Anticipating the partial windup of a pension plan

Supreme Court ruling makes it critical to understand what a partial windup is — and how it is triggered

Pension reforms that occurred in most Canadian jurisdictions during the late 1980s and early 1990s were largely intended to enhance the protection of pension plan members.

However, one of the consequences was that the partial windup of a pension plan became a complex, expensive and lengthy process.

Add to this the Supreme Court of Canada’s 2004 ruling in the Monsanto case requiring the distribution of surplus on partial windups in Ontario, and administration of partial windups has become even more onerous. (For more on the Monsanto case, go to www.hrreporter.com, and enter “Monsanto” in the search field.)

For employers, it is important to understand what a partial windup is and when a business decision or action taken could lead to a partial windup.

To understand what a partial windup is, it is best to start by looking at a full windup. Because a full windup of a pension plan often coincides with the termination of the jobs of the plan membership, pension legislation contains special rules that are meant to protect affected employees.

Upon windup, an employee’s pension vests immediately. Detailed disclosure to members and reporting to regulators is required. Regulatory approval is necessary before the payment and settlement of the members’ pension entitlements can occur. Finally, any surplus in the plan must be distributed.

To protect employees who are affected by an event that may be significant but does not lead to a full windup, such as a workforce downsizing, pension legislation includes the concept of a “partial” plan windup.

In a partial windup, affected employees’ share of the plan is deemed to be wound up and they are afforded similar protection to members who are part of a full windup.

Pension laws in all jurisdictions include the concept of a partial windup, with one notable exception — Quebec.

In 2001, at the same time that it instituted immediate vesting and a minimum level of cost-of-living increases for all employees who terminate pension plan membership, Quebec eliminated the concept of a partial windup.

Many in the pension industry welcomed this change because:

•it provides additional protection (through immediate vesting and minimum cost-of-living increases) and equal treatment to all individuals terminating plan membership, whether the termination is due to individual circumstances or part of a larger event;

•the time and costs associated with administering partial windups have been eliminated in Quebec; and

•some of the thornier issues that have plagued partial windups, such as the treatment of surplus, are avoided.

Partial windups usually occur as a result of events such as the sale of a division, the discontinuance of a business operation or a significant reduction in plan membership. The specific circumstances differ from jurisdiction to jurisdiction. Below are the most common criteria that apply under Ontario pension law, which are similar to the criteria in other jurisdictions.

•A significant number of pension plan members terminate employment as a result of the discontinuance of all or part of the business or as a result of the reorganization of the employer. What constitutes a significant number of members is, of course, subject to interpretation. While 20 per cent of plan members is often viewed as the threshold, regulators in Ontario have indicated that they base their determination on the specifics of each situation.

For example, they may look at the absolute number of members terminating employment, even if these members represent a small proportion of total plan membership. Also, they may consider a series of small layoffs occurring over a period of months or years as one event for purposes of determining whether to order a partial windup.

•All or a significant portion of the business carried on by the employer at a specific location is discontinued. This rule applies even if the size of the location being discontinued is small. For example, an employer with thousands of employees in Toronto may face a partial windup if it closes a small sales office of, say, five people in Kingston.

•All or part of the employer’s business is sold and the purchaser does not provide a pension plan for the affected employees. Even if the purchaser does provide a pension plan, a subsequent full or partial windup of the purchaser’s plan could require the partial windup of the vendor’s plan.

While regulators have the authority to order a partial windup under these circumstances, pension law generally also permits, but does not obligate, an employer to declare partial windups.

In some circumstances, the employer may decide to voluntarily declare a partial windup. The employer may adopt this approach to create more certainty if there is a high likelihood the regulators will order a partial windup anyway.

In most situations, though, employers will wait to see whether the regulators adopt the position that the event constitutes a partial windup. Employers adopting the wait-and-see approach should be mindful that, even if the regulators do not pursue a partial windup initially, one or more of the affected employees may pressure the regulators to pursue a partial windup in the future.

In any case, if an employer is facing one of the events that could trigger a partial windup, a number of precautions can be taken:

•Assess the risk that the event will lead to a partial windup: Because partial windup rules and regulatory policies vary by jurisdiction, the employer should clarify which jurisdictions and rules apply to that situation.

•Measure the financial impact of a partial windup: A partial windup that affects a significant number of employees could mean a large increase in employer contributions and a large hit to the income statement. Someone in the finance department will want to understand the financial implications of a partial windup.

•If the pension plan is in a surplus position, consider the impact of surplus distribution: Due to the Supreme Court of Canada’s 2004 Monsanto decision, there is a high likelihood that if a surplus exists, a partial windup will lead to a surplus distribution from the plan. (Exceptions do exist for employees covered by Alberta and British Columbia pension laws, as both these jurisdictions provide exemptions from surplus distribution on partial windup.)

This means that surplus ownership issues will need to be addressed once the basic pension benefits are settled. Also, the employer should be aware that any pension improvements for affected employees may be treated as a form of surplus distribution.

The complexities associated with partial windups are yet another illustration of the fact that Canada is still operating under a pension system suitable only for the last century.

There are several ways to address these issues, but not under the current system. Until the government and regulatory bodies understand the need to update the rules governing Canada’s private pension system, issues such as these will continue to cost employers time, money and headaches.

Gavin Benjamin is a principal in the Toronto offices of Towers Perrin. He can be contacted at (416) 960-7419 or [email protected].

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