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Litigation risk for defined-contribution plans on the rise

|Written By Julius Melnitzer

As defined-contribution and combination plans continue to make headway as the designs of choice for many employers in Canada and the United States, litigation risk for sponsors is on the rise.

Generally speaking, employers often prefer defined-contribution to defined-benefit plans because the risks shift to the employees. But that’s turning out to be a bit simplistic.

“It is true that in a DC plan, the employee is responsible for investment and mortality risk,” says Kathryn Bush of Blake Cassels & Graydon LLP.

“The concern, however, is that notwithstanding the shifting in investment and mortality risk to the employees, ultimately DC arrangements would not be without risk.”

While the jurisprudence is sparse in Canada with about 10 decided cases, it’s much further along in the United States.

“Canadian lawyers and plan sponsors need to examine both the Canadian and U.S. jurisprudence to get a true indication of the trends and concerns that may affect them,” says Bush.

“It’s important to remember there are not many people who actually convert voluntarily.”


A case involving Via Rail Canada Inc. and Unifor dealt with a proposed change from a defined-benefit to a hybrid plan consisting of a defined-contribution component.

Via Rail employees hired before Jan. 1, 2014, belonged to a defined-benefit plan. With a new collective agreement as of July 1, 2013, the parties agree to negotiate a new pension plan for employees hired on or after Jan. 1, 2014. The parties also agreed to have an interest arbitrator determine the matter if they were unable to reach a consensus.

Via Rail proposed placing new employees into a hybrid plan where the employer would fund the defined-benefit component and mandatory employee contributions would fund the defined-contribution side. The union didn’t agree with the proposal.

Before the arbitrator, Via Rail argued that continuing to offer the defined-benefit plan to all future employees wasn’t an option given the company’s current pension liabilities. Via Rail noted the defined-benefit plan was far superior to plans offered by its competitors and that under its 107-per-cent net-replacement ratios, many members would receive higher disposable take-home pay in retirement than they received as active employees. The hybrid plan, Via Rail noted, would still yield a net-replacement ratio of 93 per cent, which was well above the norm.

“Via Rail also emphasized that the cost of current contributions to the DB plan as a percentage of payroll was significantly higher than other comparable organizations,” says Bush. “The company pointed to the trend away from DB plans among its competitors and submitted that the hybrid plan would permit Via Rail to better manage the risks and volatility of the DB component of its plans.”

The union objected to the risk shift involved in the inclusion of a defined-contribution component. Employees, Unifor argued, were likely less sophisticated than the employer in their ability to understand and manage risks and volatility.

“The union was also concerned with the impact that directing new employees towards the hybrid plan would have on the viability of the DB Plan,” says Bush.

The arbitrator accepted Via Rail’s proposal. He concluded that the defined-benefit plan, with its 92-per-cent gross replacement ratio and 107-per-cent net-replacement ratio, was “arguably dysfunctional” and that the hybrid scheme would still provide generous amounts. He did, however, accept the union’s proposal to include an indexing mechanism to adjust the defined-benefit component of the plan for inflation.

Similarly, a case involving NCR Canada Ltd. and the International Brotherhood of Electrical Workers Local 213 arose when the company amended its defined-benefit pension plan to introduce a defined-contribution component. Employees who became members of the plan before the 2002 amendment could choose whether to stay in the defined-benefit component or move to the defined-contribution side. Nineteen union members stuck with the defined-benefit component.

About 10 years later, NCR announced an intention to amend the plan further to force all members into the defined-contribution component. The union grieved, arguing that NCR was estopped from amending the plan in this way because of certain representations made to members when it proposed the first amendment.

The arbitrator found the company was in fact so estopped. The British Columbia Labour Relations Board refused to second-guess the arbitrator. The B.C. Court of Appeal dismissed a further appeal for lack of jurisdiction, ruling that the issue of estoppel in the collective bargaining context wasn’t a matter of general law but rather pertained to the principles and policies of labour relations. As such, the issue fell within the core expertise of the labour arbitrator and, on appeal, to the board.

As it turns out, the case and other examples of representations that have come back to haunt companies offer a lesson.

“The key is not to oversell because if people believe that you have promised them a pension of a set amount, they also believe that the failure to receive that amount must be actionable,” says Bush.

“What they believe depends ultimately on how good the original communication was, and that’s why lawyers should be telling their clients to tone down the rhetoric.”

Weldon v. Teck Metals Ltd. dealt with an entirely different but important issue. The case required the B.C. Court of Appeal to determine the applicability of the province’s six-year general limitation period that runs from the date on which the right to bring a claim arises.

Here, the plaintiffs alleged Teck Metals had provided inadequate information when it agreed to transfer to a new defined-contribution plan from a defined-benefit one, something that took effect on Jan. 1, 1993.

