IBM United Kingdom Holdings Limited v Dalgleish and others


On 4 April 2014, the High Court (Mr Justice Warren) handed down judgment in the latest in a series of cases relating to the IBM Pension Plans, this time considering whether the sponsoring employer of the “DB Plans” was in breach of the implied duty of good faith owed to members.

In this Alert:

Key points

  • The Court decided that IBM was in breach of the duty of good faith in relation to decisions taken by the employer as to the future of the DB Plans in 2008/09
  • The Court also took the opportunity to consider further the test that should be applied when considering whether or not the implied duty of good faith has been breached
  • IBM has announced that it will appeal the judgment.

The facts of the IBM case

The facts of the IBM case are complex and cover a lengthy period of time.  However, in summary, they are:

Project Ocean

In 2004, IBM presented proposals (known as “Project Ocean”) to the Trustee in relation to the DB Plans which resulted in an increase in the member contribution rate for the contributory DB Plans and a reduction in the accrual rate for the non-contributory DB Plan.  IBM also agreed with the Trustee to pay contributions to the DB Plans to reduce the past service deficit and a parent company guarantee in respect of company contributions was also put in place until 2014.

In explaining these changes to members, IBM issued a number of communications including a webcast by the HR Director and various Q&A and explanatory documents.

Project Soto

In late 2005 and early 2006, IBM presented proposals (known as “Project Soto”) which, in essence, gave DB members an option to either:

  • remain in the DB Plans and continue accruing DB benefits, subject to agreements which would result in only 2/3rds of future salary increases being pensionable, or
  • transfer to the new Enhanced DC Plan to earn enhanced DC benefits from July 2006 but retain a final salary link in respect of past service DB benefits.

Crucially, as part of the discussions surrounding these changes, IBM indicated that there were no further plans to change the pension arrangements and that these changes were therefore viewed as “long-term”.

Project Waltz

In 2009, IBM presented a proposal for its pension arrangements known as “Project Waltz”, which contained five key elements:

  • The closure of the DB Plans to future accrual with effect from April 2011.
  • Entry by DB members into agreements by which future pay increases would not be pensionable.
  • An “early retirement window” from November to December 2009 during which those potentially eligible could apply for early retirement with the benefit of existing favourable discount factors.
  • A new early retirement policy from April 2010 under which, save for “exceptional circumstances”, early retirement would only be allowed on cost neutral terms.
  • Allowing former active members of the DB Plans entry into the DC plan (known as the “M” Plan).

The Representative Beneficiaries argued that the changes effected by Project Waltz were a breach of the duty of good faith. In particular, focus was drawn to the fact that the changes were driven in order to maintain the Earnings per Share (EPS) that IBM had committed to Wall Street that it would provide.

What is the “duty of good faith”?

The “implied duty of good faith” is a concept that originates in the employment sphere in the context of the employer / employee relationship. It is effectively shorthand for an implied term in the contract between the employer and employee that neither party should take steps that would destroy or seriously damage the relationship of trust and confidence between them.

The application of the principle to pension schemes was first considered in theImperial Tobacco case in 1990, which established that the same principle applies in the context of the sponsoring employer of a pension scheme and the members of that scheme. Whilst the duty of good faith has been taken into account in a number of employment related cases, IBM is only the second case since Imperial Tobacco to consider it in detail in the pensions context. Inthe Prudential case (2011), the High Court concluded that the test as to whether or not an employer had breached its duty was whether it had acted irrationally or perversely in taking a discretionary decision.

Has IBM changed the test to be applied?

Having considered a number of cases concerning the duty of good faith, Mr Justice Warren further clarified the test described in the Prudential case. In particular, the IBM case focuses on the extent to which members’ expectations have to be considered in weighing up whether or not an employer is in breach of this duty.

The judgment draws a distinction here between members’ “Reasonable Expectations” and “mere expectations”. A “Reasonable Expectation” is “an expectation as to what will happen in the future engendered by the employer’s own actions which gives employees a positive reason to believe that things willtake a certain course”. In contrast, a “mere expectation” is one which an employee may assume or expect will happen in the ordinary course of events if things “carry on as they are”, but such an expectation may arise independently of any encouragement on the part of the employer.

The “Reasonable Expectations” of members have to be considered when an employer is making changes which affect scheme members. Whilst an employer is entitled to consider (and act in) its own interests, including its own financial interests, it cannot do so without balancing this against members’ Reasonable Expectations. In contrast, whilst “mere expectations” should still be considered by an employer when taking decisions in relation to a pension scheme, “it cannot be seriously contended that a mere expectation by itselfcan be the foundation on which a case alleging breach of the Imperial duty is built”.

The decision

When considering Projects Ocean and Soto, Mr Justice Warren concluded that a reasonable member reading the communications in respect of them would have formed the Reasonable Expectation that benefit accrual would continue into the future, although they would also have understood that a significant change in financial and economic circumstances might cause further changes.  Similarly, the reasonable member would have had a Reasonable Expectation that the early retirement policy would not change until 2014, unless there was a “relevant justification” for the change.

Against the above background, the judge decided that Project Waltz was inconsistent with the Reasonable Expectations of members and that IBM UK acted in breach of its duty of good faith to the members of its DB Plans in closing them to future accrual and imposing a new restrictive early retirement policy.  In doing so, he noted the “unreasonably short” window provided to members to take early retirement on favourable terms. He also found that IBM provided misleading information to members during the consultation process which preceded the closure.

Whilst it is not a breach of duty to prefer investors to employees/members, Mr Justice Warren was conscious that the Reasonable Expectations of members had arisen prior to IBM’s commitment to Wall Street.

A separate remedies hearing will now take place to determine what remedy IBM must make to the members.

Impact for other pension schemes

The result of this case was driven in large part by the weight of factual evidence in support of the members’ expectations in relation to the DB Plans. The judgment runs to almost 450 pages and there is a detailed review of a number of communications and discussions behind the scenes at IBM that indicate a long standing desire on the part of the US parent company to reduce the UK pension costs.

However, Mr Justice Warren’s analysis of the good faith test does demonstrate the need for employers and trustees to be judicious in their communications with members in relation to pension scheme changes, particularly where a number of changes are made in a short period of time.