, when considering whether a power has been exercised for a collateral purpose, the Court’s concern will be to discern the purpose on an objective basis rather than with what the donee subjectively intended. Mr Rowley and Mr Tennet took similar positions.
That an objective approach is appropriate is in keeping with, for example, the emphasis which Lords Nicholls and Steyn placed on looking at matters objectively in Malik (see paragraph 131 above). I was also referred in this connection to passages in Pitmans Trustees Ltd v Telecommunications Group plc [2004] Pens LR 213 (where Morritt V-C distinguished between “intention” and “motive” in paragraph 65), Hillsdown Holdings plc v Pensions Ombudsman (where Knox J distinguished between “purpose” and “motive” at 881-882) and Topham v Duke of Portland (1863) 1 De G J & S 517 (where Turner LJ said at 571 that “it is one thing to examine into the purpose with which an act is done, and another thing to examine into the motives which led to that purpose”).
For my part, I would not wish to exclude the possibility of an employer’s decision being impugned by reference to his subjective purpose, especially since (a) the Courts have in other contexts had regard to subjective intentions and purposes (see e.g. Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 and Snell’s Equity, 32nd edition, at 10-020) and (b) there may be scope for reading the authorities mentioned in the previous sentence as distinguishing between intention/purpose on the one hand and motive on the other, rather than between objective and subjective approaches. However, the point does not seem to matter in the present case, and I am happy to proceed on the basis that an objective approach is to be adopted.
The 2005 Decision
In closing, Mr Rowley summarised the matters on which he relied as establishing breach of the obligation of good faith as regards members of the DB Section generally in these terms:
“When Prudential made the [2005] Decision:
120.1 it was not fully aware of the 2005 valuation results;
120.2 it failed to have regard to the fact that the likely deficit that would be shown by the 2005 actuarial valuation was generated by its own insistence that the Scheme’s holding of bonds should be significantly increased;
120.3 the board had not clearly addressed the relationship between (i) the long term funding objective which it supported and which involved a reasonable expectation of payment of discretionary increases in full and (ii) the policy of limiting discretionary increases on the basis of LPI/2.5%;
120.4 to Prudential’s knowledge, the Trustee’s consideration of the proposals was not yet complete;
120.5 Prudential had not engaged in any genuine negotiation with the Trustee and declined to do so when the possibility was raised by Ms. Brewer on 9 November 2005, a position that was repeated in Mr. Jones’s email to Mr. Abrahams dated 15 November 2005 …;
120.6 the consideration by the Trustee which had taken place and the indications of the basis [on] which Prudential proceeded to make the decision were founded on presentations to the Trustee and to the majority of the directors which caused several of the directors to understand that full discretionary increases would be paid at least if the Scheme’s funding level supported such payments;
120.7 Prudential did not introduce a limitation referring to increases above 2.5% only being paid in exceptional circumstances;
120.8 Prudential did not make clear to either the Trustee board or the members that its proposal to pay £75m for 10 years would be subject to three triennial reviews;
120.9 Prudential gave no separate consideration to the terms on which AVCs, transfer payments and augmentations had been converted into pension;
120.10 at no stage did Prudential consider the fact that the Scheme’s then funding position arose in part from the fact that the level of contributions paid since 1992 meant that the employers had enjoyed a part contributions holiday worth some £354 million;
120.11 Prudential failed to have proper regard to the very strong expectations of members that had been generated by its long-standing policy, paying only lip-service to a policy dating back more than two decades.”
Mr Rowley said that certain of the points concerned procedural fairness and others substantive fairness. Some of the criticisms, Mr Rowley said, crossed the line. It is to be noted that it was not alleged that Prudential had made its decision to achieve a collateral advantage or otherwise for an improper purpose.
I shall take in turn the individual criticisms Mr Rowley made of the 2005 Decision.
“[Prudential] was not fully aware of the 2005 valuation results”
While the 2005 valuation was not signed off by Watson Wyatt until 2006, it can be seen from paragraphs 85-97 above that much was known about the Scheme’s financial position by the time Prudential made its decision. In fact, Mr Betteridge was able to report to the PAC board on 7 November 2005 that “Final results” had been received from Watson Wyatt showing a deficit of £243 million and a funding level of 94%, and the final valuation gave exactly the same figures. I do not consider that Prudential was bound to wait for the 2005 valuation to be finalised before making a decision. I cannot see, in particular, that it was irrational or perverse of Prudential to make a decision on the basis of the information then available to it.
“[Prudential] failed to have regard to the fact that the likely deficit that would be shown by the 2005 actuarial valuation was generated by its own insistence that the Scheme’s holding of bonds should be significantly increased”
There is no reason to doubt that Prudential was aware that the likely deficit was attributable in part to the shift from return-seeking assets to bonds. It is clear enough that Mr Betteridge knew that this was so. Moreover, the relationship between investment strategy and funding level was adverted to in a number of documents which Watson Wyatt produced during 2005: for example, a January 2005 note to the asset allocation and valuation assumptions working party (which included Prudential representatives) explained, “As the expected returns on equities differ from those on other asset classes, eg bonds, an immediate or planned future reduction in the equity content in the asset portfolio will affect the long term expected future investment returns and therefore the current funding level”, and more than one presentation showed the funding level varying with the bond content.
As for “insistence” by Prudential that the Scheme’s holding of bonds should be significantly increased, it is true that Prudential was keen that there should be a shift to bonds and made this an element of the package it put forward to the Trustee (which also included contributions of £75 million a year). On the other hand, it was open to the Trustee to reject the package and to pursue a different investment strategy.
Early on in the trial, I wondered whether the “de-risking” produced by the shift to bonds could be said to have been to the benefit exclusively of Prudential. On reflection, however, I do not think that is the case. The change in investment strategy (especially when taken in conjunction with the £75 million contributions Prudential was offering) will also have made the position of members more secure, particularly in relation to pension increases. It is noteworthy in this context that Prudential was not alone in favouring a move away from equities. As long ago as 1999, Watson Wyatt had recommended the Trustee to review its investment strategy, taking the view that there was a mismatch between assets and liabilities (paragraphs 76 and 77 above). The Trustee board has also been concerned to limit the risks to which the Scheme is exposed. In 2001, for example, the board discussed how far it should increase the Scheme’s exposure to bonds, in 2002 it decided that a working party should review asset allocation, and in 2005 the Trustee wished to achieve “security for the existing guaranteed level of benefits” (paragraphs 81 and 88 above). Mr Parncutt said in cross-examination that “without any additional funds being paid by the company, there was concern by the trustee that … the guaranteed benefits under the scheme couldn’t be met”. Other pension schemes have also moved away from return-seeking assets (paragraph 78 above). The principle of matching assets and liabilities has become increasingly popular with pension trustees (paragraph 78 above). One reason why pension schemes have invested less heavily in equities has been, as Mr Pollock explained, that returns from equities have in recent years been relatively poor and volatile. Mr Abrahams made a similar point (paragraph 82 above).
