Surplus Must Be Distributed On Partial Wind Up
“On the partial wind up of a pension plan, members, former members, and other persons entitled to benefits under the pension plan shall have rights and benefits that are not less than the rights and benefits they would have on a full wind up of the pension plan on the effective date of the partial wind up.” – Subsection 70(6) of the Ontario Pension Benefits Act
The words ‘Monsanto,’ ‘surplus,’ and ‘partial wind up’ have been at the forefront of every discussion between plan sponsors, their consultants, their actuaries, and their legal advisors over the past four years. July 29, that long debate ended with The Supreme Court of Canada’s interpretation of that subsection. Here is a compilation of what lawyers and consultants think will happen as a result of this decision.
Monsanto Canada’s first pension plan was launched in 1934. In 1996, it had three plans which were merged. At the time of the merger, one plan was 83 per cent funded with the others at 102 per cent and 161 per cent funding. The merged plan was 131 per cent funded.
In December 1996, an internal restructuring meant 146 employees would lose their jobs. Monsanto served notice that it would partially wind up its pension plan as of May 31, 1997. In its partial wind-up report, it amended the plan to provide the terminated employees with benefit enhancements worth an estimated $4.8 million. Actuarial surplus at the time of filing was estimated at approximately $14 million. The terminated employees share, after enhancements, was approximately $3.1 million. As well, terminated members were to maintain their rights to surplus, if any, if and when the plan was ever fully wound up.
The superintendent refused to approve the wind up report on the grounds it did not protect the interests of the terminated plan members. This was appealed to the Financial Services Tribunal, which, in April 2000, ordered the superintendent to approve the Monsanto report. The superintendent appealed this to the Ontario Divisional Court. In March 2001, this court overturned the tribunal’s decision. This decision, in turn, was appealed by Monsanto and other parties to the Ontario Court of Appeal. November 22, 2002, the Court of Appeal upheld the decision of the Divisional Court. Monsanto was then granted leave to appeal to the Supreme Court of Canada in June 2003.
In a unanimous judgment, the Supreme Court of Canada (SCC) dismissed Monsanto’s appeal with costs. It held that the Financial Services Tribunal’s interpretation of Subsection 70(6) of the Ontario Pension Benefits Act (PBA) was incorrect and that distribution of actuarial surplus on the effective date of the partial wind up is required.
The SCC decided the question before it was one of law and should be determined based on a standard of ‘correctness’ as opposed to ‘reasonableness.’
For example, it decided tribunal panels were not necessarily made up of pension experts and, therefore, these panels lacked any specialized expertise to which the courts should defer.
The SCC interpreted Subsection 70(6) of the PBA as requiring the distribution of surplus at the time of partial plan termination. As public policy legislation intended to protect plan members, the SCC said there must be a balance between the rights of employers and employees. However, it found that in the end surplus is a windfall to both the plan sponsor and the members. Therefore, a delay in the realization of surplus rights for affected members to the date of an eventual full plan termination is unfair, while requiring surplus distribution at the time of the partial plan termination does not take away any rights of the employer.
The SCC rejected arguments that surplus distributions, in the context of partial plan terminations, disproportionately favor the interests of employees over those of the employer. It said there continue to be good reasons for employers to sponsor pension plans and that its interpretation is unlikely to disrupt the balance between employer and employee interests.
Other observations made by the SCC include:
- A partial plan termination requires a notional full plan termination for purposes of evaluating the pro rata share of the assets and liabilities related to the partial plan termination.
- Partial plan terminations are the same as full plan terminations for all purposes.
- The question of surplus entitlement in the Monsanto plan is not affected by the decision and will need to be determined at a later date.
Who Is Affected
DB plans affected are those that are federally- registered or registered (or have members in) in Ontario, Saskatchewan, Manitoba, Quebec, New Brunswick, Nova Scotia, or Newfoundland and Labrador where:
- The plan has undergone a partial wind up at some point in its history
- Apartial wind up is expected to occur at some time in the future
- An event has occurred with respect to the plan at some point in the past which could be characterized as a partial wind up (for example, a plant closure, corporate restructuring, or a sale of a division), whether or not a partial wind up was declared.
- A DB plan, which was sponsored or administered in the past, has been converted into a Defined Contribution (DC) plan.
Because a number of the pension jurisdictions in Canada – including the federal jurisdiction, Nova Scotia, Saskatchewan, Manitoba, New Brunswick, and Newfoundland – contain language similar to that of the Ontario PBA and that it appears surplus matters must consider the jurisdiction of the employment of each pension plan member, this decision could conceivably affect most pension plans in Canada which have ever contained surplus assets.
Further, as the decision is retroactive in nature, it applies even if a pension plan currently has a deficit.
