A Tip of the Hat Supreme Court s Indalex Decision Puts Spotlight on Pension Plan Governance

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1 A Tip of the Hat Supreme Court s Indalex Decision Puts Spotlight on Pension Plan Governance The tables have turned again as the Supreme Court of Canada opted to allow the company s appeal in the highly anticipated Sun Indalex Finance, LLC v. United Steelworkers ( Indalex ) decision, released February 1, The pension community has been waiting for the Supreme Court s response to the unexpected findings of the Ontario Court of Appeal since 2011, hoping it would bring much needed clarity in the context of insolvency proceedings and pension plan governance. While it does provide answers to important questions about creditor priorities and pension deficits in the insolvency context, the lengthy Supreme Court decision still leaves us wondering what exactly Indalex means for plan administrators of ongoing defined benefit plans. Although Indalex was successful on appeal and the Supreme Court has curbed the Court of Appeal s expansive view of plan administrators fiduciary duties, Indalex ultimately places a renewed emphasis on an administrator s standard of care, especially in the case where the administrator is also the plan sponsor. The focus in this Bulletin is on those aspects of the Supreme Court s decision that have an impact on plan governance particularly how fiduciary duties have evolved and the manner in which employers should address conflicts of interest when its roles as plan sponsor and plan administrator collide. These topics have particular relevance to sponsors and administrators of ongoing plans outside the realm of insolvency. Getting to the Supreme Court Indalex was the sponsor and administrator of two defined benefit pension plans a Salaried Plan and an Executive Plan. Both plans were underfunded and the Salaried Plan was in the process of being wound up prior to Indalex obtaining creditor protection under the Companies Creditors Arrangement Act (CCAA) in The CCAA court authorized Indalex to borrow funds pursuant to a debtor-in-possession (DIP) credit agreement, to allow Indalex to continue to operate its business during the restructuring period. The CCAA court ordered a super-priority charge in favour of the DIP lenders they were to be paid ahead of all other secured creditors. Of particular note, the order expressly granted priority over statutory deemed trusts and statutory liens. A Tip of the Hat Supreme Court s Indalex Decision Puts Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 1

2 At a motion to approve the sale of the Indalex assets and distribute the sale proceeds to the DIP lenders, the pension plan beneficiaries and United Steelworkers claimed that pursuant to deemed trust provisions in the Ontario Pension Benefits Act (PBA), the sale proceeds should be paid to the pension funds first. The CCAA court opted to approve the sale and allow the proceeds to be put towards the amounts owing to the DIP lenders, but set aside $6.75 million (a reserve sufficient to cover the deficiencies in the Salaried Plan and the Executive Plan) pending the resolution of the pension issue. The U.S. parent of Indalex paid the remaining amounts owed to the DIP lenders according to its obligations under a guarantee. As a result, the U.S. parent inherited the rights of the DIP lenders to be paid from the sale assets and claimed the $6.75 million dollars should be paid to it and not the pension plans. The CCAA judge ultimately ruled the U.S. parent had a right to the full reserve to offset its payment under the guarantee. It was held that no amounts from the reserve were payable to the ongoing Executive Plan for its deficit because there was no wind up triggering any special payments. Further, all contributions and special payments that were due to be paid to the Salaried Plan on wind up had been made on schedule. The plan beneficiaries claim was therefore denied which meant the plans remained in deficit and benefits for retirees were reduced. The union and plan beneficiaries appealed, leading to a surprising Court of Appeal decision in The Court of Appeal found the entire pension plan wind-up deficiency of the Salaried Plan was subject to a deemed trust (not just the contributions that were due to be paid), and thus took priority over other secured creditor claims, including the DIP lenders. The Court further held that Indalex, as plan administrator, breached its fiduciary duties to plan beneficiaries during the CCAA proceedings when: 1) it did nothing to fund the plans deficits; 2) it failed to give beneficiaries notice of the CCAA proceedings; 3) it agreed to give the DIP lenders a super-priority charge; and 4) it did not take steps to address its conflicts of interest. As such, the Court of Appeal imposed a constructive trust as a remedy in order that the deficiency in the Executive Plan would also rank ahead of the DIP lenders. Indalex appealed to the Supreme Court of Canada. Supreme Court Findings in a Nutshell Seven justices heard the Indalex appeal and three wrote decisions. The majority decision on each issue can be summarized as follows: There was a statutory deemed trust imposed on the entire wind-up deficiency of the Salaried Plan. (This was a 4-3 decision.) The DIP lenders charge had priority over that deemed trust because the federal CCAA scheme (under which the DIP lenders were given a super-priority charge) is paramount to the provincial pension legislation that created the deemed trust. (This decision, based on the doctrine of federal paramountcy, was unanimous.) Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 2