At all events, I do not consider that the extent to which the anticipated deficit was attributable to the change in investment strategy meant that the decision Prudential took as regards pension increases was irrational or perverse or that it otherwise breached the obligation of good faith.
“the board had not clearly addressed the relationship between (i) the long term funding objective which it supported and which involved a reasonable expectation of payment of discretionary increases in full and (ii) the policy of limiting discretionary increases on the basis of LPI/2.5%”
I agree with Mr Tennet that adoption by Prudential of an “LPI/2.5%” policy (i.e. one under which pension increases were capped at 2.5%) was not incompatible with the use of a long-term funding objective based on pension increases at RPI. This point cannot render Prudential’s decision irrational or perverse or otherwise involve breach of the obligation of good faith.
“to Prudential’s knowledge, the Trustee’s consideration of the proposals was not yet complete”
I do not think it was incumbent on Prudential to delay its decision until the Trustee had completed its consideration of the proposals (though Prudential would presumably have needed to revisit matters had the Trustee in the event rejected what was proposed). This point cannot render Prudential’s decision irrational or perverse or give rise to a breach of the obligation of good faith.
“Prudential had not engaged in any genuine negotiation with the Trustee and declined to do so when the possibility was raised by Ms. Brewer on 9 November 2005, a position that was repeated in Mr. Jones’s email to Mr. Abrahams dated 15 November 2005”
I do not consider that Prudential was obliged to engage in “genuine negotiation” with the Trustee before making its decision or that failure to do so could render the decision irrational or perverse or in breach of the obligation of good faith.
Moreover, Prudential’s proposals were not sprung on the Trustee without warning in November 2005. The issues had been aired by the asset allocation and valuation assumptions working party, which included Trustee directors, and Prudential had sounded out the working party on its developing proposals at a meeting on 15 July (see paragraph 91 above). Mr Betteridge had updated the Trustee board on 15 June, and Prudential’s proposals had been explained at the Trustee board’s meeting on 14 September.
“the consideration by the Trustee which had taken place and the indications of the basis [on] which Prudential proceeded to make the decision were founded on presentations to the Trustee and to the majority of the directors which caused several of the directors to understand that full discretionary increases would be paid at least if the Scheme’s funding level supported such payments”
This criticism relates in part to the passage in the minutes of the Trustee board’s meeting of 14 September 2005 in which Mr Jones is reported as saying that “if inflation were to rise above 2.5% then increases above this figure should be able to be paid”. It also, as I understand it, arises from a bullet point in a Watson Wyatt presentation to the 9 November meeting of representatives of the Trustee and Prudential. The bullet point in question, which was included in a section dealing with the “Employer’s position and proposals”, read:
“Higher increases would be paid if RPI exceeded 2.5% pa and the financial position of the Scheme supported the funding of a higher level of increase”.
I have already commented on the passage from the 14 September minutes (paragraph 96 above). The probability, I think, is that the minutes are not entirely accurate. Whatever, though, Mr Jones said at the meeting, he subsequently set out Prudential’s position in writing in his letter to Mr Abrahams of 5 October, which, it seems, was circulated to the other Trustee directors.
Turning to the presentation to the 9 November meeting, this emanated from Watson Wyatt rather than Prudential itself. In any case, little weight could reasonably have been attached to the precise wording of a particular summary of Prudential’s proposal in an individual presentation. Someone seeking a reliable account of exactly what was proposed could have been expected to look elsewhere (e.g. to Mr Jones’ 5 October letter).
At all events, I do not think that any misunderstanding on the part of Trustee directors (even if generated by infelicities in what they were told) can render Prudential’s decision irrational or perverse or otherwise in breach of the obligation of good faith.
“Prudential did not introduce a limitation referring to increases above 2.5% only being paid in exceptional circumstances”
This point would seem to go to what Prudential decided rather than to the validity of its decision.
The PAC board endorsed proposals for the Scheme at its meeting on 7 November 2005. As already mentioned, the minutes of that meeting summarise the policy as regards discretionary increases in these terms:
“it was the Company’s intention to award discretionary pension increases in future in line with RPI subject to a normal maximum of 2.5%pa. Those increases could be suspended for one or more years if the financial position of [the Scheme] deteriorated materially. But higher increases could be paid if RPI exceeded 2.5% in any year and the then financial position of the Scheme supported the award of a higher level of increase.”
It is fair to say (as Mr Rowley did) that this statement of the policy does not feature the word “exceptional”. However, (a) it is stated to be a summary and (b) it refers to a “normal” maximum (implying that there would be a higher increase only in circumstances which were abnormal or “exceptional”). Further, other documentation from this period (for instance, Mr Jones’ letter to Mr Abrahams of 5 October) indicates that the plan was for increases above 2.5% to be exceptional.
“Prudential did not make clear to either the Trustee board or the members that its proposal to pay £75m for 10 years would be subject to three triennial reviews”
There was a certain amount of evidence to the effect that it was to be expected that contributions would be reviewed on a three-yearly basis. Mr Abrahams, while saying that the Trustee directors saw the £75 million a year contributions from Prudential as “something they could rely on for their future funding”, also regarded it as “implicit that if there was a surge in value … the matter could be reviewed”. Mr Singer thought it “natural to review contributions in conjunction with every triennial valuation”.
However that may be, it was common ground between Mr Tennet and Mr Rowley that Prudential became contractually obliged to make contributions of £75 million a year for 10 years. The position changed in 2009 only because the Trustee agreed to Prudential reducing its contributions.
On that basis, I cannot see how it can have been incumbent on Prudential to explain that its contributions could be subject to reviews. It would have been open to the Trustee to insist that they did not change.
In any case, I do not think the supposed failure to explain matters to the Trustee or members can have rendered Prudential’s decision irrational or perverse or otherwise have affected the validity of the decision.
