Supreme Court Resolves Key Pension Issues

In a much anticipated ruling, the Supreme Court of Canada has affirmed a decision of the Ontario Court of Appeal which itself brought much-needed clarity to the law surrounding the use of pension plan assets to:

• pay the administrative expenses of operating the plan;
• offset employer contribution obligations in both the defined benefit (“DB”) and defined contribution (“DC”) components of a single pension plan; and
• fund member-initiated litigation against the plan sponsor.

In Nolan v. Kerry (Canada) Inc. (“Kerry”), the Supreme Court upheld an Ontario decision which had found that the plan sponsor was entitled to charge certain administrative expenses to the plan fund, and following the plan's partial conversion from a DB plan to a DC plan, use surplus assets in the DB component to offset contribution obligations to the plan's DC component. The Supreme Court also refused to allow the members' committee to have their costs paid from the pension fund.

This decision is of great importance to pension plan sponsors across the country, as it was decided primarily on the basis of contract and trust law principles. While careful review of the particular plan documentation and applicable pension standards legislation is still needed, the decision now applies to plan sponsors in each Canadian common law jurisdiction. The following findings in particular will be of interest to plan sponsors:

1. unless a pension trust explicitly provides from the outset that the plan sponsor is to pay plan administrative expenses, the plan sponsor retains the right to charge administrative expenses to the pension fund. Plan documents which are silent on the issue of payment of plan expenses, or a plan sponsor's established practice of using corporate revenues to meet plan expenses, do not create a legal obligation on the part of the employer to pay expenses;
2. provided that the plan is appropriately structured so that members of the DC component of the plan are beneficiaries of the trust holding the assets of the plan's DB component, DB surplus can be used to cross-subsidize the DC component, thus allowing the employer to take contribution holidays in both the DB and DC components of the plan; and
3. adversarial claims (as opposed to claims relating to the due administration of the plan or fund) will not qualify for a costs award from the pension fund.

Background

As part of an asset purchase transaction completed in 1994, Kerry (Canada) Inc. (“Kerry”) assumed the role of sponsor and administrator of a defined benefit pension plan (“Plan”) from DCA Canada Inc. (“DCA”). The Plan had been established in 1954 as a DB plan, funded by both company and employee contributions. Those contributions were made to a pension fund constituted as a trust. The original trust agreement contained language preventing the trust fund from being used or diverted for purposes other than for the exclusive benefit of plan members, and provided that the expenses of the trustee were to be paid by the company.

In 1965, the provisions of the Plan were revised to permit the use of Plan assets to satisfy employer contribution requirements. In 1975 and 1987, the Plan was further amended to explicitly permit the payment of plan expenses from the fund.

During the period from January 1, 1985 until the end of 1994, DCA paid various administration expenses from the pension fund of the plan (“Fund”) and also took contribution holidays. Kerry continued those practices after 1994.

Effective January 1, 2000, Kerry amended the Plan (“2000 Amendment”) to add a new DC component (“DC Component”). All new members hired after January 1, 2000 participated in the DC component, while existing members were given the opportunity to convert their DB entitlement to an account balance in the DC component.

A group of former employees petitioned the Ontario Superintendent of Financial Services (“Superintendent”) to:

1. refuse to register the 2000 Amendment;
2. order Kerry to reimburse the Plan for contribution holidays taken since 1985; and
3. order Kerry to reimburse the Plan for certain expenses which had been paid from the Fund.

The Superintendent refused the former employees' requests and consequently, the issues were raised before the Financial Services Tribunal (“FST”). The FST's decision generally favoured Kerry and the former employees appealed the decision to the Ontario Divisional Court, which largely reversed the FST's decision and ruled that, among other things, Kerry was not entitled to charge expenses to the fund (and therefore had to reimburse the fund for all expenses charged to the Plan since January 1, 1985, including the period of time before it assumed sponsorship of the Plan) and was not able to use the remaining DB surplus to take contribution holidays in the DC Component. Kerry subsequently appealed the decision of the Divisional Court to the Ontario Court of Appeal, which overturned the Divisional Court ruling, largely restoring the decision of the FST. In turn, the members' committee sought and was granted leave to appeal to the Supreme Court, which ultimately dismissed the appeal and affirmed the decision of the Ontario Court of Appeal.

