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TRANSFER FROM A DEFINED BENEFIT TO A DEFINED CONTRIBUTION FUND: DOES IT CONSTITUTE CHANGE TO CONDITIONS OF EMPLOYMENT?

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.

 

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 Another[3] 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 Act[4] (“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 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 Johannesburg[6].

 

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.

 

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 term[8] 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.

 

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 Foundries[10] 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.

 

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 & Another[17] 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.

 

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 Fund[18] 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.

 

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 & Others[22]. 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 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.



[1] TEK Corporation Provident Fund and others v Lorentz [1999] 4 All SA 299 (A) at para.4.

[2] 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.

[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).

 

[7] G Damant and T Jithoo “The Pension Promise: Pension Benefits and the employment contract” (2003) 24 ILJ 1.

 

[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).

[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.

[15] Section 186(2) (a) of the LRA.

[16] Supra at 894B-E.

[17] (2000) 21 ILJ 1467) (PFA).

[18] Supra at para.20.

[19] Case Number: 31964/2004 (TPD).

[20] Supra at page 14.

[21] Supra at page 16.

[22] [2005] 7 BLLR 703 (LC).

 
 
   

 

In association with Bowman Gilfillan Africa GroupMember of Lex MundiMember of Employment Law Alliance