Pension Tension


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Will Directors be Implicated in the Looming Pension Crisis

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Pension Tension

  1. 1. Financial Services Group Pension Tension: Canadian Advisory Volume 3 Issue 15 2009 Will Directors be Implicated in the Looming Pension Crisis? For more information Setting the Scene questionable investment vehicles such as please contact: asset-backed commercial paper or shares National The economic downturn, low interest based on subprime mortgages and loans. Brad Lorimer rates and plunging stock markets There will no doubt be allegations made Senior Vice President, have created the potential for a perfect where companies have contribution National Director shortfalls, taken contribution holidays 416.868.2479 storm for liability arising out of the administration of Canadian employer- or engaged in plan conversions or plan sponsored benefit plans. It seems that mergers. There have already been a David A. Griffiths every day there is a news article about number of cases decided recently dealing Senior Vice President with the alleged misuse of plan surpluses pension fund values in decline or the National Consulting Director and the inappropriate allocation to the 416.868.5554 difficulties faced by companies that have not, or will not, be able to make required plan of plan expenses, the most notable pension contributions. Some companies of which is Nolan v Kerry1. Many legal Ontario will not survive the current financial experts believe that this is just the trickle Mark LeSaevage before the dam breaks. Vice President crisis. They will be forced to restructure 416.868.5795 or declare bankruptcy, which could lead to pension-related problems such as the The Law in Transition recent ones faced by Stelco, Air Canada Québec and Algoma Steel. Making an already risky situation more Bernard Dupré Vice President challenging for plan fiduciaries, Canadian 514.840.7783 Let the Finger Pointing Begin courts seem quite willing to apply common law trust principles to broaden Baby boomers are worried about their statutory fiduciary duties and obligations. Prairies Kathleen Cook future and will be looking for someone to It is currently unclear when and to what Prairie Region FSG Leader blame when vested pension benefits prove extent these principles may apply. As more 403.267.7878 to be less than what was promised. Fingers pension-related actions are tried, a more definitive body of case law will emerge. will be pointed at plan administrators, pension committee members and Further complicating matters, pension B.C. Paul Lively directors and officers of corporations law in Canada is under review and will Senior Vice President where investment returns are much lower soon change significantly. Four provinces 604.443.3353 than anticipated, where plans invested too heavily in the company’s stock, or in 1 Kerry (Canada) Inc. V DCA Employees Pension Committee, 2007 ONCA 416.
  2. 2. Pension Tension: Will Directors be Implicated in the Looming Pension Crisis? have received commissioned reports this past year recommending The Fiduciary Standard of Care substantive amendments to existing pension statutes2. As well, the Canadian Association of Pension Supervisory Authorities (CAPSA) The duty owed to plan beneficiaries on the part of fiduciaries is recently released a proposed agreement that establishes a mechanism considerable. Fiduciaries must comply with both the standard of for determining how the many different pension statutes will apply care set out in relevant pension legislation4 and the common law to pension plans that are multi-jurisdictional3. Although pension of trusts5. Essentially, fiduciaries must act with the utmost care law reform in Canada is long overdue, the fact remains there is in managing and administering the plan or fund. They must act uncertainty about where the law is headed. The combination of solely for the benefit of the plan’s beneficiaries and avoid even the unfavourable economic conditions and a law in transition make for a appearance of a conflict of interest6. very dangerous cocktail with respect to fiduciary liability. Types of Fiduciary Exposures Who is a fiduciary? Fiduciaries will be held personally liable for wrongdoing stemming It is important to understand who is considered a fiduciary. from a breach of their statutory and common law duties or for Fiduciaries are defined by the duties they carry out, not by their negligence in the administration and management of the benefit titles or professions. In the context of employer-sponsored benefit plan. Potential claims against fiduciaries include the following plans, any person or entity who exercises any authority or control allegations: over how the plan is administered or how plan assets are managed, invested or disposed of, or who provides investment advice to • plan conversions were improperly executed plan beneficiaries is considered a fiduciary. This would include the plan administrator, pension committee members and investment • the benefit program was inadequately funded managers. It would also include the plan sponsor (usually the employer entity) and, by extension, its directors and officers who exercise any discretionary authority over the management or 2 Getting Our Acts Together: Pension Reform in Alberta and British Columbia released November 28, 2008; A Fine Balance: Safe Pensions, Affordable Plans, Fair Rules (Ontario) released November 20, 2008; The Nova Scotia administration of a plan, regardless of how insignificant. Despite Pension Review Panel’s report was due in December 2008 but not released at the time this article was prepared. the fact that fiduciaries can allocate or delegate some or all of their 3 Agreement Respecting Multi-Jurisdictional Pension Plans released on October 21, 2008. 4 Fiduciaries must exercise the care in administration and investment of the pension plan and fund that a person duties in the management or administration of the plan to others, of ordinary prudence would exercise in dealing with the property of another person. As well, fiduciaries must use they cannot contract out of their fiduciary obligations. It is fairly apt all the relevant knowledge and skill they possess, or ought to possess, given their profession, business or calling. Pension Benefits Act, R.S.O., 1990, c. P.8 s 22 to say, “Once a fiduciary, always a fiduciary”. 5 There are very high standards of honesty, loyalty and prudence. Fiduciaries are not permitted to delegate decision-making power to non-qualified individuals and they must maintain an even hand in dealing with different classes of beneficiaries under any plan. Fiduciaries must also be free of any conflicts of interest. 6 Corporate directors and officers are in a particularly difficult situation because they also have fiduciary obligations to the corporation and its shareholders that are different and often in conflict with any fiduciaries they may have as plan administrators. This publication contains general information only and is intended to provide an overview of legal, liability and insurance issues. The information is not intended to constitute legal or other professional advice.
