IBM defined benefit pension scheme changes were not made in bad faith, appeal court rules

It found that the High Court had applied the wrong legal test when it ruled that IBM had acted unlawfully when it closed its DB schemes to future accrual and made a number of other changes, including restricting early retirement on beneficial terms and discounting future increases in salary from its definition of 'final salary' for the purposes of the scheme.

The High Court also gave too much emphasis to the scheme members' reasonable expectations, the Court of Appeal said. There was no specific legal requirement to take into account members' reasonable expectations, it ruled.

"The Court of Appeal has made it even harder for employers' decisions to be challenged, which will no doubt come as a relief to employers," said pensions disputes expert Hayley Goldstone of Pinsent Masons, the law firm behind Out-Law.com. "However, many trustees will be left wondering how to encourage employers to offer a better deal to members on closure to accrual."

In April 2014, Mr Justice Warren found that IBM's closure of its two UK DB schemes to future accrual as of April 2010 had breached its duty of good faith to the members of those schemes, due to their reasonable expectations of IBM in light of its previous conduct. The company's 'Project Waltz' initiative came shortly after two other DB pension scheme restructuring exercises, and affected approximately 5,000 scheme members.

In his judgment, the High Court judge said that IBM had breached its contractual duty of 'trust and confidence' to the scheme members in relation to the way that the consultation on the changes was carried out; as well as its duty of good faith, known as its 'Imperial duty' after a previous case, in relation to some of the changes themselves. He said that the test for whether the duty had been breached involved testing whether IBM had acted reasonably and appropriately. The correct test was whether any rational employer would have acted in the way IBM would have done.

"It seems to us that, in referring to the reasonable employer test, as he often did, [the High Court judge] may have incurred the risk ... that 'concentrating on the outcome runs the risk that the court will substitute its own decision for that of the primary decision-maker'," said appeal court judge Sir Timothy Lloyd, giving the judgment of the Court of Appeal. "In particular, reference to the reasonable employer may lead to the application, even if unconsciously, of a test diluted and distorted from the true test of irrationality."

"In our judgment the judge did approach the issue on an incorrect basis, by according to the reasonable expectations which he had found to be proved a paramount significance, such that [IBM] could only be found to have acted in accordance with their relevant duties either by giving effect to the reasonable expectations or by showing that there was no other course open to it in the given circumstances. The existence of the reasonable expectations, or at any rate the history of the communications to employees … were relevant factors to be taken into account by the decision-maker. But to elevate them to a status in which they had overriding significance over and above other relevant factors was erroneous in law," he said.

The appeal court also rejected calls for IBM to carry out a new consultation process before it can implement its Project Waltz plans, as the original consultation process had been defective in some aspects. Rather, the trustees would be entitled to claim damages from IBM for breach of its contractual consultation duties, it ruled.

"The principal reason for rejecting the claim … is that it would change the position of IBM and of the members of the plans far too radically, by requiring Project Waltz (which on this basis is not legally objectionable in itself) to be unravelled and cancelled, and by putting IBM in the position of having to consider and formulate what would have to be entirely new proposals for the reform of the benefit provisions of the plans, a long time after the relevant events ... and in what are likely to be profoundly altered circumstances," the judge said.