A Heavy Burden: Trustees need to be aware of the legal pitfalls they face and the protection available to them

We’re delighted to have experienced pensions specialist, Michael Jones, provide his take on some of the issues Trustees are facing in the current climate.

It is probably fair to say that trusteeship has never been harder. The ever-increasing amount of regulation and knowledge required to keep up with developments shows no sign of letting up, with recent changes including the trustee’s duty to cover Trustee Knowledge and Understanding (TKU) obligations and the duty to review the sponsor’s covenant.

Given the sheer weight of responsibility trustees take on, the fact they may also be personally financially liable if things go wrong could be a step too far.

A breach of trust can occur even when the breach is not deliberate, or as a result of reckless or negligent behaviour.

CASE STUDY: ES GROUP PENSION SCHEME

The Pensions Ombudsman case of the ES Group Pension Scheme is a perfect example of when trustees have become personally liable.

Several former trustees were accused by over 70 scheme members of a breach of trust over some of the investments they made.  The Ombudsman ruled the trustees concerned as having a ‘joint and several’ liability and were ordered to pay back over £500,000, showing trustees’ fears of personal financial ruin can indeed be real.

EXONERATION

Trustees are unsurprisingly worried that even where they are trying their best, they may still make mistakes and end up being sued personally by a disgruntled member, new trustees or a third party. As a trust is not a legal ‘person’, any claim will be against the trustees, which is why exoneration clauses and  indemnities in the scheme’s documentation and insurance play a vital part in minimising the risks they face.  Member claims take two forms: breach of trust and maladministration.  Breach of trust is the most serious and covers a very wide area, including:

•  non compliance with the terms of the trust
•  not acting honestly or loyally in the carrying out of their duties
•  not showing due care and diligence in managing their affairs
•  not being prudent in the performance of their investment functions and
•  breaching any of their legal obligations

A breach of trust can occur even when the breach is not deliberate, or as a result of reckless or negligent behaviour.  For claims against trustees brought by scheme members or new trustees, the greatest protection will come from an exoneration clause in the scheme’s legal documents.  Depending on how the clause is drafted, it may potentially exonerate a trustee – whether lay or professional – from all forms of liability, except actual dishonesty, meaning actual fraud.  However, the test for dishonesty is subjective – that is, did the trustee himself believe he was acting dishonestly – rather that objective – that is, would a reasonable trustee have believed the act was dishonest – although case law is not settled on the point.  Trustees should review their own exoneration clause carefully and take legal advice if necessary to establish what liability is exonerated and what is not.  Case law suggests that former trustees can continue to benefit from an exoneration clause even if the clause does not appear to expressly cover them.

WHEN INDEMNITY MATTERS

To the extent that the trustee is not directly exonerated from his act by the scheme’s own trust documentation, or to the extent that the claim is from a third party, and therefore not covered by an exoneration clause, the trustee would then be looking to any indemnity cover they may have.

Most schemes have some form of indemnity wording in their trust documentation. Trustees therefore need to check what liabilities and/or expenses are covered.  For example, is negligence covered, or just wilful default?  If the indemnity does not allow for scheme assets to be used to meet the claim, then case law suggests the rules may not be amended to introduce such a provision.

Trustees may benefit from an indemnity directly from the employer, either given under the scheme’s trust documentation or in a separates agreement. If the indemnity is in a separate agreement it may be project-specific, such as covering losses following a merger.  Trustees should again understand the terms under which a claim can be made, and any restrictions that may apply.

The main problem for trustees relying on an employer indemnity is that it is only as strong as the company providing it.  Therefore, if the employer becomes insolvent, the indemnity will be worthless and the trustees will need to rely on other forms of protection.  Regular due diligence by the trustees of the indemnity provider’s financial position is therefore recommended.  If necessary, counter indemnities from a stronger group of companies could be sought.

It is also common for trustees to seek protection against a weakening in the indemnity provider, caused by corporate restructuring, so that the provider cannot be asset-stripped, and the benefit of the indemnity cover nullified.

GETTING THE RIGHT INSURANCE

Today many trustees are also looking at insurance as a way of dealing with the uncertainties associated with employer backed indemnities.  Such insurance can either be financed out of scheme assets – although it is important to remember that such insurance cannot cover fines from The Pensions Regulator – or paid for directly by the employer.  Whether the cost of the cover is worth the premium depends on who is paying it, what risks are covered and how long the insurance lasts.

Trustees considering purchasing trustee liability insurance should fully understand how the policy works alongside any existing exoneration and indemnity provided under the scheme rules.  It is not worth paying for insurance that stands a chance of never being used.  Amending the exoneration and indemnity clauses and applying “to the extent not covered by insurance” to the wording gets around the point.

Trustees should also ensure that legal costs incurred defending unsuccessful claims are also covered under the policy, otherwise they could incur personal expense that may not be recoverable, even if the claim fails.  The danger of relying solely on insurance is either that it fails to provide the cover expected when called upon, or is not renewed at a point in the future when a claim arises. Therefore, trustees may want an agreement from the employer to continue to finance insurance for a fixed future period.  This commitment again relies on the employer surviving and doing what it said.

Finally, there are some limited statutory defences/discharges available to trustees.  The most well known is Section 61 of the Trustee Act 1925 where a court can relieve a trustee of personal liability if they have “acted honesty and reasonable” and “ought fairly to be excused”.

However, such protections should be seen as a last resort and should not be considered as a replacement for wide exoneration and indemnity protection.  Trustees should therefore establish the protections they currently benefit from and then, if needed, enter into a dialogue with their employer as to the provision of liability insurance.

Michael Jones is a partner at Charles Russell

[This article appeared in Engaged Investor in July/August 2011]