The soul of discretion

1. The soul of discretion Caroline Carter, Paul Randall and Marcus Fink

2. Introduction Caroline leading on this slideCaroline leading on this slide

3. Introduction To be or not to be �� what do we mean by �discretion�? Caroline leading on this slide Caroline leading on this slide

4. Ways to describe discretion Ability or power to decide responsibly. Unrestricted freedom to choose. The exercise of good judgment or common sense in practical matters. Prudence or circumspection. Knowing how to avoid embarrassment or distress.

5. Meaning of discretion Paul leading on this slide � see scriptPaul leading on this slide � see script

6. When do we see discretion in an employment, incentives and pensions context? express discretion: where a discretion is conferred on, or reserved to, the employer or another person in express terms; �quasi� discretion: where, operating within the confines of a commercial and legislative framework, the employer or trustee has the freedom to make a decision or choice; where the employer may influence the exercise of discretion by another person. Paul leading on this slide � see scriptPaul leading on this slide � see script

7. Examples of express discretion powers of pension scheme trustees; award of bonuses; rights of good and bad leavers under a bonus scheme or share plan; the grant of incentive awards; powers of trustees of employee benefit trusts. Marcus leading on this slide In the pension context, express discretions are often incorporated into trust deeds creating pension scheme trusts or employee benefit trusts. Express discretions are important in the pensions and employee benefit trusts contexts as they give the trustees the necessary flexibility for the pension scheme/employee benefit trust to work. In the employment and incentives context, an express discretion will often be written into employment contracts and documents such as bonus plans or share plan rules to deal with e.g. eligibility for a bonus or other award or what happens to an early leaver. A company which has in place employee share plans often sets up an employee benefit trust (EBT) to operate in conjunction with those plans. An EBT is a trust the beneficiaries of which are the current and former employees of the company or group. The company will fund the EBT trustees to buy shares to hold within the trust until they are needed to satisfy awards made to individuals under the share plans. The trust deed will normally confer, in express terms, absolute discretion on the trustees as to how they apply the funds or shares held within the trust for the benefit of the beneficiaries. Marcus leading on this slide In the pension context, express discretions are often incorporated into trust deeds creating pension scheme trusts or employee benefit trusts. Express discretions are important in the pensions and employee benefit trusts contexts as they give the trustees the necessary flexibility for the pension scheme/employee benefit trust to work. In the employment and incentives context, an express discretion will often be written into employment contracts and documents such as bonus plans or share plan rules to deal with e.g. eligibility for a bonus or other award or what happens to an early leaver. A company which has in place employee share plans often sets up an employee benefit trust (EBT) to operate in conjunction with those plans. An EBT is a trust the beneficiaries of which are the current and former employees of the company or group. The company will fund the EBT trustees to buy shares to hold within the trust until they are needed to satisfy awards made to individuals under the share plans. The trust deed will normally confer, in express terms, absolute discretion on the trustees as to how they apply the funds or shares held within the trust for the benefit of the beneficiaries.

8. Express discretion: pension scheme trustees � examples Marcus leading on this slide When an employer decides to establish an occupational pension scheme, care should be taken with the drafting in the employment contract about the pension scheme which is in operation. The wording should not make an express promise about a particular pension scheme existing but rather that �employees may participate in such pension scheme as the Company may from time to time offer��. Moving on: When an employer decides to establish an occupational pension scheme and the trust documentation is drafted, a number of discretions will be granted to the trustees. These discretions are important as they give the trustees the necessary flexibility for the pension scheme to work. Looking at some examples of discretions: the power of amendment: the vast majority of amendment powers require some involvement by both the principal employer and the trustees before the scheme may be amended. To the extent that an employer is involved in the exercise of the power, it must act in accordance with its implied duty of good faith towards its employees (more about this later). The trustees must exercise their power in the best interests of the beneficiaries. Whoever exercises the power of amendment they must do so for the purpose for which it was conferred, namely to promote the purposes of the scheme. (Series of cases starting with Courage � Marcus refer to pages 474 to 476 of latest edition of Pensions Law Handbook). Dependant pensions/early retirement pensions/ill-health pensions: run through the normal checks that trustees need to do. Lump sum death benefits: often there will be an expression of wishes form from the deceased which the trustees should consider. The trustees will then have the discretion to decide from a list of beneficiaries in the trust deed (e.g. spouse, children, relatives) who should receive the benefit and in what proportions. the power to deal with surplus: the scheme rules may give the trustees a discretion to pay surplus assets to the employer on winding-up, they must at least take the employer�s interest into account.Marcus leading on this slide When an employer decides to establish an occupational pension scheme, care should be taken with the drafting in the employment contract about the pension scheme which is in operation. The wording should not make an express promise about a particular pension scheme existing but rather that �employees may participate in such pension scheme as the Company may from time to time offer��. Moving on: When an employer decides to establish an occupational pension scheme and the trust documentation is drafted, a number of discretions will be granted to the trustees. These discretions are important as they give the trustees the necessary flexibility for the pension scheme to work. Looking at some examples of discretions: the power of amendment: the vast majority of amendment powers require some involvement by both the principal employer and the trustees before the scheme may be amended. To the extent that an employer is involved in the exercise of the power, it must act in accordance with its implied duty of good faith towards its employees (more about this later). The trustees must exercise their power in the best interests of the beneficiaries. Whoever exercises the power of amendment they must do so for the purpose for which it was conferred, namely to promote the purposes of the scheme. (Series of cases starting with Courage � Marcus refer to pages 474 to 476 of latest edition of Pensions Law Handbook). Dependant pensions/early retirement pensions/ill-health pensions: run through the normal checks that trustees need to do. Lump sum death benefits: often there will be an expression of wishes form from the deceased which the trustees should consider. The trustees will then have the discretion to decide from a list of beneficiaries in the trust deed (e.g. spouse, children, relatives) who should receive the benefit and in what proportions. the power to deal with surplus: the scheme rules may give the trustees a discretion to pay surplus assets to the employer on winding-up, they must at least take the employer�s interest into account.