“Prudential gave no separate consideration to the terms on which AVCs, transfer payments and augmentations had been converted into pension”
Mr Rowley put forward the criticism set out above as one of the factors rendering the 2005 Decision a breach of the obligation of good faith as regards members of the DB Section generally. He also argued that Prudential had breached the obligation as regards Category I, II and III Members in particular. Among the points Mr Rowley made were that AVCs, transfer payments and augmentations were “money purchase in character”, that the pensions obtained were “determined by the application of a conversion factor which made an allowance for future increases in line with RPI”, and that Prudential had nevertheless failed to give separate consideration to Category I, II and III Members. It is convenient to address at this juncture both the specific criticism quoted above and the position of Category I, II and III Members more generally.
Mr Tennet did not suggest that Prudential had, as a matter of fact, given separate consideration to the position of Category I, II and III Members or, more specifically, the terms on which AVCs, transfer payments and augmentations had been converted into pension. Viewing matters objectively, however, I do not consider that it was irrational or perverse of Prudential to treat pensions derived from AVCs, transfers and augmentations in the same way as other pensions under the Scheme, nor that such treatment otherwise breached the obligation of good faith.
My reasons include these:
Prudential had never committed itself to increasing pensions acquired by means of AVCs, transfers or augmentations. Several of the communications quoted in paragraphs 64-70 above said that pension secured by AVCs would “qualify for increases granted at the discretion of the Company”. The 2001 leaflet similarly said that the pension “may be increased, at the Company’s discretion” (paragraph 67 above). (The emphasis has been added in each case);
an assumption used in determining conversion factors cannot be regarded as constituting a promise. Moreover, the possibility of pension increases was only one of the matters taken into account when determining conversion factors. Other assumptions have in the event proved to have been favourable to members acquiring pension rights. After analysing periods between 1992 and 2005, Mr Pollock found that “[o]ver most periods to 2005 the investment return achieved did not match the expected return at the beginning of the period”. He concluded:
“Overall actual experience in the Scheme up to 2005, in terms of investment returns and rates of pension increases, is such that AVC funds set aside are, in most years, insufficient in themselves to provide RPI increases going forward. Additionally this assumption takes no account of improvements in longevity”;
with or without the prospect of pensions rising in line with RPI, there were advantages to acquiring pension rights by AVCs, transfers and augmentations. Mr Linnell, for instance, observed:
“paying AVCs under the scheme avoided the payment of expenses, which one would otherwise have to meet with an individual savings contract, and also any profit element for the provider. There was also a significant tax advantage in the way in which contributions were treated in the tax system. Finally, it was convenient because contributions were deducted from salary as part of the payroll process”.
As regards his augmentation, Mr Linnell said that the “key consideration” was that the money would have suffered tax if simply paid to him;
overall, the acquisition of rights in the Scheme has, notwithstanding the 2005 Decision, proved beneficial to members. A retrospective analysis of the value that a pensioner has received through converting a cash sum into a pension payable from the Scheme led Mr Pollock to conclude that “the conversion terms provided by the Scheme have been favourable to members, so that, as a whole, members have ‘gained’ from the conversion terms and the Scheme has ‘lost’”;
the factors by reference to which AVCs were converted into pension were set by the Scheme Actuary or, later, the Trustee, rather than Prudential, even if Prudential was consulted (see paragraphs 19 and 63 above);
in broad terms, AVCs, transfers and augmentations increased the pension rights which members enjoyed under the Scheme. That could rationally be thought to be a factor weighing in favour of treating pensions acquired by AVCs, transfers and augmentations in the same way as other pension rights under the Scheme.
It is perhaps worth adding a few additional points:
conversion factors did not fully allow for pensions being increased in line with inflation until 2000, when factors were revised in accordance with recommendations made by Watson Wyatt (see paragraphs 53-63 above). Even then, it was Watson Wyatt’s understanding that Prudential had “the sole discretion over the award of a discretionary increase” (to quote from Mr Singer). Earlier Scheme Actuaries had also understood pension increases to be discretionary;
members retiring in the years before the 2005 Decision will have enjoyed pension increases in line with inflation until 2006. By way of example, Mr Norman, who represents members who have made AVCs, has been drawing pension since the beginning of 1996 and so will have had his pension increased a number of times before the 2005 Decision was taken;
in the years since the 2005 Decision, pension increases have continued to be awarded (except in 2010, when the RPI figure was a negative one), albeit not at the rate of inflation;
some of those who made AVCs or transfers, or who had their pensions augmented, will also have commuted pension rights. Where the factors used to convert their AVCs, transfers and augmentations into pension would have been more favourable to members had different assumptions been made as to pension increases, the commutation factors would have been less so. In this connection, Mr Gould said:
“you were able to convert the AVC fund into pension at the same rate you give up your pension for cash. So in effect you were taking the AVC fund as cash and leaving your Prudential pension unaffected”;
I cannot accept Mr Rowley’s submission that the way in which conversion factors were set was generally known to members. While some members were evidently aware of how conversion factors were calculated (Mr Norman, for instance), they are likely, I think, to have been in a small minority.
“at no stage did Prudential consider the fact that the Scheme’s then funding position arose in part from the fact that the level of contributions paid since 1992 meant that the employers had enjoyed a part contributions holiday worth some £354 million”
I do not think it is correct to say that no consideration was given to the role which Prudential’s “part contributions holiday” had played in producing the Scheme’s deficit. Thus, the paper from Mr Betteridge and Mr Jones which was before the PAC board meeting on 25 July 2005 noted that one of the reasons for the deterioration in the Scheme’s funding was that “Contributions since 2002 have been insufficient (by half) to fund ongoing service accrual”. Again, the paper that Mr Betteridge and Mr Jones presented to the GEC meeting on 8 September 2005 referred to “‘under-contribution’ in 90s”, albeit that the figure given was £222 million rather than £354 million.
It is also fair to point out (a) that Prudential’s “part contributions holiday” was originally recommended by Mr Fudge, when he was the Scheme Actuary (see paragraph 73 above), and (b) that Prudential was undertaking to make deficit-reducing contributions to a total value substantially in excess of £354 million.
In any case, I do not consider that the obligation of good faith meant that Prudential had to have regard to particular matters (see paragraph 147 above), nor that any failure to do so would of itself mean that its decision was irrational or perverse or otherwise in breach of the obligation of good faith.
