TRANSFER FROM A DEFINED BENEFIT TO A DEFINED CONTRIBUTION FUND:
DOES IT CONSTITUTE CHANGE TO CONDITIONS OF EMPLOYMENT?
By Francisco Khoza (Senior Associate, Bowman Gilfillan Inc.)
Introduction
Employers are constantly looking for opportunities to reduce their liabilities in order to
maximise profit. After all profit making is the paramount object of establishing an
enterprise. In their quest to reduce their liabilities, a number of employers have taken
steps to terminate defined benefit funds (“DB Fund”) and have established defined
contribution funds (“DC Fund”). The rationale behind the migration from DB to DC Funds
rests primarily in the distinction between the two types of funds.
A DB Fund is, “one which undertakes to provide its members with the benefits defined in
its rules… a pension expressed as a percentage of final salary and based on years of
service.1” A DC Fund is, “a fund in which members are entitled ultimately to withdraw
whatever the fruits of the investment of the defined contributions may realise.2” The
advantage offered by a DB Fund to employees was crisply articulated by Goldblatt J in
the recent case of Kuit and Others v Transnet Pension Fund and Another3 when he
stated, inter alia, that,
“As a defined benefit, balance of costs fund, the benefit obligations of the Fund
do not vary depending upon the funding level of the Fund.On the contrary they
remain constant and defined in the rules. The very purpose of a defined benefit
fund is to guarantee the payment of a defined quantifiable benefit. By virtue of
this guarantee members are afforded the security of knowing that by law they are
entitled to a predefined benefit which is not depended upon the investment
fortunes of the fund.”
A DB Fund offers employees the security of knowing that the employer has an obligation
to ensure that the fund is in a sound financial position. For the employer the
aforementioned obligation represents an on going potential liability. Consequently,
employers have taken steps to reduce their exposure by terminating DB Funds and
establishing DC Funds.
The issue under consideration in this article is whether a change from a DB to a DC
Fund will constitute a change to conditions of employment.
Membership and employment law
An employer commonly establishes a pension fund in terms of the Pension Funds Act4
(“the Act”). The employer then contracts with its employees that, inter alia, they are
required to join a particular pension fund and to make contributions thereto, whilst the
1
TEK Corporation Provident Fund and others v Lorentz [1999] 4 All SA 299 (A) at para.4.
Resa Pension Fund v Pension Fund Adjudicator 2000 (3) SA 313 at 317J to 318 A.
3 Case Number 2001/9865 (WLD) (unreported).
4 No. 24 of 1956.
2
employer undertakes likewise to make contributions to the pension fund. The
relationship arises directly from the contract of employment. What is not clear is whether
the employees have the right to insist on remaining as members of a DB Fund for so
long as they choose. The aforementioned relationship gives rise to certain
consequences in labour law. 5
Where membership of a DB Fund is a condition of employment, the question arises
whether a transfer from a DB Fund to a DC Fund would constitute a variation of
conditions of employment? In employment law, where a provision is a condition of
employment, variation thereof cannot be done unilaterally. The aforementioned was
confirmed by the High Court in Johannesburg Municipal Pension Fund v City of
Johannesburg6.
In the Johannesburg Municipal Pension Fund case, the Respondent (the City of
Johannesburg) purported, unilaterally, to terminate certain funds, to cease contributions
to the funds and to transfer the members of the funds to a new pension fund, as it
claimed it was entitled to do in terms of the rules of the respective funds. In relation to
the ability of the City of Johannesburg to transfer the members from a DB Fund to a new
DC Fund, Malan J at 294A stated that,
“unilaterally altering pension benefits that form part of terms and conditions of
employment must be regarded as falling within the definition of “unfair labour
practice” in S186 (9) of the Act: the conduct in question relates to the provision of
benefits to employees (Hospersa and another v Northern Cape Provincial
Administration (2000) S1115 1066 (LAC) in para [9] at 10691-1070C) and is
unfair because of its unilateral nature”
However, whether or not a transfer from a DB to a DC Fund will constitute a variation of
conditions of employment depends on the nature of the ‘pension promise’ made in the
contract of employment.
