Grant Thornton and Pinsent Masons collaborate to support effective data sharing across financial services
Out-Law Guide | 21 Jun 2010 | 2:41 pm | 10 min. read
This guide is based on UK law as at 1st February 2010, unless otherwise stated. It is part of a series of guides on Pensions, aimed at company directors.
Directors often have an interest in pensions that goes beyond their interest in their own pension entitlement. Many are trustees of the company pension scheme. This inevitably means additional duties and additional risks. Often, the implications are not fully appreciated when the appointment is offered and accepted.
The risks can be extreme. In one of the leading trust law cases, a set of trustees acted in accordance with advice received from a leading barrister about their duties. An aggrieved beneficiary complained, and the matter ultimately reached the House of Lords, who by a three to two majority agreed with the beneficiary. As a result, the trustees were ordered to repay millions to the trust. One of the trustees committed suicide in the face of bankruptcy.
Although the case was highly unusual – it’s rare to hear of trustees being sued in a personal capacity – it illustrates the pressures and responsibilities involved. Some protection is available (see Personal liability, below) but trusteeship is not a role to take lightly, and you should think carefully before accepting the appointment.
The trustees hold the legal title of the pension scheme assets and have stringent legal duties to ensure that those assets are used to provide benefits in accordance with the terms of the trust (as overridden by statute).
Essentially, a pension scheme trustee’s duties are to: hold the trust assets;
Trustees are also legally required to be familiar with the pension scheme’s documentation and have an understanding of the legal, funding and investment obligations relating to the scheme. They will need to keep records to show the pensions regulator that they have complied.
Essentially, the legal requirements mean that you should read the trust deed and rules of the pension scheme carefully before becoming a trustee. While most trust deeds are not exactly page-turners, this is an effort you really must make (not least because the regulator now requires you to).
If you do not understand anything, ask questions. You would be surprised how often the wording is out of date, ambiguous or just plain wrong. Since statute often overrides the terms of the trust, you should make sure you get trustee training and legal advice where necessary.
Every pension lawyer will advise you to take these steps, and every pension lawyer will concede that most clients take no notice. The late Peter Carter-Ruck, specialist in libel law, was heard frequently to observe that he ran his office off the clients who took his advice and his Rolls-Royce off the clients who did not. The same observation could be made, on this point at least, by pension lawyers.
As noted above, trustees potentially put everything on the line. To what extent can they protect themselves?
There are three different types of protection: indemnities, insurance and exoneration clauses. An indemnity, whether contained in a trust deed or in a side-letter, acknowledges that a third party (the pension scheme or the employer or some other party) will ensure that a trustee is not out of pocket if he or she is found liable in given circumstances.
Trustee insurance is, to all intents and purposes, just another form of indemnity.
The concept of indemnities and insurance will be relatively familiar to directors, exoneration clauses less so. In contrast to an indemnity, where the trustee remains liable but someone else pays, an exoneration means, as its name suggests, that the trustee escapes liability completely.
Trustees benefit from a statutory exoneration, which says that if it appears to the court that a trustee is personally liable for any breach of trust, but has acted honestly and reasonably, and ought fairly to be excused, then the court may relieve them from personal liability. The problem is that this provision does not automatically apply. It’s only effective if a particular court, in its discretion, decides to make use of it.
Additionally, trustees may have the benefit of express exoneration provisions in the pension scheme rules. However, the courts will not interpret such clauses as allowing trustees to act in bad faith or recklessly. Trustees who think they can get away with anything because they are protected by the exoneration clause are badly misguided.
An exoneration clause does not prevent the pensions regulator from imposing a fine for breach of one of the particular statutory provisions over which it has control. Fines by the pensions regulator, however, are rare and can only apply where trustees have failed to take ‘all such steps as are reasonable to secure compliance’ with the particular statutory duty.
Exoneration provisions do not apply to trustees’ investment functions. But if trustees delegate decisions about investments to a fund manager, they will not be responsible for any defaults by that fund manager if they have taken all reasonable steps to ensure that he or she:
Indemnities and exoneration clauses can have substantially different effects. An indemnity (or insurance) is only as good as the person who undertakes to pay out. Where the indemnifier does not have the funds to provide the necessary cover, it’s useless. Where the indemnifier is unwilling to pay out, the trustees may find themselves in serious difficulties and may need to take legal action to recover the money.
An exoneration clause, on the other hand, requires no action by the trustees. Claims against trustees by a beneficiary will be unable to succeed since they will not be liable for their mistakes. Exoneration provisions, however, won’t cover you for all acts or in all circumstances. Further, they only protect you against claims by members or the employer: they will not help if, for example, your investment managers make a complaint.
From the viewpoint of pension scheme members, indemnities are often seen as more desirable than exoneration clauses: exoneration clauses can leave schemes seriously out of pocket for the mistakes of trustees.
Trustee indemnity insurance can potentially give added protection to the trustees if they cannot rely on their indemnity protection. The insurer may reimburse the trustees for any successful claim brought against them by a beneficiary.
Trustees should bear in mind, though, that insurance cover is normally heavily skewed in favour of the insurer. Insurers have almost never made a payment to trustees under an indemnity insurance policy. The golden rule is: prevention is better than cure. Administer the scheme properly and make sure you’re happy with the exoneration provisions, and claims won’t be upheld against you in the first place.