Teck Metals argued the limitation period ran from the time the plaintiffs joined the plan on the date it took effect. The plaintiffs claimed the limitation period didn’t commence until the plaintiffs suffered a loss either by retiring or otherwise becoming eligible for payments under the plan.

The appeal court upheld the lower court’s ruling that the alleged loss had occurred in 1993.

Accordingly, the limitation had expired.


Bush organizes the U.S. cases that she has compiled into four categories: stock-drop claims, fee-based matters, issues based on plan description, and miscellaneous cases based on fiduciary duty. What follows is a sampling of some of the cases.

The leading stock-drop case is the U.S. Supreme Court’s decision in Fifth Third Bancorp v. Dudenhoeffer. The case centred on Bancorp’s defined-contribution retirement savings plan that included an employee stock-ownership plan that invested primarily in its own stock.

When Bancorp’s stock fell, the plan participants sued. They claimed the plan fiduciaries should have known Bancorp’s stock price was too high and excessively risky. The fiduciaries defended on the basis that fiduciaries of the employee stock-ownership plan were subject to a relaxed duty of prudence compared with pension plan fiduciaries generally.

The court disagreed, unanimously holding that the fiduciaries were subject to the same duty of prudence as pension fiduciaries generally except they didn’t have an obligation to diversify assets.

In Harris v. Amgen Inc., the Ninth Circuit Court of Appeals applied Fifth Third Bancorp and refused to invoke a presumption of prudence or a duty to diversify in a case about two defined-contribution plans that included an option to invest in company stock. But the court did hold that the defendants had breached their duty of loyalty by failing to provide certain information to plan participants.

Coulter v. Morgan Stanley & Co. Inc. arose after the defendants elected to make employer contributions to the employee stock-ownership plan in question in the form of company stock rather than cash. When Morgan Stanley stock plunged after the financial crisis in 2008, the plaintiffs sought to recover their losses.

But the Second Circuit Court of Appeals ruled against the plaintiffs, concluding that the impugned conduct couldn’t be a basis for fiduciary liability, something that arose only to the extent that authority or control over plan management or assets exists or is exercised by a person.

“An employer acts in its capacity as a fiduciary when administering a plan but not when making business decisions allowed for by a plan,” says Bush. “The decision to fund the employer’s contribution with company stock was made when the stock in question was not a plan asset and therefore the decision was not a fiduciary act.”

Pfeil v. State Street Bank and Trust Co. is noteworthy for the Sixth Circuit Court of Appeals’ ruling that pension legislation that protects 401(k) retirement plan fiduciaries from liability where participants exercise control over their individual accounts under the plan didn’t apply.

“The court stated that control by plan participants over the allocation of pension assets across a range of investment options does not exempt fiduciaries from their duty to use ‘prudence when designating and monitoring the menu of different investment options that [are] offered,’” says Bush.

When it comes to fee-based claims, Santomenno v. John Hancock Life Insurance Co. involved allegations that the service provider to two 401(k) retirement plans was a fiduciary that had charged excessive fees.

But the Third Circuit Court of Appeals held that the service provider wasn’t a fiduciary merely because it presented a menu of investment options to plan trustees.

In Loomis v. Exelon Corp., the Seventh Circuit Court of Appeals ruled that pension plan administrators had no obligation “to scour the market to find and offer the cheapest possible fund.” They hadn’t, therefore, breached their fiduciary duties by offering retail mutual funds instead of wholesale or institutional investment vehicles to participants.

“The Americans have got out the door quickly on fee-based litigation, and I think we’ll see more litigation in Canada on that issue,” says Bush. “Nowadays, fees are high, returns are low, and members are grouchy.”

Bush also notes claims based on plan descriptions. In Kirkendall v. Halliburton Inc., plan participants alleged Halliburton had improperly reduced retirement benefits.

The Second Circuit Court of Appeals, however, held that Halliburton’s conduct didn’t constitute an amendment to the plan within the meaning of the governing legislation.

And when it comes to miscellaneous claims based on fiduciary duty, Adams v. Anheuser-Busch Co. Inc. dealt with the issue of whether the terms of a plan provided participants with a right to enhanced benefits. The plan provided for enhanced pension benefits for plan participants “whose employment with [an Anheuser-Busch company] is involuntarily terminated within three (3) years after [a] Change in Control.”

The District Court found the plaintiffs hadn’t been “involuntarily terminated” as they had found jobs with a successor corporation. The Sixth Circuit Court of Appeals, however, reversed the District Court, ruling that the plan administrator’s decision to deny the enhanced benefits was “arbitrary and capricious.”

This story originally appeared in Law Times.