The “pension promise”
In order to determine the scope and the content of the pension promise, the express
provisions of the relevant employees’ employment contracts and any human resources
handbook outlining conditions of employment, should be considered.
5
Issues related to the benefit of membership of a pension fund may be said to constitute matters
of mutual interest as between an employer and an employee. “Matter of mutual interest” has been
construed widely in order to encompass employee benefits like pension benefits (see Ran Tyres
and Accessories v Industrial Council for the Motor Industry (Transvaal) 1941 TPD 108). In terms
of section 64 of the Labour Relations Act No.66 of 1995 (“LRA”) employees have the right to
strike over any “matter of mutual interest”. Furthermore, section 186(2) (a) of the LRA allows
employees to resolve, through arbitration, any dispute relating to the unfair conduct of an
employer relating to the provision of benefits to an employee.
6
2005 (6) SA 273 (WLD).
There is a significant debate among academics as well as practitioners as to whether the
rules of a pension fund are, to any degree, incorporated into the employment contract.7
Assuming the rules are incorporated, the question is whether all the rules are
incorporated by reference or only those that relate to benefit categories and levels. An
approach that advocates partial incorporation raises difficulties in that it suggests that
benefits or participation in a fund can only be varied with the consent of employees.
If we assume that all the rules of a pension fund are incorporated by reference into the
contracts of employment of the members of the pension fund, then the pension benefits
are effectively discretionary benefits. This is because the rules in relation to the
amendment of rules and the dissolution of the pension fund are then also incorporated
into the employment contracts. The same result is achieved if the theory is correct that
fund rules are not incorporated into the employment contract, because then the variation
of benefits or termination of the pension fund have no impact on the employment
contract. Perhaps the preferable view is that there is no incorporation of retirement fund
rules into employment contracts and therefore the benefits provided in terms of the
pension fund rules do not constitute conditions of employment.
The key issue to determine is whether employees have a contractual right to belong to a
specific fund or whether the employer has discretion to require them to move from one
fund to another.
Employer discretion to transfer employees from a DB Fund to a DC Fund
Usually a contract of employment does not contain an express provision enabling an
employer to transfer the employees from a DB to a DC Fund.
In the absence of an express provision in the employment contract allowing the transfer
of the employees from a DB to a DC Fund, the employer has to prove the existence of a
tacit or implied contractual term allowing such a transfer.
In order to decide whether a tacit term8 is to be imported into a contract, one must first
examine the express terms of the contract.9 It should be established whether, regard
being had to the express terms of the agreement, there is any room for importing the
alleged implied term. This is because the express terms may deliberately exclude the
possibility of implying terms of a particular type. In addition, no tacit term can be
imported in contradiction of an express term.
G Damant and T Jithoo “The Pension Promise: Pension Benefits and the employment contract”
(2003) 24 ILJ 1.
7
8
A tacit or an implied term of a contract has been described in Alfred McAlpine & Son (Pty) Ltd v
Tvl Provincial Administration 1974 (3) SA 506 (A) as,
“an unexpressed provision of the contract which derives from the common intention of the
parties, as inferred by the Court from the express terms of the contract and the
surrounding circumstances. In supplying such an implied term the Court, in truth,
declares the whole contract entered into by the parties.”
9
Pan African World Airways Inc. v SA Fire and Accident Insurance Co Ltd (1965) 3 SA 150 (A).
In order to determine whether the incorporation of an implied term is appropriate in a
particular case, our courts have developed the so-called officious bystander test. This
test was expressed in Shirlaw v Southern Foundries10 as follows:
“Prima facie that which in any contract is left to be implied and need not be
expressed is something so obvious that it goes without saying; so that, if while
the parties were making their bargain, an officious bystander were to suggest
some express provision in their agreement, they would suppress him with a
common, ‘Oh of course’.”