9. Express discretion: bonuses most City employer bonus schemes are discretionary; BUT does that mean they are non-contractual? Caroline leading on this slide The classic use of discretion in the employment context is in relation to bonuses. In practice the distinction between bonus provisions being contractual and discretionary or non-contractual is not always straightforward. Many bonus provisions have a combination of contractual and discretionary or non-contractual elements. For example, there could be a contractual entitlement to the payment of a bonus, but the calculation used and the amount payable could remain discretionary and non-contractual. It is easy for so called discretionary bonuses to in fact give rise to a contractual entitlement to the employee.Caroline leading on this slide The classic use of discretion in the employment context is in relation to bonuses. In practice the distinction between bonus provisions being contractual and discretionary or non-contractual is not always straightforward. Many bonus provisions have a combination of contractual and discretionary or non-contractual elements. For example, there could be a contractual entitlement to the payment of a bonus, but the calculation used and the amount payable could remain discretionary and non-contractual. It is easy for so called discretionary bonuses to in fact give rise to a contractual entitlement to the employee.

10. Express discretion: bonuses Risk factors for a discretionary bonus to become contractual: custom and practice; when to discontinue the scheme; bonus conditions; poor drafting. Caroline leading on this slide There are several key risk factors for a discretionary bonus to in fact become contractual:- Bullet point one: Firstly, a contractual obligation to pay a bonus can be implied through custom and practice. For example, in Small and ors v The Boots Co PLC the staff handbook provided that "After a qualifying period of service, there are additional discretionary benefits, such as bonuses�However, they are not intended to be contractual". Having awarded bonuses under this scheme (which was partly performance-related) for around 40 years, Boots decided not to pay any further bonuses. The Employment Appeal Tribunal found that the scheme was not discretionary, particularly given the length of time over which bonuses had been paid. An implied obligation of this kind will usually only arise if the employer's practice in granting bonuses has been both open and consistent over a number of years (for instance, by granting bonuses of the same amount or on the same calculation year on year). Bullet point two: Secondly, an employer may need to expressly refuse bonuses if it is to avoid an obligation to pay them. For example in Noble Enterprises v Lieberum, the employer was held to have discretion whether to operate the scheme from year to year, but once the bonus year began, this discretion was limited. The scheme had operated for five years, and since the employer had not informed the employee that it intended to discontinue the scheme before the start of the year, the employee had a reasonable expectation that he would receive a bonus in return for his efforts. Bullet point three: Thirdly, if the bonus provision identifies conditions, these can create an obligation to pay the bonus once they are satisfied. So, where a bonus scheme provide for a bonus to be payable on the achievement of certain performance conditions, if the performance conditions have been met, an employer will effectively be obliged to award the bonus. For example, in Clark -v- Nomura International PLC it was held that, where a discretionary bonus was expressed to be "not guaranteed in any way and is dependent on individual performance", the employer was bound to base its decision solely on the identified factor (i.e. individual performance), and no other. This meant that, if the identified factor had been satisfied, the employer was under a contractual obligation to pay the bonus. Of course in practice whether or not to attach any conditions/criteria to the award of a bonus can give rise to a conflict because if the employer attaches no criteria/conditions at all for the bonus award, this can open the door to discrimination claims. On the other hand attaching criteria increases the risk of the bonus award becoming contractual. We will discuss this later. As a practical drafting point, an employer outlining criteria according to which the bonus will be awarded should make sure it is stated that the criteria is not exhaustive/conclusive, that it may consider other criteria at its absolute discretion, and that at its absolute discretion it can decide if the criteria have been met. Bullet point four: Fourthly, simply poor drafting can inadvertently give rise to a contractual entitlement. On the next couple of slides we set out some practical bonus drafting tips. Caroline leading on this slide There are several key risk factors for a discretionary bonus to in fact become contractual:- Bullet point one: Firstly, a contractual obligation