Plan Expenses

The Supreme Court agreed with the Ontario Court of Appeal's holding that legal principles do not require a plan sponsor to pay plan expenses, unless the trust agreement (if the plan is funded by means of a trust) provides that expenses are not to be paid from the trust. Consequently, if the plan sponsor undertakes to pay plan expenses, it must do so unless the plan or trust is properly amended. If the plan or trust contains no such undertaking, however, the sponsor is under no legal obligation to pay any such expenses.

In Kerry, both the initial Plan text and trust agreement were silent on the matter of plan expenses. No legal obligation was created by the fact that the Plan documentation did not address the topic (in contrast, the trust agreement explicitly provided that the company was to pay the trustee's fees directly, and it was agreed by Kerry that it remained responsible for these expenses).

Moreover, the fact that DCA voluntarily elected to pay expenses for a period of time did not require it (or its successors as Plan sponsor) to continue to pay such expenses in perpetuity, since no legal obligation was created by the company's conduct.

Significantly, the Court found that the amending provisions of the trust agreement, which did not permit amendments which would allow the Fund to be used for purposes other than for the “exclusive benefit” of the Plan members, did not prevent DCA from amending the Plan to explicitly provide that expenses could be paid from the Fund. As the company was under no prior obligation to pay administrative expenses, which could have been paid from the Fund from the outset, the amendment to the Plan text did not alter the rights or obligations of the company, the trustee or the Plan members.

Consequently, apart from certain consulting fees related to the decision to introduce the DC Component that the Ontario Court of Appeal and Supreme Court agreed had not been incurred for the benefit of members, Kerry was not required to reimburse the Fund for any expenses charged after January 1, 1985.

The Supreme Court also went slightly further than the Ontario Court of Appeal in two respects. First, the Court provided some helpful guidance as to how “exclusive benefit” language in a pension plan trust agreement should be interpreted. Noting that many persons benefit indirectly from the use of pension funds (including both dependents of the plan members, and the plan sponsor), the phrase “exclusive benefit” cannot be interpreted to mean that only the plan members can benefit from the use of trust funds. This finding may be of use to plan sponsors in future disputes regarding the interpretation and application of historical trust language in other contexts.

Secondly, the Ontario Court of Appeal had left open, however tentatively, the possibility that while expenses of a third party could be reimbursed from a pension fund, the direct expenses of the employer might not be capable of being reimbursed without triggering a partial revocation of the trust. The Supreme Court has laid these concerns to rest, observing that it is immaterial whether the services are provided by a third party or the employer, provided that the expenses charged are reasonable and the services necessary for the operation of the plan. This would apply not only to invoices from third parties originally paid by the employer, but also to services provided directly to the plan by the employer.

Contribution Holidays

It has been a fairly common practice for sponsors of pension plans with both DB and DC components to use surplus assets in the DB component to offset contribution obligations in both the DB and DC components of the plan. This practice was called into question by the Divisional Court. In affirming the decision of the Ontario Court of Appeal, however, the Supreme Court has made it clear that if structured properly, a plan sponsor may use DB surplus to take contribution holidays in respect of both its DB and DC obligations. It follows from this as well that DB assets can also be used to pay expenses relating to a DC component, provided that the plan so permits.

The Supreme Court accepted the Ontario Court of Appeal's conclusion that there were no impediments either in the statutory or common law to structuring a pension plan to contain both DB and DC components. As it was not unreasonable to designate the members of the DC Component as beneficiaries of the trust (since trusts may have different classes of beneficiaries and contain numerous accounts), the cross-subsidization of the DC Component did not offend the requirement of the trust that the assets be used solely for the exclusive benefit of the beneficiaries of the Fund.