It does not matter if the negotiating parties failed to think of the situation in which the
term would be required at the time when they entered into the agreement, provided that
their common intention was such that a reference to such a possible situation would
have evoked from them a prompt and unanimous assertion of the term which was to
govern it.11 Furthermore, the term sought to be implied must be capable of clear and
exact formulation. “Once there is difficulty and doubt as to what the term should be or
how far it should be taken, it is obviously difficult to say that the parties clearly intended
anything to be implied.12 The objective nature of the officious bystander test requires the
court to determine from all the circumstances (at the time of contract) what a reasonable
and honest person who enters into such a transaction would have done, not what a
crafty person might have done who had the malicious intent to trick the other party into
an omission of the term.13
The relevant facts to investigate are the express terms of the contract and the
surrounding circumstances at the time when the contract was entered into. Subsequent
circumstances, which could not have been present in the minds of the parties, will
obviously not be relevant, but in cases of doubt, the subsequent actions of the parties
under the contract may be relevant in drawing an inference about their intentions at the
time it was entered into.14
The following arguments can be made in favour of an implied term permitting an
employer to compel employees to transfer from a DB to a DC Fund:
1.
Notwithstanding that it was a condition of employment that the employees were
required to join the DB Fund, this does not necessarily suggest that the employer
intended to fetter its ability to participate in other retirement funds in the future,
nor that the employee expected that to be the case. As such, there is an implied
discretion which the employer can rely on in compelling the employees to
transfer from a DB to a DC Fund.
10
(1926) Ltd [1939] 2 KB 206.
11
Techni-Pak Sales (Pty) Ltd v Hall (1968) 3 SA 231 (W).
12
Desai v Greyridge Investments (Pty) Ltd 1974 (1) SA 509 (A).
13
Administrator (Tvl) v Industrial and Commercial Timber and Supply Co Ltd 1932 AD 25.
14
Christie The Law of Contract 3rd Ed p 193.
2.
The fact that the rules of the DB Fund have provisions which permit an employer
to terminate its participation and to participate in another fund would suggest that
there is discretion.
The position is however by no means clear and it could be equally argued that there is
no implied term permitting a transfer. If this is the case, then an employer will only be
permitted to transfer employees to another fund with their agreement. If the employer
were unable to procure agreement then the mechanism of a lock out would need to be
considered. However, the aforementioned is not often an option with white collar
employees.
Exercise of employer discretion to compel employees to transfer
Assuming that the employer could rely on an implied discretion to transfer the
employees, any discretion exercised by it would need to be exercised in good faith.
Employees have the right to require the employer to observe its duty of good faith
towards them when making any decision in relation to their membership of the DB Fund.
The employees also have a right, in appropriate circumstances to challenge the
employer’s conduct in regard to pension matters on the basis that such conduct
constitutes an unfair labour practice.15
The duty of good faith
In TEK case,16 the court held that,
“The trustees of the fund owe a fiduciary duty to the fund and to its members and
other beneficiaries… The employer is not similarly burdened but owes at least a
duty of good faith to the fund its members and beneficiaries. (Compare Imperial
Group Pension Trust Ltd & Others v Imperial Tobacco Limited & Others [1991] 2
All ER 597 (Ch) at 604g-606j)”.
The contents of the duty of good faith in the context of pension funds were explained by
the Pension Funds Adjudicator in IBM Pensioners’ Action Group v IBM South Africa
(Pty) Ltd & Another17 as follows:
1.
The employer must not without reasonable and proper cause conduct itself in a
manner calculated or likely to destroy or seriously damage the relationship of
confidence and trust between the employer and the employees.
2.
The employer must not exercise a veto capriciously.
3.
The employer must exercise its rights for the efficient running of the scheme.
4.
The employer must not exercise its rights for the purpose of forcing members to
give up their accrued rights.
5.
The duty to act in good faith does not equate to the duty to act reasonably.
15
Section 186(2) (a) of the LRA.
Supra at 894B-E.
17 (2000) 21 ILJ 1467) (PFA).
16
6.
The duty is not a fiduciary duty, and in deciding whether or not to give its consent
the employer is free to look after its own interests, financial or otherwise, in the
future operation of the fund.
7.
The employer may not announce a blanket policy of refusing to consider benefit
increases – it should be willing to review its decision in changed circumstances.
