Rock and a hard place: how to compulsorily convert defined benefit members to accumulation members 29 November 2011 In brief Employers may face unfunded superannuation benefits where defined benefit plans have been utilised rather than accumulation style funds. In order to avoid this uncertainty employers may seek to convert defined benefit members to accumulation members. This may require individual employee consent. In dealing with such matters an employer may face an additional hurdle of obtaining the consent of the superannuation trustee to the conversion. The Supreme Court of New South Wales recently gave judicial advice to a superannuation trustee that it would be justified in agreeing to convert defined benefit members to accumulation members. This judgment provides helpful guidance to employers considering converting defined benefit superannuation fund members to accumulation members and thereby bringing certainty to their superannuation funding obligations. Background Freehills recently acted on behalf of a superannuation trustee in obtaining judicial advice that it was justified in consenting to the compulsory reclassification of all defined benefit members to accumulation members (KCA Super Pty Limited as trustee of the superannuation fund known as KCA Super’ (No 2)  NSWSC 1301). The commercial background is a familiar scenario of: a large international conglomerate (whose head office is located overseas) seeking to replace its uncertain defined benefit funding obligations with the certainty of accumulation funding obligations, and the Australian subsidiary having a corporate fund that contained a closed defined benefit division with a small number of defined benefit members. The legal background was: under the trust deed, the trustee’s consent was required to the reclassification of defined benefit members as accumulation members if the fund was terminated (which the employer had the power to unilaterally decide), the defined benefit members were entitled to approximately half the surplus, and the trustee was advised that the reclassification of defined benefit members as accumulation members would not breach an employee’s employment contract. The negotiations between the trustee and the employer centred around the appropriate amount of the uplift (the amount in addition to the member’s crystallised defined benefit) that would be credited to the converting members’ accumulation accounts and accordingly the probability that members to retirement age (age 65) would be no worse off as an accumulation member. Following extensive negotiations, the employer advised the trustee that if the trustee did not consent to the employer’s final uplift offer, the employer would take steps to terminate the fund. Accordingly, the trustee found itself stuck between: ‘the rock’ of the amount of the uplift in the employer’s final uplift offer was expected to result in defined benefit members being equal to or better off 80 per cent of the time to retirement age (age 65) than if they had remained defined benefit members and accordingly it was expected that members would be worse off 20 per cent of the time to retirement age, and ‘a hard place’ of if the trustee did not consent the employer had indicated that it would commence terminating the fund which would result in defined benefit members receiving a smaller amount than in ‘the rock’ scenario. The trustee sought judicial advice under s 63 of the Trustee Act 1925 (NSW) to assist it in deciding between the rock and the hard place. Decision Justice Brereton held that the trustee was justified in consenting to ‘the rock’ (ie the compulsory conversion of the defined benefit members to accumulation members) and gave some important indicators for future conversions: The fundamental question for the trustee was whether the uplift proposal adequately compensated members for additional investment risk, expenses, costs and potential tax liability involved in transferring to the accumulation division? The Court indicated that: the trustee should consider not just the risk of members being worse off but also the potential for members to be better off, even in the absence of the threat to terminate the fund, the uplift was not manifestly inadequate compensation merely because the members were expected to be equal or better off less than 100 per cent of the time to retirement age, and considering the threat of termination and the fact that members would be slightly better off if they are reclassified as accumulation members than if the fund was terminated, this strongly favored the trustee consenting to the reclassification of the defined benefit members as accumulation members. The employer’s obligation of good faith does not prevent the employer from terminating the fund to free itself of the burdens of the deed and improve its financial prospects. Implications This decision confirms that it is possible to convert employees from defined benefit to accumulation style superannuation funds and provides guidance to employers wishing to convert their defined benefit employees to accumulation members and to trustees that are asked to consent to such a conversion. This article was written by Sarah Yu, Special Counsel, and Natalie Colbert, Solicitor, Sydney. More information For information regarding possible implications for your business, contact Sarah Yu Special Counsel, Sydney Direct +61 2 9225 5787 [email protected] Justine Turnbull Partner, Sydney Direct +61 2 9322 4493 [email protected] This article provides a summary only of the subject matter covered, without the assumption of a duty of care by Freehills or Freehills Patent & Trade Mark Attorneys. The summary is not intended to be nor should it be relied upon as a substitute for legal or other professional advice. 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