Many plan sponsors may be prompted to fundamentally re-examine their pension plan investment and funding strategies and review their plan design. Since many sponsors find that the risks and rewards of funding pension plans are not shared equally, they will see this decision as creating an even greater imbalance raising questions about the SCC’s premise that its decision “is unlikely to disrupt the balance between employer and employee interests.”
The Association of Canadian Pension Management (ACPM) worries that mandatory distribution of plan surplus from ongoing pension plans will jeopardize funding security for all plan members. As well, it says this decision has the potential to discourage the maintenance and establishment of DB plans in Canada.
The ACPM, which, along with the Office of the Superintendent of Financial Institutions (OSFI), was granted intervenor status in the appeal, argued it is inequitable to benefit one group of members – in this case, those affected by a partial plan wind up – because the date of the partial wind-up happened to be at a time when the plan was in surplus, while leaving remaining members, including retirees, in a plan with less secure, possibly deficit, funding.
The decision will certainly impact how employers fund their pension plans in the future, says Beswick. Many plan sponsors favour ‘conservative’ funding to maintain a funding cushion to counter market downturns. With this ruling, “What incentive is there for a company to fund at a conservative level, allowing for a cushion?” asks Beswick. “Many plan sponsors will now try to fund their plans without accumulating any surplus to avoid being forced to distribute it as a result of a partial wind-up.”
The SCC decision does not explicitly address the issue of retroactivity, so the application of this decision to past partial wind-ups of Ontario-registered pension plans will likely depend on the policy adopted by the Financial Services Commission of Ontario (FSCO). FSCO could order the distribution of surplus for any partial wind up:
- That has taken place since 1969, when the predecessor to Subsection 70(6) was enacted
- That has taken place since 1987, when the current Subsection 70(6) was enacted
- That has taken place since another date to be specified by FSCO
- Going forward only
For future partial wind ups, the SCC decision will require distribution of any surplus related to the part of the pension plan being wound up as of the effective date of the partial wind up. The distribution could be made to plan members or to the plan sponsor, or both, depending on factors such as the plan’s surplus entitlement provisions and the agreement of the parties.
However, it is unclear what will happen if the employer is unwilling to pay out the surplus or reach an agreement on surplus distribution with the members and former members which Ontario requires. Since the superintendent lacks the power to force parties to reach a surplus-sharing agreement and the PBA does not contain surplus arbitration provisions, litigation may be the only remedy to these situations.
The SCC’s decision adds more uncertainty to pension plan valuations. When assessing the financial status of any pension plan that had, or may have had, a partial wind up, the actuary will have to either estimate the potential liability or at least disclose that there is a potential liability.
Finally, the SCC’s decision means the Ontario government needs to revise the current ‘temporary’ surplus regulation, which has already been extended seven times. While a new regulation is clearly needed to address issues arising from Monsanto and other cases relating to pension surplus, given its opposition to Bill 198, which was introduced in 2002 and would have addressed these and other points, it is unclear whether the Ontario Liberal government will take any action to resolve this issue.
One approach that might be considered is to eliminate the concept of partial wind ups and instead make other improvements to pension benefits legislation such as requiring immediate vesting. Quebec has already done this and the concept is included in the Canadian Association of Pension Supervisory Authorities’ Proposed Principles for a Model Pension Law.
What Should Sponsors Do
As a result of the Monsanto decision, employers who maintain (or in the past maintained) DB plans should:
- Review the history of their plans to determine whether there have been any partial wind ups in the past, whether under the employer’s current pension plan, or their predecessors.
- If there has been a partial wind-up in the past, determine whether there was actuarial surplus at the time and, if so, consider how much surplus should be distributed and to whom the surplus belongs. Also, employers should consider whether there is any argument that surplus need not be distributed.
- If actuarial surplus should have been distributed, determine whether any additional funding obligations will arise as a result because actuarial surplus which should have been distributed has been used for other purposes such as contribution holidays or benefit enhancement.
A Different Take
Heath Lambert Benefits Consulting has a different take on the impact of the Monsanto decision.
Its interpretation is that it is of little immediate importance for most DB plan sponsors because the decision simply upholds the original interpretation of a law that has been on the books in Ontario since 1969.
The sole issue from the Monsanto case is that of pension surplus ownership in the event of a partial plan termination. This can create a serious dilemma for plans where surplus ownership is not clear.
However, since the surplus ownership issue has been clearly addressed in most plans established since the mid-1980s, sponsors of these plans need give little consideration to the Monsanto decision. Sponsors of other plans can defer dealing with the surplus ownership question indefinitely until an event giving rise to a partial plan wind up occurs.
Based on material from Heath Lambert Benefits Consulting; Borden Ladner Gervais; Blake, Cassels and Graydon LLP; Mercer Human Resource Consulting; The Association of Canadian Pension Management; Watson Wyatt Worldwide; Eckler Partners.
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