“Prudential failed to have proper regard to the very strong expectations of members that had been generated by its long-standing policy, paying only lip-service to a policy dating back more than two decades”
This point, of course, goes to the heart of members’ dissatisfaction with Prudential’s decision. As I have already said (paragraph 52 above), there was a general understanding among members (or at any rate those taking a significant interest in the Scheme) that, except when inflation had been particularly high in the 1970s, pension increases had fully compensated for inflation, and there was a widespread expectation that that pattern would continue.
It is apparent from the evidence that such expectations were considered by Prudential. Mr Betteridge is recorded as telling the asset allocation and valuation assumptions working party on 15 December 2004that Prudential “acknowledged that communications provided to members meant that members had strong expectations that … increases would be granted indefinitely”. In their paper for the PAC board meeting on 25 July 2005, Mr Betteridge and Mr Jones commented that “stopping DII altogether would come as a massive shock and be seen as a breach of commitments previously given”, and the minutes of the board meeting disclose that the board noted that the “reputational aspect of pensioners’ ‘reasonable expectations’ would require consideration when funding [the Scheme]”.
The question remains whether the “very strong expectations of members” made Prudential’s decision irrational or perverse or otherwise in breach of the obligation of good faith. I do not think they did. My reasons include these. First, and crucially, rule 7.3 of the current Rules (and its predecessors) conferred on Prudential a discretion which was not subject to any express restrictions. Secondly, although pension increases had been more or less in line with RPI since 1991, the relationship between RPI and pension increases had been less clear in earlier years. Thirdly, whilst there was an expectation among members that pensions increases would be granted, there was also an appreciation that Prudential had not guaranteed or committed itself to increases. Fourthly, Prudential was entitled to have regard to its own interests when deciding on increases. Fifthly, Prudential was undertaking to make contributions substantially in excess of those that were required of it under the Rules. Lastly, there had been changes in circumstances: in particular, investment returns had declined, longevity had increased, and the Scheme’s solvency had deteriorated.
Conclusion
In my judgment, the 2005 Decision did not breach the obligation of good faith. I do not consider that the criticisms of the decision advanced on the Beneficiaries’ behalf, whether taken individually or together, show Prudential to have acted irrationally or perversely or otherwise in breach of the obligation of good faith.
Pension increases in 2006-2009
The Beneficiaries’ case is to the effect that, when deciding on the pension increases for 2006-2009, Prudential failed to apply, or misapplied, the policy it had decided on in November 2005.
A key premise of this part of the Beneficiaries’ case is that Prudential did not decide in 2005 that pension increases above 2.5% should be awarded only in exceptional circumstances. Mr Rowley focused particularly on the last sentence of the passage from the PAC minutes of 7 November 2005 quoted in paragraph 97 above. The sentence in question reads:
“But higher increases could be paid if RPI exceeded 2.5% in any year and the then financial position of the Scheme supported the award of a higher level of increase.”
Mr Rowley argued that this sentence showed that what was envisaged was “an annual process of looking to see if the then financial position of the scheme could support a higher level of increase”.
On this footing, Mr Rowley submitted that in none of the years 2006-2009 did Prudential apply the correct policy or, alternatively, that the policy was applied incorrectly and a correct application of the policy would have led to higher pension increases (in line with RPI in 2006 and 2008, of at least 3% in 2007 and of an uncertain size in 2009).
To my mind, however, these submissions attach too much weight to the wording used in the minutes of the 7 November 2005 board meeting. As I have previously noted, the statement of the policy on which Mr Rowley focused is stated to be a summary, and other documentation from the period indicates that the plan was for increases above 2.5% to be exceptional. Moreover, the 7 November minutes themselves speak of “a normal maximum of 2.5%”. In the circumstances, I do not accept that the policy adopted in 2005 was for pension increases above 2.5% to be awarded whenever RPI exceeded that figure and the financial position of the Scheme supported a higher level of increase.
Even if I had been persuaded that the policy had not been followed (whether accurately or at all) in some or all of the subsequent years, I would not necessarily have accepted that the decisions taken were irrational or perverse or otherwise breached the obligation of good faith. To my mind, Prudential was not bound either to continue with the 2005 policy or to implement it in any particular year. In other words, I do not think it need have been irrational or perverse of Prudential to arrive at a decision which was inconsistent with the 2005 policy.
Consequences
It follows from what I have already said that I do not consider that Prudential’s decisions as regards pension increases were in breach of its obligation of good faith. Had I taken a different view, the question would have arisen whether it was open to Prudential to reconsider its decisions. Mr Rowley said not. In particular, he argued that, if the 2005 Decision was invalid, Prudential was bound to follow the “policy” it had pursued in previous years.
I am not persuaded. The submission would have had more force if Prudential could be said to have resolved to award increases in line with RPI without the need for annual decisions; it could then have been argued that, unless and until Prudential validly resolved otherwise, it was to be taken to have awarded increases. However, Mr Rowley fairly accepted that this contention was not open to him. The Rules required Prudential to “make regular reviews”, and it in fact made decisions as to increases on an annual basis.
There was some debate before me as to whether, before 2005, Prudential had a “policy” of granting increases in line with RPI or merely a “practice” of doing so. The distinction could have been significant if the adoption of a “policy” had meant that pensions were to be increased in line with RPI without the need for further decisions. I do not consider, however, that any “policy” Prudential may have had carried that implication. Regardless of whether there was a “policy” of increasing pensions in line with RPI, pensions were never increased without specific decisions to that effect being made by Prudential.
It seems to me, accordingly, that, had I concluded that any or all of Prudential’s decisions were invalid, it would not have followed that pensions were to be deemed to have been increased in line with RPI. The position would rather have been that Prudential could have reconsidered what (if any) pension increases to grant.
The Estoppel Issues
Estoppel by representation
Legal principles
Some of the ingredients of estoppel by representation were referred to in a pensions context in Steria Ltd v Hutchison [2006] EWCA Civ 1551, [2006] PLR 291. Neuberger LJ there stated (at paragraph 93):
“When it comes to estoppel by representation or promissory estoppel, it seems to me very unlikely that a claimant would be able to satisfy the test of unconscionability unless he could also satisfy the three classic requirements. They are (a) a clear representation or promise made by the defendant upon which it is reasonably foreseeable that the claimant will act, (b) an act on the part of the claimant which was reasonably taken in reliance upon the representation or promise, and (c) after the act has been taken, the claimant being able to show that he will suffer detriment if the defendant is not held to the representation or promise. Even this formulation is relatively broad brush, and it should be emphasised that there are many qualifications or refinements which can be made to it.”