There is no rule of law that says that trustees need to be individuals. It’s entirely possible to have a company as a trustee, and many pension schemes operate in this way, with the individuals who would have been trustees acting as directors of the trustee company. This has significant advantages for the trustee directors, though it has some drawbacks, too.
The main advantage is that it’s the company that’s liable to scheme members, not the trustee directors. The trustee directors’ only duties are to the trustee company. The duties of a director are a little less exacting than the duties of a trustee (although, as this book shows, they’re still pretty onerous).
The main disadvantage is that company law is much more restrictive than trust law about the extent to which people can be indemnified or exonerated by companies of which they’re directors. (See: Indemnity and insurance protection for directors, an OUT-LAW guide.) There are also additional requirements under company law relating to conflicts of interests (See: The code of directors' duties, an OUT-LAW guide that addresses conflicts of interest.) These must be complied with in addition to the general conflict requirements applying to all trustees.
Trustees should exercise their powers in order to further the purposes of the pension scheme. The courts have developed strict tests to ensure they do this.
One of the duties of trustees is not to put themselves in a position where there is a conflict between their duties and their private interests.The court will not consider whether or not the trustee has allowed their external interest to influence the decision making – the fact that they have acted while in a position of conflict of interest will be enough to constitute a breach of trust.
For directors, this can be a particularly difficult problem. If a director is a trustee and a member of the pension scheme, on any given issue they may have multiple competing interests (for example, the setting of employer contribution rates at a time when company finances are hardpressed).
The problem has been addressed in part by statute, and the courts have also set out a limited exception to the strict conflict of interest rule. Neither of these changes offers a complete solution to the problems faced by directors: extreme care still needs to be taken.
Trustees who are also members of their pension scheme (as the majority of them are) frequently have theoretical conflicts between their personal interests as members and their duties as trustees. The government has therefore given statutory protection to such trustees.
But this is less helpful than it may appear. It applies only to a member’s interest as a member. A trustee who owes director’s duties to the employer would not be protected. Also, trustees must still exercise their powers in order to further the purposes of the pension scheme. Those who act in their own interests and against the interests of the scheme will find themselves in deep trouble.
Separately, the courts have also been looking to the commercial realities of pension scheme trusteeship and showing a markedly more sympathetic approach. Where pension scheme rules state that the trustees must include people who hold the role of director (or equivalent) and the conflict of interest is slight, there may be some leniency. (See the brief case study, Edge v Pensions Ombudsman, opposite.)
Of course, there are occasions where your interests and duties conflict starkly. Just how should you approach the setting of employer contribution rates at a time when company finances are hard-pressed? The company’s and the pension scheme’s interests may be diametrically opposed. As a director/trustee, you owe duties to both. If you find yourself in such a conflict, you should take legal advice as to whether you need to step aside from the decision-making process, or even resign one of your posts.
Between the cases where the conflict is slight (for example, deciding whether to grant a small increase to all members’ benefits, including your own) and the cases where the conflict is extreme, are many intermediate cases. How should you decide whether you can safely act or not? There is a simple rule of thumb: if you find yourself badly wanting to be involved in the decision, you should probably stand aside.
The Court of Appeal considered the problem of trustees’ conflicts of interest in Edge v Pensions Ombudsman, where the pension scheme rules required the trustees to hold or have held an office equivalent to that of director.
The court recognised that decisions of such trustees would inevitably be perceived by some to favour one interest at the expense of another. It concluded that the only sensible answer was to accept that the scheme was established on the basis that the pension rules were intended to provide a body of trustees that could be relied upon to consider all interests fairly and properly; and that those who seek to challenge a decision of that body should bear the ordinary burden of establishing that the decision has been reached improperly.
If your pension scheme rules specify the composition of the trustee body, this ruling could come to your assistance in cases where the conflict between the different duties isn’t serious.
Related to the problem of conflicts of interest is that of confidential information.
Trustees are obliged to use all the information at their disposal when considering trustee business and making decisions, and to share anything of relevance with their fellow trustees.
But what if you know something that’s both relevant and confidential? The simplest solution is to persuade the company to allow you to release information to fellow trustees ‘for their eyes only’. If this isn’t possible, you should seek legal advice – and do so promptly.
There are specific statutory obligations relating to the disclosure of information, which your pensions advisers can help you with. And the pensions regulator and the Financial Services Authority (FSA) are encouraging employers to promote their pension schemes to their staff. But perhaps surprisingly, neither trustees nor employers are under any general legal duty to advise pension scheme members about their pension rights.
In fact, it’s good practice not to advise members about their rights at all. It’s all too easy to fall into the trap of handing out advice of the type that’s regulated by the FSA and which most directors and trustees are not authorised to give. Still more dangerously, you could run the risk of giving the wrong advice because you do not know all of the facts. An employee may keep crucial bits of information about their personal circumstances hidden from you – for example, the fact that they are about to hand in their notice.
Sometimes, the advice could run directly counter to the interests of other members. Trustees should not favour one group at the expense of another.
The best policy, despite the natural human instinct to be helpful, is therefore to avoid giving advice to pension scheme members, no matter how much they look for a steer from you. And do not make the mistake of giving advice ‘off the record’ – you are just as liable for what you say off the record as you are for what you say on it.
Grant Thornton and Pinsent Masons collaborate to support effective data sharing across financial services