Action needed to retain right to pay pension surplus to employer

A little-known provision of the Pensions Act 2004 has sent pension lawyers into a spin. They are now advising schemes that if they wish to retain the right to make payments to employers the trustees need to pass a resolution quickly. We examine the troublesome section.

On this page:
Surplus provisions revisited
Transitional arrangement
Why is it relevant?
Taking action
Our research
Extract from s.251 of the Pensions Act 2004.

Nearly six years after the Pensions Act 2004 received royal assent, a seemingly innocuous section is causing pension lawyers concern. Part of the section in question, s.251, is reproduced in the box below . As can be seen, it is innocently headed "Payment of surplus to employers: Transitional power to amend scheme". According to the explanatory notes to the Act, s.251 "introduces transitional powers for trustees to amend scheme rules to take account of the repeal of the Income and Corporation Taxes Act 1988 provisions and the substitution of a new s.37 of the 1995 Pensions Act".

Whether intended or not, a strict interpretation of the wording of the section means that payments out of pension fund surpluses may only be permitted if trustees have passed a resolution to that effect by 5 April 2011. Some lawyers are going so far as to say that the section prohibits any payments being made to employers unless the appropriate resolution is made.

Surplus provisions revisited

Between 1987 and 2006, HM Revenue & Customs (HMRC) rules did not permit schemes to be funded in excess of 105% using a valuation basis prescribed by statute. If a scheme's funding level exceeded this limit, HMRC required trustees to reduce it in one of a number of specified ways, one of which was paying all or part of the surplus to sponsoring employers.

This requirement was removed by the Pensions Act 2004 with effect from 6 April 2006. Payments to employers are now only permitted in line with Department for Work and Pensions (DWP) rules, which means that before any payments out of surplus can be made the scheme must be fullly funded on a buyout basis and the trustees must be satisfied that the payment is in the interests of scheme members.

Transitional arrangement

The surplus provisions introduced by the 2004 Act are more restrictive than the previous rules. It seems that s.251 was intended to allow schemes to pass a resolution retaining their existing surplus provisions. A number of professional firms, including solicitors Hogan Lovells and actuaries HamishWilson, suggest that when the Pensions Bill was going through Parliament it was scrutinised inadequately and does not properly reflect the government's intentions.

David Pollard, senior pensions partner with solicitors Freshfields Bruckhaus Deringer, believes that if a court were asked to review the section it would probably take a commonsense rather than a literal approach and interpret it in accordance with the heading, accepting that it is a purely transitional arrangement. However, he, along with many other pensions lawyers, suggests that waiting for a judicial interpretation of the section could be a risky strategy. Trustees are therefore being advised that, if they wish employers to retain the right to a payment from the scheme, they should make a short resolution to that effect.

Why is it relevant?

At a time when very few schemes have a surplus on any basis, trustees may question the purpose of making a resolution permitting payments to employers. But there are valid reasons why it may be prudent for trustees to take action, which are unrelated to paying surplus to employers. One is that on a literal interpretation of the wording of s.251, it applies to any payments made from the scheme to the employer. Therefore it could, for example, prevent the trustees from returning overpayments of contributions, repaying loans or making payments under lien rules (allowing an employer access to a member's pension for a debt due to it as a result of criminal, negligent or fraudulent activity). The provision of the Pensions Act 1995 replaced by s.251 allowed for exceptions to the no-payments rule, such as administration payments. Lawyers do not believe that it was Parliament's intention to exclude all payments but until the section is amended trustees may find it difficult to make routine payments unless the resolution is made.

Another reason offered by pensions professionals for making the resolution is that it may give trustees greater bargaining power with employers. Employers may be more willing to fund schemes at a higher level if the surplus is not "locked in". The section permits trustees to attach conditions to the surplus provisions so the resolution does not have to give employers an automatic right to surplus in all circumstances.

A final reason for trustees retaining the power to pay surplus moneys to employers is that under international accounting rules, if payments of surplus are not allowed, the ability to recognise the asset on the balance sheet is severely restricted, even if the scheme is more than 100% funded on the international accounting standard (IAS19) basis.

Taking action

Trustees of defined-benefit pension schemes have three possible courses of action, according to David Pollard. They can decide that they will do nothing but keep an eye on developments; they can seek clarification of the section, for example by obtaining an opinion from counsel; or they can make a resolution preserving the employer's existing right to payments from the scheme.

If trustees decide to pursue the last of these three courses of action, a number of conditions need to be satisfied. These are that:

• the scheme must have been established before 6 April 2006 and the trust deed and rules in force immediately before that date must have contained a power to pay surplus to a sponsoring employer while the scheme is ongoing;
• the trustees must be satisfied that the resolution is in the interests of scheme members;
• employers and members must be given three months' written notice of the trustees' intention to pass the resolutions (although members' consent is not required);
• the power to pass the resolution may only be used once and must be used before 6 April 2011;
• the power to make the payment may only be exercised by the trustees; and
• the scheme must be fully funded on a buyout basis before any payment of surplus can be made.

The need to give notice to members of the trustees' intention to make the resolution could make some schemes pause for thought. At a time when many schemes are in deficit, members are likely to question the motives behind a resolution giving the trustees power to permit payments to employers. Therefore the notice needs to be carefully worded. It may be incorporated into other member communications such as the scheme report.

Although the section seems to relate to ongoing schemes only, law firm Hogan Lovells recommends that reference to refunds on winding up is included in the resolution to ensure that employers retain the right to payments on wind-up.

The three-month notice requirement means that trustees have to start the process very soon if they are to have the resolution in place by the April 2011 deadline. It is understood that the DWP has been asked to amend the section as soon as possible but there is no guarantee that amending Regulations will be made in the near future.

Our research

This feature is based on s.251 of the Pensions Act 2004 and client newsletters produced by Eversheds, Freshfields Bruckhaus Deringer, HamishWilson and Hogan Lovells.