Questions have arisen in several pension cases as to whether materials supplied to members have contained sufficiently clear representations to found estoppels (whether by representation or otherwise). In ITN v Ward [1997] PLR 131, Laddie J noted (in paragraph 22) that where “the allegedly misleading wording of booklets and announcements” was the subject of complaint:
“The question of whether those documents are misleading and, in particular, whether they gave rise to or evidence an underlying common assumption between the parties, and whether members of the scheme could reasonably have relied on them as setting out accurately how the scheme would operate, can only be assessed by looking at them as a whole and having regard to their function.”
In Redrow plc v Pedley [2002] EWHC 983 (Ch), [2002] PLR 339, Morritt V-C observed in relation to explanatory booklets relied on in support of an estoppel by convention claim (at paragraph 65):
“None of the booklets was clear enough and each of them contained passages clearly indicating that nothing contained therein could override the meaning and effect of the deeds and rules.”
In Hearn v Younger [2002] EWHC 963 (Ch), [2005] PLR 49, Etherton J referred (in paragraph 111) to:
“the problem of establishing any kind of estoppel based on an explanatory pension scheme booklet which is expressed in general terms and is manifestly not intended to override the trust deed and rules, and in which, in any event, it may be difficult to find a statement or representation sufficiently clear and unequivocal to contradict the trust deed and rules.”
Laddie J commented specifically on explanatory booklets in ITN v Ward. He said (at paragraph 23):
“the booklet is merely the employer's or trustees' attempt to summarise the meaning and effect of the scheme and its rules. Prima facie it is not and would not be expected to override the trusts created by the definitive deed and the rules implemented under it. [S]uch booklets are usually deliberately framed in general terms in an attempt to make them more readily intelligible to those members who read them. They are a précis of some, but by no means all, of the important features of the scheme. It must be borne in mind that any précis of long and complicated documents will lose some of the detail (unless the discarded matter is mere surplusage). To that extent any précis can be said to be inaccurate and there will be some who will be adversely affected by the inaccuracy, assuming, of course, that they take the précis to be definitive on the points it deals with rather than a basic introduction.”
It is important to remember that estoppel by representation is concerned with representations of fact. A promise may imply a representation of any fact necessary for its making (see Spencer Bower and Turner, “Estoppel by Representation”, 4th edition, at paragraph II.6.1), much as a person who makes a statement as to his intentions may be estopped from denying that, as a matter of fact, those were his intentions. Where, however, the question is whether it is open to a person to go back on a true promise, promissory estoppel may be in point but estoppel by representation will not be.
There is a further point to make. What is at issue here is whether there is an estoppel in favour of members of the Scheme (or classes of member) generally. Judges have commented on the difficulties of establishing such an estoppel in several cases. In Redrow plc v Pedley, Morritt V-C said this of an estoppel by convention claim (at paragraph 63):
“it is necessary to show that the principle is applicable to all existing members. I agree with Laddie J in ITN v Ward [1997] PLR 131 that it is not necessary for that purpose to call evidence relating to each and every member’s intention. But that will not absolve a claimant from adducing evidence to show that the principle must be applicable to the general body of members as such.”
The Beneficiaries’ case
It is the Beneficiaries’ case that Prudential is estopped from denying that members of the DB Section generally (or at least Category I, II and III Members as classes) are entitled to receive increases in pensions on the basis of “the policy of RPI with the proviso”. On that basis, it is said that Prudential must:
consider annually the change in RPI over the preceding year;
grant members an increase of that amount, unless the rate of inflation is exceptionally high and therefore the increase cannot reasonably be funded by the Scheme with such additional contributions as Prudential can and ought reasonably to make;
adopt an appropriate “catch-up” policy if and in so far as the proviso set out in the previous sub-paragraph has been applied in any year.
Discussion
Mr Rowley recognised the difficulties the Beneficiaries faced in establishing estoppel by representation. He accepted, in particular, that it is not easy to show that a class has the benefit of an estoppel.
On the facts of the present case, a short answer to the estoppel by representation case is that Prudential did not make a “clear representation” to the effect that it would necessarily increase pensions in line with RPI (either at all or except in times of high inflation). While members of the Scheme were told that pensions had in the past been increased to compensate for inflation, and were led to believe that Prudential expected to continue with the practice, they were also informed that such increases were discretionary. The “Member’s Booklet”, for example, said that Prudential did “not commit itself … to continue the practice of granting discretionary increases” (1988), that Prudential did “not guarantee” to cushion staff against inflation (1996) and that Prudential might “choose to award discretionary increases” (2001). The booklets were, moreover, expressly stated to represent “an outline” or “a summary” which did not contain the “full provisions of the Scheme” or “all the detailed provisions”. As can be seen from paragraphs 33-44 and 64-70 above, other communications from Prudential contained similar qualifications.
A second difficulty with the estoppel by representation case relates to detriment. I can see no reason to suppose that members of the Scheme generally have suffered any detriment as a result of relying on any representation that Prudential might be thought to have made. As Mr Tennet pointed out, membership of the Scheme, with or without pension increases in line with RPI, can only have been a benefit, and there is no evidence that members of the Scheme generally would have behaved in any different way but for representations as to pension increases made by Prudential.
Nor does it appear that members making AVCs or transfers, or receiving augmentations, have, in general, suffered any detriment. It has not been shown that such members would have been better off if the AVCs, transfers or augmentations had not been committed to the Scheme. As mentioned above (paragraph 179(iii)), the acquisition of pension rights by AVCs, transfers and augmentations had advantages regardless of whether the pensions rose in line with RPI, and the acquisition of rights in the Scheme has, overall, proved beneficial. It is noteworthy, too, that Mr Pollock found (and I accept) that “the Scheme provided more generous terms for members converting cash sums into pension than the inflation-proofed terms generally available in the market in the period since 1992”.
A final point is that, as I see it, an estoppel by representation, even if established, could not assist the Beneficiaries. As I have said, estoppel by representation is concerned with representations of fact. In the present case, I cannot see how precluding Prudential from denying a representation of fact (say, as to whether it intended or expected to grant pension increases in line with RPI) could help. The question is not whether Prudential is free to deny such a representation but whether it is bound to fulfil expectations which, on the Beneficiaries’ case, it engendered.