3 Indalex s corporate interests came into conflict with its fiduciary duties as pension plan administrator during the CCAA proceedings. Indalex breached its fiduciary duties to plan beneficiaries by not properly addressing these conflicts. (Unanimous decision but there was a difference in opinion as to when exactly the conflict of interest arose.) A constructive trust over the pension wind-up deficiency was not an appropriate remedy because there was no identifiable asset that Indalex retained as a direct result of the breach of its fiduciary duty. (This was a 5-2 decision.) The union was denied their costs from the Salaried Plan because they only represented a small portion of the plan members. (Unanimous decision.) The Evolution of Fiduciary Duties Indalex brings clarity to insolvency proceedings that involve underfunded pension plans in terms of creditor priorities and the status of wind-up deficiencies, but our focus here is on the implications of the case for plan sponsors and administrators of ongoing pension plans to whom the CCAA regime does not apply. The Supreme Court has developed an analysis of fiduciary duties that is more fluid and nuanced than ever before. Plan administrators need to be aware of the impact this has on plan governance and their responsibilities toward plan beneficiaries. The Supreme Court confirmed Indalex, in its role as plan administrator, was in a fiduciary position and therefore had a duty to act in the best interests of plan beneficiaries. This is not new law. Indalex further confirmed plan administrators have a duty to address conflicts of interest. Again, this is not a new concept. It is the Supreme Court s insistence that fiduciary duties cannot be disregarded while an employer makes decisions in its corporate capacity, and the tests the Supreme Court applies to evaluate conflicts of interest, where we see the scope and depth of fiduciary duties evolve. Before Indalex There Were Two Hats In Imperial Oil Ltd. v. Ontario (Superintendent of Pensions) a group of former employees accused the employer of being in a conflict of interest when implementing an adverse plan amendment because they owed a duty to act in the best interests of plan members. The Pension Commission of Ontario (now replaced by the Financial Services Commission of Ontario) dismissed the members application, and in explaining its reasons, used a two hat metaphor that has become a popular characterization within the pension community for understanding a corporation s dual roles as plan sponsor and plan administrator. Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 3

4 The theory is that an employer has a dual role a plan administrator acting in the interests of the plan members and a plan sponsor acting in the interests of the corporation. The finding in Imperial Oil was that an employer could take off its administrator hat when wearing its corporate hat, allowing it to avoid conflicts of interest. The two hats theory has worked its way into common plan governance practices. When making decisions, employers took a functional approach, asking themselves whether the nature of the decision is corporate or administrative. If it was corporate, they put on their corporate hat and assumed they could proceed safely without needing to protect the best interests of plan members. Both the Court of Appeal and the Supreme Court in Indalex have found the two hats approach oversimplifies the employer s duties. Both courts rejected the argument that when an employer is making decisions in its corporate capacity, it is not burdened by its fiduciary obligations as a plan administrator. Justice Deschamps, writing for two of the seven Supreme Court justices, emphasized that it was incorrect for an employer to view decisions that it made wearing its corporate hat as entirely separate from the company s fiduciary duties to plan beneficiaries stemming from its role as plan administrator. Specifically, Justice Deschamps comments: Sun Indalex and the Monitor argue that the employer has a fiduciary duty only when it acts as plan administrator when it is wearing its administrator s hat. They contend that, outside the plan administration context, when directors make decisions in the best interests of the corporation, the employer is wearing solely its corporate hat. On this view, decisions made by the employer in its corporate capacity are not burdened by the corporation s fiduciary obligations to its pension plan members and, consequently, cannot be found to conflict with plan members interests. This is not the correct approach to take in determining the scope of the fiduciary obligations of an employer acting as plan administrator. This view is shared by Justice LeBel, writing for three justices, [Indalex] could not switch off the fiduciary relationship at will when it conflicted with its business obligations or decisions. While the two hats metaphor can still assist corporations who act as both plan sponsor and plan administrator visualize and understand their dual roles, it is at best a starting point for identifying and addressing conflicts of interest that arise as a consequence of those dual roles. Indeed, following Indalex, an employer must always keep its fiduciary duties in mind and take action when those duties come into conflict with the employer s duties to the corporation. Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 4