  3. 3. Vol 3 Issue 15 2009 • expenses were improperly charged to the plan fiduciaries who administer benefit plans is much more limited than such capacity to indemnify directors and officers. Whereas directors, • advice or counsel was improper acting in their capacity as such, can be indemnified for their negligent actions generally, fiduciaries cannot be indemnified if they • there were misleading representations are grossly negligent. • benefits have been changed or denied In addition, if the funds to indemnify fiduciaries are to come from • the plan was wrongfully terminated or amended trust assets and the trust documents do not clearly set out those rights, such indemnification may be subject to court approval • there was a lack of investment diversity pursuant to the common law. • there were administrative errors Insurance • there was a conflict of interest It is a common belief that fiduciaries are protected from personal liability in regard to the above-noted exposures by their company’s • benefit calculations were incorrect Directors’ and Officers’ Liability (D&O) or Commercial General Liability (CGL) insurance policy. Unfortunately, that belief • advisors or service providers were inappropriately selected is substantially unfounded. CGL policies generally offer only • there were civil rights violations and/or discrimination. limited protection for certain types of errors and omissions in the administration of employee pension and benefit plans. The typical These allegations could be made in the context of a civil action by D&O insurance policy excludes coverage for claims arising out of the or on behalf of plan beneficiaries, or in the course of an investigation breach of pension legislation or common law applicable to pension or proceeding conducted by provincial regulators charged with or other benefit plans. enforcing pension plan legislation. There is also a misconception that fidelity bonds offer protection for fiduciaries from personal liability in regard to the breach of their Additional Exposure for Directors duties. These bonds, however, are designed to insure the company for the theft of assets by company employees and offer no coverage It is also crucial to note that directors have statutory duties under to fiduciaries. both federal and provincial legislation to ensure that pension plan contributions are made. Under provincial pension legislation, where Fiduciary Liability Insurance a director has permitted (or acquiesced to) an offence related to the failure to make a required payment to a pension fund, such director One type of risk transfer product that does provide protection to is not only subject to fines, penalties and interest but may also be fiduciaries is the Fiduciary Liability Insurance (FLI) policy. However, liable to personally make the outstanding payment7. It remains it is important to understand what is covered under such a policy. to be seen if recent amendments to Canadian bankruptcy and FLI policies generally offer protection to the benefit plan, the insolvency legislation granting employees a super-priority right to sponsor corporation, its directors, officers and employees for losses pension benefits may temper the above-noted exposure somewhat; arising out of claims made for breaches of fiduciary obligations however, there are still significant risks8. and for negligent administration of the plan itself. Not all FLI policies are created equal, so it is vital to review the policy’s major provisions, including the insuring clauses, the definitions, the Risk Transfer and Insurance Issues exclusions and other terms and conditions to determine the breadth of coverage. Given the considerable exposures faced by fiduciaries, it is important to determine what risk transfer mechanisms are available to them. Limited Rights to Indemnification 7 Pensions Benefits Act, R.S.O., 1990, c. P.8 s.110(4) 8 Recent amendments to the Bankruptcy and Insolvency Act grant a priority charge in bankruptcies and receiverships for outstanding current service pension plan contributions. It is one school of thought that if Unlike business corporation statutes that provide for the these outstanding contributions can be satisfied out of the bankrupt entity’s estate, it would be less likely that indemnification of directors and officers, pension legislation has provincial regulators would pursue the corporation’s directors under pension legislation to make up the shortfall. 8 Unlike other jurisdictions in Canada, Quebec does allow for indemnification of pension committee members. no similar provisions with respect to fiduciaries.8 Indemnification Bill 30 provides that pension committee members can be indemnified for any prejudice they suffer in the exercise of fiduciaries can be addressed in plan documents or in separate of their tasks provided they have not committed any fault. agreements. However, the capacity of a corporation to indemnify
  4. 4. It is important to note that the FLI policy does not cover claims for benefits due under the plan9. This has caused a great deal of confusion amongst insureds who did not receive proper advice at the time the policy was purchased. There may also be limitations on coverage for the improper use of plan surplus and for the statutory liabilities imposed on directors as discussed above. Summary Recent economic, demographic, judicial and legislative factors are all contributing to the increased exposures Canadian fiduciaries now face. The duties and obligations are significant, and, in the current environment, the potential for civil and regulatory action being taken against fiduciaries is great. A wide range of individuals involved in the administration of pension and benefit plans, including corporate directors, qualify as fiduciaries. These individuals cannot contract out of their liabilities to plan beneficiaries. As well, directors have additional statutory obligations with respect to pension contributions. Indemnification rights available to fiduciaries are much more limited than those afforded to directors and officers while carrying out their duties to the corporation. Many insurance products believed to offer protection to fiduciaries in carrying out their obligations provide only limited coverage. Fiduciary Liability Insurance can protect fiduciaries from a number of the key exposures they face. However, each FLI policy is unique and the wording contained therein can be confusing. It is highly recommended that fiduciaries explore all risk transfer options available to them with the aid of an experienced insurance professional. Brian Rosenbaum, LL.B. Legal and Research Practice, Financial Services Group Aon Reed Stenhouse 9 The typical definition of loss in FLI policies exclude benefits, or that portion of any settlement or award in an amount equal to benefits due under the plan.