Mr Rowley responded to this point by suggesting that the elements of promissory estoppel existed. I have not been persuaded. It suffices to say that I do not think Prudential can be said to have made any promise, let alone a clear or unequivocal one, to increase pensions in line with RPI (either at all or except in times of high inflation). No promise can, in my view, be spelt out of the communications to members, and members did not understand Prudential to have given a guarantee or commitment. In any case, it would have been open to Prudential to argue, had the ingredients of promissory estoppel been established, that any such estoppel would not have extinguished its rights but merely suspended them.
Estoppel by convention
Legal principles
Estoppel by convention came to the fore in Amalgamated Investment & Property Co Ltd v Texas-Commerce International Bank Ltd [1982] QB 84. Lord Denning MR there said (at 122):
“When the parties to a transaction proceed on the basis of an underlying assumption - either of fact or of law - whether due to misrepresentation or mistake makes no difference - on which they have conducted the dealings between them - neither of them will be allowed to go back on that assumption when it would be unfair or unjust to allow him to do so. If one of them does seek to go back on it, the courts will give the other such remedy as the equity of the case demands.”
The other members of the Court endorsed a passage from the then-current edition of Spencer Bower and Turner, “Estoppel by Representation”, which read:
“When the parties have acted in their transaction upon the agreed assumption that a given state of facts is to be accepted between them as true, then as regards that transaction each will be estopped against the other from questioning the truth of the statement of facts so assumed.”
Amalgamated Investment & Property Co Ltd v Texas-Commerce International Bank Ltd concerned a contract, but it is apparent from later authorities that estoppel by convention can arise in relation to transactions other than contracts: see Revenue and Customs Commissioners v Benchdollar Ltd[2009] EWHC 1310 (Ch), [2010] 1 All ER 174.
In the Benchdollar case, Briggs J summarised “the principles applicable to the assertion of an estoppel by convention arising out of non-contractual dealings” in the following terms (in paragraph 52):
“(i) It is not enough that the common assumption upon which the estoppel is based is merely understood by the parties in the same way. It must be expressly shared between them. (ii) The expression of the common assumption by the party alleged to be estopped must be such that he may properly be said to have assumed some element of responsibility for it, in the sense of conveying to the other party an understanding that he expected the other party to rely upon it. (iii) The person alleging the estoppel must in fact have relied upon the common assumption, to a sufficient extent, rather than merely upon his own independent view of the matter. (iv) That reliance must have occurred in connection with some subsequent mutual dealing between the parties. (v) Some detriment must thereby have been suffered by the person alleging the estoppel, or benefit thereby have been conferred upon the person alleged to be estopped, sufficient to make it unjust or unconscionable for the latter to assert the true legal (or factual) position.”
In Stena Line Ltd v Merchant Navy Ratings Pension Fund Trustee Ltd [2010] EWHC 1805 (Ch), [2010] Pens. L.R. 411, Briggs J made an adjustment to paragraph (i) of this summary. He said (in paragraph 137) that “the crossing of the line between the parties may consist either of words, or conduct from which the necessary sharing can properly be inferred”.
Mr Rowley stressed that Briggs J’s summary was of “the principles applicable to the assertion of an estoppel by convention arising out of non-contractual dealings”. However, the need for a “crossing of the line” is apparent from other cases, notably The August Leonhardt [1985] 2 Lloyd’s Rep 28 (especially at paragraph 35) and Republic of India v India Steamship Co Ltd (No. 2) [1998] AC 878 (at 913). Further, that Briggs J’s (iii)-(v) are of general relevance, and not just in the context of non-contractual dealings, is indicated by the authorities cited in paragraphs 42-45 of his judgment.
The present case
The Beneficiaries contend that Prudential, members of the Scheme and the Trustee have all interpreted their legal relationship as meaning that Prudential would award increases on pensions in payment in accordance with “the policy of RPI with the proviso” and that it would be unconscionable for Prudential now to be allowed to go back on that assumption.
It seems to me, however, that the estoppel by convention case must fail for much the same reasons as that founded on estoppel by representation.
In the first place, the parties did not assume that Prudential was committed to increasing pensions in line with RPI (either at all or except in times of high inflation). Members of the Scheme, like Prudential itself, understood that increases were discretionary. In any case, no different assumption “crossed the line” between Prudential and members of the Scheme. To the contrary, communications to members, taken as a whole, confirmed that pension increases were discretionary.
Secondly, as mentioned in paragraphs 205 and 206 above, it is not apparent that members of the Scheme generally (or Category I, II or III Members generally) have suffered any detriment as a result of relying on any assumption as to pension increases.
Conclusions on estoppel arguments
For the reasons given above, I do not consider that Prudential is estopped from denying that, as classes, either members of the DB Section or Category I, II and III Members are entitled to have their pensions increased on the basis of “RPI with the proviso”.
I should stress, though, that I have been considering the position of members of the DB Section and Category I, II and III Members as classes. I am not to be taken as deciding that members of the DB Section cannot establish estoppels on an individual basis.
The Contract Issues
The List of Issues includes questions as to whether any or all of Category I, II and III Members are contractually entitled as against the Trustee to annual or other periodic increases to pensions in payment. While setting out arguments on these issues in his written closing submissions, Mr Rowley did not press them orally. In my judgment, he was right not to do so. I do not read the relevant documents as containing any promise by the Trustee that pensions would be increased, let alone that they would be increased without any decision to that effect by Prudential.
The ConstructionIssues
Directions are sought as to the extent (if any) to which the Trustee has (and has had) power to grant pensions carrying an automatic right to annual or other periodic increases to Category I and II Members.
It is common ground that, until 1995, it was for the Actuary rather than the Trustee to determine what additional pensions AVCs would generate. The Beneficiaries contend, however, that it has been open to the Trustee since 1995 to decide that AVCs should produce escalating pensions. In this regard, Mr Rowley pointed out that rule 2.2 of the current Rules (and its relevant predecessors) stipulated simply that the amount of an additional pension should be (a) determined on a money purchase basis directly referable to the amount of the contributions and (b) reasonable having regard to the amount of the contributions and the value of the other benefits under the Scheme (see paragraph 19 above). No bar, Mr Rowley said, is imposed on escalating pensions, and such a pension falls naturally within the ordinary meaning of the words “additional pension” (i.e. a pension which is in addition to a member’s basic Scheme benefits). For similar reasons, it is the Beneficiaries’ case that the Trustee has had power to grant an escalating pension in exchange for a transfer in. No relevant restriction is, Mr Rowley submitted, to be found in either the present rule 8.2 (for which, see paragraph 21 above) or its precursors.