5 Tools for Navigating This New Territory Justice Cromwell wrote that Indalex did not have a duty to avoid conflicts of interest the nature of the employer s dual role (protecting both plan member and corporate interests) made that impossible. The employer s only breach was in failing to identify and then address its conflicts that arose in relation to securing the DIP credit agreements, obtaining approval for the sale of assets, and bringing a motion to be permitted to file for bankruptcy. All three justices who wrote the Indalex decision provided tools for employers to identify and address conflicts. Under the two hats approach it would have been enough to decide whether the nature of a decision is corporate or administrative and then proceed, wearing one of those hats. It would be like looking at a snapshot before the decision is made and then proceeding with one hat and an almost willful blindness as to whether the employer was actually in a conflict. Now it is no longer enough to consider whether a decision should be classified as corporate or administrative. In Indalex, Justice Deschamps requires the employer to consider the potential consequences of its decision, including its impact on plan members, before proceeding. In addition, Indalex seems to suggest there is an ongoing obligation to watch for developing conflicts. Justice Cromwell provides a more specific test for identifying conflicts. When exercising its duties for the company, an employer should consider whether there is a substantial risk the plan beneficiaries could be materially and adversely affected by the employer s actions or decisions. The Supreme Court judges were unanimous in finding the employer had a duty not just to identify conflicts of interest, but also to address them: According to Justice Deschamps, a plan administrator is obligated to find solutions that are tailored to the particular circumstances, considering such options as providing notice to plan members or finding another party to represent the members interests. The suggestion is that employers must take an active role in addressing the conflict. In seeking to provide guidance for future CCAA proceedings, Justice Cromwell advised that [f]irst and foremost, an employer-administrator who finds itself in a conflict must bring the conflict to the attention of the CCAA judge. From this, we might assume that Justice Cromwell believes the employer only has a duty to disclose the conflict, as opposed to the duty to actively find solutions. However, Justice Cromwell does indicate that the goal in advising the CCAA judge would be to ensure the pension plan beneficiaries have the opportunity to have their interests effectively represented. As such, outside the insolvency context, where there is no CCAA judge to advise, one would think addressing the conflict in accordance with Justice Cromwell s findings would require the employer to take some action to ensure the beneficiaries interests are represented. Writing for the minority, Justice LeBel suggests that it was impossible for a corporation to wear two hats and therefore it would be appropriate for a replacement administrator to be appointed. Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 5

6 What Now? Indalex serves as a reminder to plan administrators to regularly revisit pension plan governance. Fiduciary duties are evolving into something more complex and as a result, employers must be more actively engaged in protecting their plan members interests. The Canadian Association of Pension Supervisory Authorities (CAPSA) recommends that plan sponsors have a conflict of interest policy that includes a process for identifying and disclosing conflicts as well as a dispute resolution mechanism. In consideration of Indalex, it would be prudent to ensure the policy also provides appropriate decision-making tools and suggested means for protecting members interests. In conducting reviews of policies, plan sponsors should consider how proactive they want to be to minimize the conflicts and how aggressive an approach they want to take when addressing conflicts. Plan sponsors should ensure their conflict of interest policy speaks directly to potential conflicts between the employer s duties to the corporation and its obligations towards plan members. Up to now, the focus has more commonly been on potential conflicts between the personal interests of individuals and the interests of the company or the plan members. Also, policies written with two hats in mind may need to be revised. Good plan governance requires employers to document their actions and decisions while governing and administering the plan. In light of Indalex, it is now prudent to record evidence that the potential consequences of the employer s actions and decisions on plan members have not just been identified, but also taken into consideration and addressed. In our view, the option of appointing a replacement administrator to address conflicts of interest that a plan sponsor/administrator may face is not a practical solution outside of insolvency proceedings. Pension legislation limits the circumstances in which the regulator can appoint a replacement administrator and does not allow a corporation to simply throw its plan administration keys on the table. Even where a replacement administrator is appointed, it is unclear how plan beneficiaries would benefit other than through increased transparency and notice. Indeed, pension legislation does not provide a mechanism to allow a replacement administrator to force an employer to contribute more to a plan that the minimum required by applicable legislation. Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 6

7 For Our Clients Indalex demonstrates how conflicts of interest may arise in the insolvency context where the interests of plan members of underfunded plans are in direct competition with the interests of the company and other secured creditors. However, the lessons provided by Indalex can be relevant in much broader circumstances. It is not hard to imagine, for example, how conflicts could arise when addressing funding decisions and investment strategies, particularly when a plan is in deficit. It is not clear whether Indalex places any additional onus on plan administrators in these or other areas but at the very least, the Supreme Court s decision implies plan administrators may need to proceed with extra caution. It may be advisable to spend more time considering notices and communication strategies for members, or perhaps finding other ways to ensure members interests are taken into account. Take this opportunity to review your governance policies and practices to ensure they are sufficiently robust to meet the higher standard of care set by the Supreme Court. Speak to your pension advisors about whether changes should be made to stay current as the scope and depth of fiduciary duties continues to evolve. Remember, when it comes to evolution, Darwin taught us, it is not the strongest that survives, nor the most intelligent, but the one that responds to change. Should you wish additional information on this topic, please contact your local Aon Hewitt Consultant, or send an to info@aonhewitt.com. Aon Hewitt publishes for the purposes of providing general information. The information in does not constitute financial, legal, or any specific advice and should not be used as a basis for formulating business decisions. For information tailored to your organization s specific needs, please contact your consultant at Aon Hewitt. This issue of contains information that is proprietary to Aon Hewitt and may not be distributed, reproduced, copied or amended without Aon Hewitt s prior written consent. Aon Hewitt 2013 Aon Hewitt Inc. All Rights Reserved. 7