No more reward without risk

Nigel Bolton and Philip Woolham look at the lessons to be learned from an important High Court judgment for local authorities and contractors on pension exit credits.

Often when you are a contractor with a local authority, the authority carries most or all of your pension risk. That is called a passthrough arrangement, as the risk is passed through to the authority. But what happens when, at the end of the contract, your pension account is in surplus (i.e. there is more in your fund than is needed to pay the promised pensions), and there’s spare cash to be distributed?  Since 2018 it’s been possible that a contractor could receive the reward of a surplus without running any risk of having to pay off any deficit.

The recent High Court case of Enterprise Managed Service Ltd & Anor, R (On the Application Of) v Secretary of State for the Ministry of Housing, Communities and Local Government [2021] EWHC 1436 (Admin) has provided welcome clarity on what was becoming an increasingly contentious issue for many Administering Authorities and Local Authorities, and indeed their contractors. 

In this case the decision saved a county council £6.5 million in a battle with its former waste management contractor. Since 2018 many Local Authorities and Administering Authorities have seen legal cases issued by former contractors for payment of exit credits, irrespective of the level of pension risk in relation to the Local Government Pension Scheme (LGPS) that the contractor ran from the time the contract was entered into. The rush was caused by the initial 2018 government regulations which allowed a payment obligation to the contractor for any surplus in the LGPS in respect of its admission. Those 2018 regulations, replicating what usually happens in the private sector, did not take into account any risk sharing or pass through arrangements that may have been entered into, reducing the contractor’s risk.

The scales tip towards the contractors

The 2018 Regulations themselves were supposed to fix an imbalance which allowed contractors to become Admitted Bodies in the LGPS but not share in any surplus in the scheme. But the new regulations swung the balance too far in the opposite direction and ended up with contractors being able to access surplus without being exposed to deficit risk, and in some situations would have seen contractors actually receiving payments larger than the amount of contributions they put into the scheme during the lifetime of the contract.

Tipping them back

To solve this, MHCLG amended the Regulations in 2020 to give LGPS authorities absolute discretion in the awarding of exit credits. These changes were made retrospectively reaching back to the date of the original 2018 regulations, so anyone exiting from 2018 should no longer be able automatically to receive a surplus. Instead, the authorities could pay out a surplus, but they didn’t have to. MHCLG had already signposted that this was going to happen, putting pension funds and authorities in a difficult position when a contractor demanded a surplus payment based on an exit after 2018 but before the 2020 regulations came out.

Judgment day

In the most recent case waste management contractor the contractor argued it was owed £6.5 million in exit credits under the original regulations and sought judicial review of the 2020 amendments. Two of the grounds from which the challenge was raised under articles 1 and 6 of the European Convention on Human Rights were both dismissed. A further ground related to regulation 3 of the 2020 regulations in which it was argued that administering authorities when determining the size of any exit credit should take account of the fact that the contractor gave the local authority a discount on the contract price in return for the pass-through arrangements including in respect of the pensions risk. In other words, the local authority would have paid less over the lifetime of the contract because the contractor did not have to price in the extra pension risk. It was also argued in the alternative that it would be irrational or unfair to deprive claimants of exit credits under regulation 3 because they had entered into pass through arrangements. Mr Justice Bourne said that the central issue in the case were the public interest reasons for introducing the 2020 regulations on a retrospective basis which were to fix a situation that arisen through policy error.

In this regard the judge’s view was that whatever agreements the Local Authority and a contractor may have reached about pension’s risk, the fact that an existing contractor was now looking to receive by way of an exit credit all of its contributions and much more were startling. That was even more the case when a proportion of that surplus would arise from funds which had accumulated before the employer even became an admitted body within the LGPS. Such exit credits here could be fairly characterised as a windfall.

Care still needed

This case may of course be appealed.

But even if it is not, contractors have not lost all rights  to an exit credit as a result of the judgment, but their rights are now restricted to a discretionary exit credit payment which should be based on balancing the particular circumstances relevant in each case for and against that payment. Administering Authorities must still take heed of the 2020 regulations, in particular:

• The administering authority must comply with its usual public law duties i.e. act reasonably nor irrelevant factors follow proper processes when considering the question.
• With regards to the 2018 and 2020 regulations regard must always be given to the possibility of a payment of exit credits, and although exercise of the discretion requires having regard to all relevant facts the regulation does not make any single factor conclusive including whether or not pass through arrangements were put in place or whether discounts were given at the time the contract was entered into.
• There is no particular overriding significance given to any single factor, the facts of each individual case will provide the relevant factors to be considered. These include whether there is an excess of assets in the fund relating to the exiting employer over the liabilities relating to that employer’s current and former employees, the proportion of excess assets which has arisen because of the value of the employer’s contributions, any representations made by the exiting contractor and any other relevant bodies such as the local authorities who have outsourced that service.   

Whether you are a local authority, administering authority or contractor the new case provides much needed clarity. As a result we would suggest the following steps should be considered:

• Policies on exit credits should be re-visited making sure that there is no fetter on discretions making the policy too rigid.
• Ensure your process is robust. Contractors and other scheme employers should be able to make representations in relation to exit credits and these must be taken into account as part of any decision making process.
• Administering authorities and local authorities should consider both the contractors’ admission agreements and how contracting documentation itself may need to be amended to take account of the outcome of any negotiations where contractors wished to do anything in relation to the new regulations and/or current judgment. Where negotiations are currently ongoing do these issues need to be re-visited in relation to pensions?

Nigel Bolton is a partner and Philip Woolham is a Senior Associate at Bevan Brittan.