Challenging discretionary decisions

The Pensions Ombudsman is currently dealing with two claims relating to alleged failures to exercise a scheme discretion to the benefit of members.  Both claims are lead claims which means that there are many other complaints before the Ombudsman relating to similar issues and although the outcomes of these cases will not bind other complainants, they will inform the trustees and sponsors of the Ombudsman’s views on the issues and how other claims are likely to be determined. 

The first claim is a dispute  between the trustees of the Boots Pension Scheme and some of its members regarding the removal of an option to apply to the trustee for an unreduced early retirement pension between age 60 and 65 when the Scheme’s benefits were bought-in in November 2023. In published correspondence, the trustees confirmed that in their view there was no legal requirement to secure the discretionary option and the buy-in transaction would not have been affordable if all discretionary benefits had been included. 

The second is a complaint brought by the BP Pensioner Group against BP and the BP Pension Fund Trustees in respect of BP’s failure in 2022 and 2023 to grant discretionary pension increases and the Trustees’ failure to recommend any such increase to BP in 2022.  In addition to seeking such retrospective increases, we understand the members are seeking a commitment that all existing discretionary benefits, including a decision to increase pensions in line with the cost of living, will be hard coded on any future buy-in of the Scheme. 

We are not involved in either dispute and no details have been published relating to the evidence or arguments before the Ombudsman. Nevertheless, we thought it useful to revisit the legal principles that govern the exercise of discretions in occupational pension schemes. 

Trustee discretion

The principles that govern the exercise of a discretion differ depending on whether it’s being exercised by a trustee, in which case it is fiduciary, or an employer, where generally it is not. 

There is nothing unique about the exercise of trustee discretion in the context of securing benefits on a buy-in or buy-out. It is the same test that applies to the exercise of any trustee discretion and as such, the trustees must:

• interpret the scheme rules correctly;
• follow the requirements of the scheme rules;
• take into account the appropriate factors in reaching their decision; and 
• make a reasonable decision which is not perverse. 

The 2023 Pensions Ombudsman determination of Mr Y v Sotheby’s Pension Scheme  is a good example of these principles being applied in practice. It involved a decision by the trustees not to use scheme surplus to secure discretionary pre-97 pension increases on the buy-out of the scheme. The member complained that, following the buy-out of his benefits with an insurer, the scheme surplus was not being used to provide discretionary increases for pensions in excess of GMPs accrued before 6 April 1997, which had been provided in eight of the previous 13 years. 

The Ombudsman determined that there was no requirement for any surplus to be used to fund additional benefits or increases on pre-97 excess pensions. The trust deed set out the options for dealing with surplus, which included payments to participating employers. The Ombudsman noted that under the scheme rules, any increases were paid subject to the consent of the employer and were not something the member was entitled to as of right. He, therefore concluded there was no irregularity in the surplus not being used to provide pensioners with additional benefits

Employer discretion

How is the member’s ability to challenge a decision affected where, as in the BP case, it is the employer that has a non-fiduciary discretionary power such as a discretion to increase pensions in payment or to augment benefits under the scheme rules?

The test here is whether in making its decision the employer has destroyed or seriously damaged the relationship of confidence and trust between itself and its employees and former employees – described as the Imperial Tobacco duty of good faith. In that case, the High Court held that the employers were not entitled to refuse consent to an increase in pensions in order to force employees to move to another fund, the terms of which gave the employers the right to any surplus and offered members an inflation-linked increase of up to 15%. 

In the House of Lords’ 2001 judgment in National Grid Co plc v Mays, which involved a decision by the employer to use a third of ongoing surplus to increase member and dependants’ benefits and the remainder to reduce employer contributions, Lord Hoffmann approved the statement that an employer “was entitled to act in his own interests provided that he had regard to the reasonable expectations of the members”. 

The 2011 case of Prudential Staff Pensions Ltd v The Prudential Assurance Co Ltd is not a surplus case but one where the employer had sole power to decide whether to award discretionary increases. There, the Court held that members’ interests and expectations may be of relevance when considering whether an employer has acted irrationally or perversely, but employer discretionary increase powers were not fiduciary. In addition, as the rules did not require trustee consent, the employer was not required to negotiate with the trustees before making a decision.

All of these cases were, however, heard before the Court of Appeal’s judgment in 2017 in IBM v Dalgleish, which is now the leading authority on an employer’s exercise of a non-fiduciary discretionary power. The Court held that to avoid breaching the duty of good faith, an employer had to take into account all the circumstances existing at the date of its decision. The adverse trading conditions affecting the employer in that case were a relevant factor, and whilst disappointing members’ reasonable expectations was also a relevant factor, it was merely one relevant factor to be considered and had no overriding significance. 

Drawing on the Supreme Court’s judgment in Braganza v BP Shipping Ltd [2015] and other employment law cases, the Court of Appeal held that the correct approach in cases involving the exercise of an employer’s discretionary power was to apply a two-fold rationality test considering whether:

• only relevant matters (and no irrelevant matters) have been taken into account by the decision-maker; and
• the result was such that no reasonable decision-maker could have reached it. 

This now sets a high bar for members to overcome. 

Other arguments

Of course, the arguments being put before the Ombudsman by the Boots Pension Scheme members and the BP Pension Scheme members are likely to involve more than whether the trustee’s decision making was unreasonable or perverse or that the sponsor’s decision was irrational. The BP pensioners also appear to be arguing that assurances given by BP that unless the company was in financial distress, their future pension increases would be raised in line with the cost of living amounted to contractual commitments and/or had become entitlements through custom and practice or, alternatively, that BP are estopped from reneging from the assurances made to members. Much will inevitably turn on the evidence. 

Concluding thoughts

These are two determinations that the industry will no doubt await with interest, not least because the Government has said that in deciding whether to use the new power under the Pension Schemes Bill to release surplus from an ongoing scheme, a key consideration for trustees will be the potential for members to benefit from that surplus. These provisions will strengthen trustees’ hands as their consent will be required to access surplus whilst a scheme is ongoing. In those situations, at least, members may no longer find themselves having to challenge decisions not to award discretionary increases. Nevertheless, the above cases will remain relevant when considering distribution of surplus on a scheme wind-up. 

In all cases, those buying-in scheme liabilities and considering whether to convert any discretionary benefits into member entitlements as part of that buy-in should always take legal advice to ensure that any decision-making process is robust and that there is an appropriate audit trail in the event of any future member challenge.