8.
The employer may not use the power of winding-up, make transfers, veto
amendments or discontinue contributions in a manner which forces the sacrifice
of existing rights.
In the Johannesburg Municipal Pension Fund18 case Malan J said the following about
the conduct of an employer in making changes to retirement funding arrangement,
“However, under the LRA, there would have to be both a fair procedure and a fair
reason for the termination (or variation) of an employment contract so as not to
constitute an unfair dismissal. This principle would apply as much to the
respondent’s withdrawal on notice from the applicants as a contributing employer
as it would to their unilateral reduction on notice of employees’ wages. Members’
employment contracts and the pension arrangements incorporated therein
cannot be unilaterally varied or terminated unless in accordance with ss 189 or
189A of the LRA, and then the variation or termination must be for operational
reasons”.
It is apparent from the aforegoing cases that, in requiring its employees to transfer from
a DB to a DC Fund an employer could not exercise its discretion maliciously, or purely in
order to force employees to sacrifice their existing entitlements.
Although the duty of good faith as discussed in the aforementioned cases refers to the
process followed, our courts have also determined that it is also about the substance of
the changes.
Erasmus v Senwes Limited and Others (unreported)19, concerned a change by Senwes
to the post-retirement medical aid subsidy it provided to its pensioners. Senwes was
contractually bound to provide the subsidy. Senwes had over the years and on a number
of occasions unilaterally changed the structure and amount of this subsidy. Later
Senwes took a decision that in effect proposed to reduce the amount of the subsidy
payable to the applicants. The applicants instituted an application in the High Court
aimed, inter alia, at restraining Senwes from, in future, reducing the subsidies.
The applicants contended firstly that, they have a contractual right to have their medical
scheme premiums subsidised and secondly that, Senwes has no right in any way to
reduce the amount of the subsidy. Senwes argued that it had no contractual obligation to
pay the subsidy to the applicants, alternatively, even if it had such a contractual
obligation, it is only obliged to pay a reasonable subsidy and that it has discretion to
determine what a reasonable subsidy is.
18
19
Supra at para.20.
Case Number: 31964/2004 (TPD).
The court stated that Senwes has the power to effect reasonable changes to the
subsidy. It cannot be said that it can never be reasonable to reduce the subsidy. In
dealing with the power of Senwes to exercise its discretion to determine what a
reasonable subsidy is, the court considered whether the power is subject to an objective
standard. In this regard the court stated that all contracts are subject to the principle of
good faith, and that parties should as far as possible be held to their contracts. The court
determined that, “Senwes’ power to amend the contracts is subject to the standard of
reasonableness and not unfettered.”20 In so far as the content of the obligation to act in
good faith is concerned, the court held that,
“In the context of a right to amend contractual terms, the reasonable exercise of
discretion must take into account the rights and interests of both (or all) the
parties to the contract. It must balance those rights and interests, always bearing
in mind the nature and content of the original contractual obligation.”21
The Labour Court has also had occasion to determine the approach to determining the
fairness of an employer’s conduct in relation to changes to employee benefits in
Protekon (Pty) Limited v CCMA & Others22. In Protekon, the employee was entitled to
travel concessions. However, Protekon without consulting the employee decided to
withdraw the travel concessions and to compensate affected employees with an
increase of salary equal to one third of the value of the concessions. The commissioner
at the CCMA held that the travel concessions constituted a ‘benefit’ as contemplated in
the LRA, and that Protekon had acted unfairly by withdrawing it. Protekon challenged the
decision of the commissioner at the Labour Court arguing that the commissioner had
erred in finding that it had acted unfairly.
On review the Labour Court held that the travel concessions indeed constituted benefits
as contemplated in the LRA. In so far as the assessment of the fairness of Protekon’s
conduct in changing the benefit is concerned, Todd AJ at paragraphs 41 to 43 stated
that,
“The applicant suggested that the commissioner should have limited himself to
assessing the fairness or otherwise of the withdrawal of the benefit, and that he
erred in considering that the “compensation” that the applicant determined should
replace the travel concessions formed part of the applicant’s “conduct” in relation
to the provision of benefits. In my view, the withdrawal of the travel concessions
and its replacement with monetary “compensation” was part of a single course of
conduct by the applicant, and the commissioner was entitled to consider that
conduct in its entirety.
