June 01, 2006
An Ontario Divisional Court decision, Nolan v. Superintendent of Financial Services, could make defined benefit (DB) plans more expensive for employers to operate, even if they have converted to defined contribution (DC) arrangements.
Reversing an earlier Financial Services Tribunal decision, the ruling ordered Kerry (Canada) Inc. to reimburse C$850,000 to the pension trust fund. This amount includes plan trustees' fees, investment managers' fees, accounting firm fee and other miscellaneous expenses. The court also ruled that when the DB plan was converted to a DC plan for future service in 2000, Kerry could not use surplus funds from the original DB plan to meet its defined contribution obligations under the same plan.
The decision was based on the court’s interpretation of language in the original trust agreement, which provided that the trustee’s expenses “shall be paid by the company” and that “all contributions may only be used exclusively for the benefit of members.” The trust documents did not include references to the payment of fees related to the plan’s administration. Because the power to revoke the trust was not specifically reserved by the employer, the court invalidated subsequent amendments to expand the circumstances in which plan-related expenses could be paid from the fund.
Various concerns have been raised about the decision, including that the significant payment to the plan does not consider potential adverse implications for plan members and the plan itself; that Kerry’s requirement to reimburse the plan includes a requirement to reimburse expenses during the 10-year period before Kerry had assumed responsibility for the plan; and that the decision does not consider the interaction between Ontario’s Pension Benefits Act and common law trust principles. The statute—which says that administrators are entitled to a refund of contributions, fees and expenses related to pension plan administration permitted by the common law or provided for in the plan text, and provides for the payment of the usual and reasonable fees of agents—differs from what the decision says, which is that it cannot be exclusively beneficial for plan members to have administration fees paid out of the fund.
Mitch Frazer questions who benefits from the plan’s existence. “Most older funds have irrevocable trust language. Regardless of whether Kerry was permitted to amend that language, the general consensus until now has been that usual and reasonable expenses can be paid from the plan under the statute. This includes reasonable fees for agents like actuaries, accountants and lawyers, as long as payment of these expenses are provided for in the pension plan.” Adds Mitch: “This is really tightening the noose around plan sponsors. These administration expenses are on top of contributions, so there is just that much more cost to the employer running that plan.”
The ruling on plan expenses has been eagerly anticipated since the case was heard over a year ago. However, says Mitch, “The decision with respect to the use of DB surplus on DC plan conversions was a real sleeper. According to the judgment, there are two pension plans, two pension funds and two classes of members. But they are all the same people, except for new hires joining the plan. This does not reflect common practice. In these circumstances, money is in a single pension fund, and if there is DB surplus on an ongoing basis, plan sponsors typically allocate amounts to DC administrative expenses.”
An application for leave to appeal has been filed, and it is likely to be heard in June. Mitch predicts that if either or both of the rulings in Kerry are upheld on appeal, Ontario plan sponsors will have to review their practice to bring plans into compliance, and class action litigation against them based on past procedures could be in the cards.
The decision could also be a factor that makes DB plans less attractive to existing or potential retirement plan sponsors. “I don’t want to say the sky is falling, but DB plans benefit employees, so anything you do to discourage them is a bad thing,” says Mitch. “The decision certainly doesn’t encourage anyone to set up a new DB plan. And if plan sponsors are considering converting their DB plan to a DC arrangement, the cross-subsidization part of the decision will not result in a smooth transition. The employer might decide on a group registered retirement savings plan or no retirement plan at all.”