In contrast, Prudential contends that the Trustee has never had any power to grant an escalating pension. As regards AVCs, Mr Tennet referred to the fact that, prior to 1995, the Rules provided for AVCs to be applied to “augment” the member’s pension (as to which, see paragraph 23 above), which, Mr Tennet said, connoted an increase in the pension to which the member would otherwise be entitled rather than a further pension to which different rules could apply. Mr Tennet argued that, in this respect, the position remained unchanged after 1995: what the present rule 2.2.4 requires the Trustee to do is quantify the amount of the addition to the member’s pension under the Scheme; it does not allow the Trustee to grant a pension on different terms. Mr Tennet sought to invoke section 111 of the Pension Schemes Act 1993 (Footnote: 2) in support of his argument. What are now rules 2.2.4 and 2.2.5 were, Mr Tennet said, clearly based on section 111(1)(c) and (d) of the 1993 Act, but the draftsman chose in both rule 2.2.4 and rule 2.2.5 to speak of “additional pension” instead of section 111’s “additional benefits”; the change, Mr Tennet submitted, is significant. Turning to transfers in, Mr Tennet argued that the position is similar: the “additional benefit” which is to be provided has to be in keeping with, and not on different terms from, other benefits under the Scheme.
Mr Simmonds suggested that there might be a third possibility: that an escalating pension can be granted for a transfer in but not for AVCs. With regard to transfers in, Mr Simmonds made reference to what is now rule 7.3, which provides:
“At the request of an Employer and upon payment by the Employer to the Fund of such sum or sums (if any) as the Actuary shall certify to be necessary (after taking account of any surplus disclosed by the last proceeding Valuation) the Trustees shall provide such additional benefits under the Scheme (consistent with Inland Revenue Approval) as the Employer shall determine subject to any condition or qualifications which the Employer may require.”
Mr Simmonds noted that this wording corresponds closely to that used in rule 8.2.2 and observed that it is difficult to see why rule 7.3 should not have been intended to extend to the grant of escalating pensions.
On balance, I have concluded that the construction canvassed by Mr Simmonds is the correct one. In other words, I take the view that it has never been possible for AVCs to generate escalating pensions, but that transfers in could do so if the Trustee so determined.
Taking transfers in first, I find the comparison between rule 7.3 and rule 8.2.2 telling. I agree with Mr Simmonds that it is hard to see why rule 7.3 should not have been intended to extend to the grant of escalating pensions. It is hard, too, to see why a narrower construction should be placed on rule 8.2.2, which uses similar wording. Moreover, rule 8.2.2, unlike rule 2.2, uses the broad word, “benefits”.
In contrast, there are indications that rule 2.2 was not intended to confer a power to provide escalating pensions. What rule 2.2.4 empowers the Trustee to do is determine the “amount of the additional pension”. This wording suggests that the power is confined to setting the figure (or “amount”) to be added to the pension to which the member would otherwise be entitled and was not meant to enable the Trustee to grant a pension on different terms. Further support for that view is to be found in the fact that the draftsman has chosen to use “pension” in place of the wider “benefits” found in section 111 of the Pension Schemes Act 1993 as well as rules 8.2.2 and 7.3.
The Hastings-Bass Issues
As mentioned earlier, the “Hastings-Bass Issues” concern whether decisions by the Trustee to grant pensions to Category I and II Members which did not carry an automatic right to annual or other periodic increases were valid and, if not, with what consequences.
The issues take their name from the decision of the Court of Appeal in In re Hastings-Bass, decd [1975] Ch 25. However, since the present case was heard, the Court of Appeal has held, in Pitt v Holt [2011] EWCA Civ 197, that the Hastings-Bass case was not authority for the “rule” which had been derived from it. I have had the benefit of written submissions on the implications of the Pitt v Holt decision.
In Pitt v Holt, Lloyd LJ, giving the leading judgment, distinguished between, on the one hand, cases in which a purported exercise of a discretionary power on the part of trustees was not within the scope of the power and, on the other hand, cases where trustees acted within the terms of a power but failed to take into account the correct considerations. Lloyd LJ summarised the law relating to the latter type of case as follows (in paragraph 222(ii)):
“the case may be one in which the trustees' act in exercise of their discretion is within the terms of their power, but is said to have been vitiated by their failure to take into account a relevant matter, or their taking something irrelevant into account, when deciding to exercise, and exercising, the discretion …. The trustees' act is not void; it may be voidable. To be voidable it must be shown to have been done in breach of a fiduciary duty of the trustees. The duty to take relevant, and no irrelevant, matters into account is a fiduciary duty. Relevant matters may include fiscal consequences of the act in question. However, if the trustees fulfil their duty of skill and care by seeking professional advice (whether in general or in specific terms) from a proper source, and act on the advice so obtained, then (in the absence of any other basis for a challenge) they do not commit a breach of trust even if, because of inadequacies of the advice given, they act under a mistake as to a relevant matter, such as tax consequences. In the absence of a breach of trust, the trustees' act is not voidable. Even if it is voidable, it cannot be avoided unless a beneficiary seeks to have it avoided, and a claim to that effect will be subject to the discretion of the court and to the usual range of equitable defences.”
Mr Rowley accepted that, in the present case, the Trustee acted within its powers. He contended, however, that the case falls within the second of Lloyd LJ’s two categories. He submitted that the Trustee failed in its duties and, hence, that its decisions in relation to the award of pensions are voidable.
Mr Rowley argued that guidance as to the Trustee’s duties is to be found in a passage from Lewin on Trusts, 18th edition. The passage in question, at 12-35, reads:
“It is obvious that a new trustee must ascertain the beneficial interests arising under the trust instrument (and any dispositions made under it), the powers conferred on him and any other material provisions. Without doing so, he will be unable to discharge his functions. Where the trusts are discretionary, the trustee must also ascertain the factors relevant to the exercise of the discretions ….”
Mr Rowley relied, too, on part of the judgment of Dillon LJ in Nestle v National Westminster Bank plc [1993] 1 WLR 1260. At 1265, Dillon LJ observed:
“It was the duty of the [trustee] bank to acquaint itself with the scope of its powers under the will. It is understandable that the bank had doubts, on a mere perusal of clause 13, as to its powers to invest in ordinary shares. It is inexcusable that the bank took no step at any time to obtain legal advice as to the scope of its power to invest in ordinary shares.”