The conduct was unilateral. It was also conduct that was not preceded by any
formal process of engagement or consultation with the affected employees with a
consensus. The commissioner was required to consider whether the conduct
constituted an unfair labour practice.
The commissioner’s approach to assessing the fairness of the applicant’s
conduct was to look separately at the question whether there was a fair reason
20
Supra at page 14.
Supra at page 16.
22 [2005] 7 BLLR 703 (LC).
21
for the conduct and the question whether a fair procedure was followed. Although
the LRA itself does not prescribe this separate analysis of questions of substance
and procedure, as it does for example in relation to the question of the fairness of
dismissal (in section 188), this approach was well established under the general
unfair labour practice jurisdiction of the 1956 LRA (28 of 1956). (The
commissioner referred in this regard to the decision of WL Ochse Webb &
Pretorius (Pty) Ltd v Vermeulen [1997] 2 BLLR 124 (LAC). In my view that is an
appropriate approach to adopt in considering the fairness of employer conduct in
relation to the provision of benefits.)”
It is apparent from the Erasmus and the Protekon cases that, not only does good faith
relate to the procedure followed in changing a benefits arrangement, but also to the
impact that the change will have on the quality of the benefits (the substantive fairness
thereof). Therefore, it could very well be a breach of the duty of good faith for an
employer to transfer the employees to a significantly worse fund.
In the event that the employer can establish a contractual discretion and in order to
comply with its duty of good faith and to act fairly, a employer would be advised to
consult with the employees, disclose all relevant facts, statistics and information, receive
and consider submissions from the employees and respond comprehensively to those
before deciding whether or not to proceed in a particular manner. Furthermore, the
employer must attempt to ensure that when the employees are transferred to the DC
Fund their benefits are overall comparable to those offered by the DB Fund. In ensuring
that the benefits are overall comparable, the employer may consider enhancing the
benefits of the employees on transfer to the DC Fund, in the event that an actuarial
assessment reveals that the members will be worse off on transfer.
It has been suggested that in the event of a transfer from a DB to a DC Fund that the
Actuary should calculate the likely benefit an employee would receive had they remained
in the DB Fund. A calculation should then be done projecting what benefit the employee
could expect to receive in the defined contribution fund bearing in mind the transfer
value transferred in, together with fixed contributions until the date of retirement. If there
is a shortfall, it is arguable that the employer should then make good such anticipated
shortfall.
Conclusion
Where an employer considers transferring its employees from a DB to DC Fund, it must
be mindful of the employment law consequences of such a decision. In particular, where
membership of a pension fund is a condition of employment, transferring employees
from a DB to a DC Fund may constitute a variation of conditions of employment. Where
membership of a DB Fund is a condition of employment, variation thereof cannot be
done unilaterally.
Whether or not the transfer from a DB to a DC Fund will constitute a variation of
conditions of employment also depends on the promise made in the employment
contract. In order to determine the content of the promise, an employer must consider
the applicable contracts of employment and any relevant human resources policies.
It is arguable that even where membership of a DB Fund is a condition of employment,
this does not suggest that the employer intended to fetter its ability to participate in a DC
Fund in future. Furthermore, the employer may rely on the rules of the fund which allow
it to terminate its participation in the fund, to found its discretion.
Where there is no implied term permitting a transfer from a DB to a DC Fund, an
employer will only be permitted to transfer employees to another fund with their
agreement. If the employer were unable to procure agreement then the mechanism of a
lock out would need to be considered.
Where the employer can establish discretion in the conditions of employment, it must
exercise such discretion in good faith. Good faith entails that, exercise of the employer
discretion must be both procedurally and substantively fair. In essence, the employer
must consult with the affected employees and ensure that the benefits they will receive
in the DC Fund are overall comparable to those offered by the DB Fund.