By affirming that it is possible to include DB and DC components within a single plan and trust, the Supreme Court has spared plan sponsors across the country the prospect of unnecessary litigation to unwind prior plan conversions, and provided reassurance to those plan sponsors who are considering converting to a DB plan into a DC plan, or introducing a DC component.

Costs

An aspect of the Ontario Court of Appeal decision which did not receive as much attention as it might have was the finding that the members' committee which brought the litigation was not entitled to have its costs paid from the pension fund. Pension litigants often look to have their legal and other expenses paid from the fund, on the basis that such suits are aimed at ensuring the due administration of the trust. The Court of Appeal refused to permit such expenses to be paid, and the Supreme Court agreed, holding that an adversarial claim such as that brought by the members' committee (which sought to have funds returned to the Fund for the benefit of the DB Component members only) was not one which should be supported by the Fund. Kerry was successful in the case, and it was not appropriate to penalize it by further diminishing the Fund surplus, reducing its ability to take future contribution holidays.

This particular holding, in conjunction with the balance of the decision, might be expected to limit the frequency of litigation brought by plan members in the future. Without recourse to plan assets – or at least facing the very real prospect that the claim will be found to be adversarial and costs denied – plan members and their counsel will have a reduced appetite for bringing suits against a plan sponsor, notwithstanding the benefit of class actions which can spread the cost of litigation amongst a large class of plaintiffs.

Conclusions

In dismissing this appeal, the Supreme Court has not engaged in a re-interpretation of the law, imposed a radical new mode of analysis, or given plan sponsors the green light to undermine the retirement income security of plan members, contrary to the claims of some observers. Rather, we believe that it has brought welcome clarity to the law by upholding a decision of the Ontario Court of Appeal that restored an analysis familiar to many members of the pension industry, and extended that ruling to encompass pension plans in each Canadian common law jurisdiction.

On the matter of plan expenses, this decision affirms that, while it remains necessary to undertake a historical review of plan documentation to determine whether expenses can validly be charged to the fund, the operating principle is that absent restrictions on this practice, a plan sponsor has the right to charge reasonable and bona fide expenses to the pension fund. Consequently, it is anticipated that plan sponsors will be able to obtain more definitive legal opinions with respect to plan expense language. Plan sponsors who, in the wake of the Ontario Court of Appeal decision, had elected not to charge their own expenses to the pension fund, may now wish to revisit those decisions in light of the Supreme Court's decision.

With respect to contribution holidays, as noted earlier, it was fairly common practice (prior to the Divisional Court decision in Kerry, at least) for plan sponsors to use DB surplus to fund DC contribution obligations after a plan conversion. That the decision of the Supreme Court affirms that this practice is not on its face inappropriate is welcome news for plan sponsors who have previously undertaken a plan conversion, or who are considering converting their plans from DB to DC in the future (or adding a DC component for new hires). The decisions of the Ontario Court of Appeal and the Supreme Court confirm that there is a proper way to move from a DB to a DC pension plan and, together, they provide sponsors with considerable guidance to structuring plans and funding arrangements to permit the cross-subsidization of DC component contribution obligations (and, it naturally follows, expenses) with DB plan surplus. We encourage plan sponsors to review their plan and trust documents to ensure that DC component members are beneficiaries of the DB trust, and also would suggest that any funding arrangements made in respect of the DC component be held as part of the DB trust (although arguably not required by Kerry, having the trustee hold the DC funding arrangement may further enhance that DC members are beneficiaries of the trust).

On a cautionary note, however, it is not clear at this stage how the reasoning in Kerry might be applied to pension plans and funds which are the subject of past mergers, both with respect to plan expenses and contribution holidays. Sponsors of plans which have received transfers of assets and liabilities from prior plans should proceed carefully before drawing overly broad conclusions from Kerry, since depending on the facts, existing jurisprudence relating to the use of assets in merged plans may complicate the analysis.