Rock and a hard place: how to compulsorily convert defined benefit

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) [2011] 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
sarah.yu@freehills.com
Justine Turnbull
Partner, Sydney
Direct +61 2 9322 4493
justine.turnbull@freehills.com
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