On the facts of the present case, Mr Rowley argued that the Trustee had failed, in breach of fiduciary duty, to ascertain what its powers in relation to AVCs and transfers were and/or to identify properly the considerations relevant to the exercise of such powers. Mr Rowley summarised the Beneficiaries’ case in these terms:
“The essence of the complaint is, and has always been, that the scope of the power … enabled the Trustee to grant an additional pension with guaranteed increases and the Trustee failed to take into account the relevant consideration that it was not limited to granting non-increasing pensions.”
In contrast, Mr Tennet and Mr Simmonds (departing in this respect, understandably, from the neutral position the Trustee has otherwise adopted) each maintained that the Trustee did not breach its duties.
I agree with Mr Tennet and Mr Simmonds. I have concluded above (paragraph 225) that it has never been possible for AVCs to generate escalating pensions. If that is right, there can of course be no question of the Trustee having breached its duties by failing to appreciate that it could grant such pensions; there was no power to do so. Even, however, if I had taken the view that it had been open to the Trustee to grant escalating pensions, I would not have considered that it had breached its duties in this regard. Likewise, I have not been persuaded that the Trustee failed in its duties in relation to the grant of pensions for transfers (where I have decided that there has been power to grant escalating pensions – see paragraph 225 above).
It is doubtless incumbent on a trustee to familiarise himself, in general terms, with his powers. However, there can be no absolute rule that a trustee must be aware of every possibility inherent in his powers. How far a trustee should go to ensure that he understands the scope of his powers must, as Mr Simmonds submitted, depend on the duty to exercise reasonable skill and care and vary according to the circumstances. If it is desirable that a trustee should be able to act in a particular way, and the trustee appreciates that his powers could potentially allow him to do so, it may well be his duty to clarify the extent of his powers (compare Nestle v National Westminster Bank plc). If, at the other end of the spectrum, the trustee neither knows, nor ought reasonably to know, of any uncertainty of practical importance, he can be under no obligation to obtain advice on the precise scope of his powers; in fact, spending money on an unnecessary exercise of that kind might itself be in breach of duty.
In the present case, I cannot see how the Trustee (or its directors) can be criticised for failing to appreciate, unaided by any legal advice on the point, that it had power to grant escalating pensions for transfers or (should I be wrong in my conclusions on the construction of rule 2.2 of the Rules) AVCs; on any view, the scope of the relevant powers was not obvious. The real question must be whether the Trustee ought to have taken legal advice in this respect (though there is room for debate as to what advice the Trustee would have been given had it sought it).
A number of witnesses gave evidence to the effect that, at the time, the Trustee board expected Prudential to continue to award discretionary increases and saw no need to consider whether the Trustee had power to grant escalating pensions. Mr Linnell, for example, gave evidence in the following terms during cross-examination:
“Q. … When you were in that position 17 years ago, in 1992, it never occurred to you, did it, to go and get legal advice as to whether you could grant pensions, which increased in an automatic way with RPI?
A. Not to my recollection, my Lord.
Q. I suggest to you that the reason it didn't occur to you was that there was perceived to be absolutely no need to confer a benefit of that type, and therefore the point never needed to be investigated.
A. My Lord, yes, we saw no need to investigate that point at the time.
Q. And the reason was that you fully expected discretionary increases to continue; there would be no point in investigating that issue.
A. Yes, my Lord.
Q. And if someone then had said at a meeting in 1992: well, look, there's this possibility of us granting an automatically increasing pension, let's go off and spend lots of money, taking legal advice on the point, your first reaction surely would have been: what a waste of money. There's no need. There's no problem here which needs to be fixed?
A. That seems reasonable, my Lord.”
In my judgment, it was, in all the circumstances, reasonable for the Trustee not to take advice on whether it could grant escalating pensions. There was no evident need to investigate the position or, in particular, to go the expense of obtaining legal advice. At the time, the Trustee had no reason to think that the grant of pensions qualifying for discretionary increases (in line with other pensions) was other than appropriate and sufficient. I do not, accordingly, consider that the Trustee failed in its duties.
It follows that the Trustee’s decisions in relation to the grant of pensions to Category I and II Members have been valid.
Conclusion
I can well understand that members of the DB Section will have been disappointed by the 2005 Decision. I can also see that they may feel themselves to have been treated unfairly by Prudential. However, the Rules give Prudential a discretion with regard to pension increases which is not subject to any express restriction. The implied obligation of good faith will have served to qualify the discretion to an extent, but in my judgment Prudential has not breached that obligation. Nor do I consider that Prudential is estopped from denying that members are entitled to have their pensions increased on the basis of “RPI with the proviso”.
The List of Issues
My answers to the specific questions posed in the List of Issues are as follows:
Members of the DB Section generally
Issue 1(a), (b) & (c): No.
Issues 2 & 3: Do not arise.
Issues 4 & 5: Prudential is not estopped from denying that the members of the DB Section who have a pension in payment are entitled to annual or other periodic increases to such pension.
Category I Members
Issue 6: Rule 2.2 does not entitle the Trustee to provide a pension that carries a right to annual or other periodic increases, and rule 2.2’s predecessors did not do so either.
Issue 7: Not pursued.
Issue 8: No.
Issue 9: Does not arise.
Issues 10-17: Do not arise.
Issue18 (a), (b) & (c): No.
Issues 19 & 20: Do not arise.
Issues 21 & 22: Prudential is not estopped from denying that the Category I Members who have a pension in payment are entitled to annual or other periodic increases to such pension.
Category II Members
Issue 23: Rule 8.2 entitles the Trustee to provide a pension that carries a right to annual or other periodic increases, as did its predecessors.
Issue 24: No.
Issue 25: Does not arise.
Issue 26: No.
Issues 27-31: Do not arise.
Issue 32(a), (b) & (c): No.
Issues 33 & 34: Do not arise.
Issues 35 & 36: Prudential is not estopped from denying that the Category II Members who have a pension in payment are entitled to annual or other periodic increases to such pension.
Category III Members
Issue 37: Not pursued.
Issue 38: No.
Issue 39: Does not arise.
Issue 40 (a) & (b): No.
Issue 41 (a), (b) & (c): No.
Issues 42 & 43: Do not arise.
Issues 44 & 45: Prudential is not estopped from denying that the Category III Members who have a pension in payment are entitled to annual or other periodic increases to such pension.