to pay a bonus can be implied through custom and practice. For example, in Small and ors v The Boots Co PLC the staff handbook provided that "After a qualifying period of service, there are additional discretionary benefits, such as bonuses�However, they are not intended to be contractual". Having awarded bonuses under this scheme (which was partly performance-related) for around 40 years, Boots decided not to pay any further bonuses. The Employment Appeal Tribunal found that the scheme was not discretionary, particularly given the length of time over which bonuses had been paid. An implied obligation of this kind will usually only arise if the employer's practice in granting bonuses has been both open and consistent over a number of years (for instance, by granting bonuses of the same amount or on the same calculation year on year). Bullet point two: Secondly, an employer may need to expressly refuse bonuses if it is to avoid an obligation to pay them. For example in Noble Enterprises v Lieberum, the employer was held to have discretion whether to operate the scheme from year to year, but once the bonus year began, this discretion was limited. The scheme had operated for five years, and since the employer had not informed the employee that it intended to discontinue the scheme before the start of the year, the employee had a reasonable expectation that he would receive a bonus in return for his efforts. Bullet point three: Thirdly, if the bonus provision identifies conditions, these can create an obligation to pay the bonus once they are satisfied. So, where a bonus scheme provide for a bonus to be payable on the achievement of certain performance conditions, if the performance conditions have been met, an employer will effectively be obliged to award the bonus. For example, in Clark -v- Nomura International PLC it was held that, where a discretionary bonus was expressed to be "not guaranteed in any way and is dependent on individual performance", the employer was bound to base its decision solely on the identified factor (i.e. individual performance), and no other. This meant that, if the identified factor had been satisfied, the employer was under a contractual obligation to pay the bonus. Of course in practice whether or not to attach any conditions/criteria to the award of a bonus can give rise to a conflict because if the employer attaches no criteria/conditions at all for the bonus award, this can open the door to discrimination claims. On the other hand attaching criteria increases the risk of the bonus award becoming contractual. We will discuss this later. As a practical drafting point, an employer outlining criteria according to which the bonus will be awarded should make sure it is stated that the criteria is not exhaustive/conclusive, that it may consider other criteria at its absolute discretion, and that at its absolute discretion it can decide if the criteria have been met. Bullet point four: Fourthly, simply poor drafting can inadvertently give rise to a contractual entitlement. On the next couple of slides we set out some practical bonus drafting tips.

11. Practical drafting tips: bonuses Caroline leading on this slide To try to minimise the risk of your bonus being held to be contractual, when drafting your bonus clause ensure discretion applies to:- the decision whether to award bonuses. Also, as I have just mentioned, if you wish to say that the bonus is awarded according to certain criteria, ensure that you state that the critieria are not exhaustive, that the employer may consider other criteria at its absolute discretion and that the employer has absolute discretion as to whether the criteria have been met; the amount of bonus paid; and the ability to suspend, alter or discontinue a bonus at any time.Caroline leading on this slide To try to minimise the risk of your bonus being held to be contractual, when drafting your bonus clause ensure discretion applies to:- the decision whether to award bonuses. Also, as I have just mentioned, if you wish to say that the bonus is awarded according to certain criteria, ensure that you state that the critieria are not exhaustive, that the employer may consider other criteria at its absolute discretion and that the employer has absolute discretion as to whether the criteria have been met; the amount of bonus paid; and the ability to suspend, alter or discontinue a bonus at any time.

12. Practical drafting tips: bonuses Caroline leading on this slide Also ensure that the clause stipulates that: - receipt of one bonus does not create entitlement to another; bonuses are only payable to those in employment and not under notice (given or received) or serving a probationary period. As the recent case of Rutherford v Seymour Pierce Ltd shows, there is no implied term that eligibility depends on continued employment at the payment date. Therefore if you do not expressly stipulate these terms in the clause wording you cannot rely on them being implied; and bonus entitlement does not accrue in the course of a year so the employee is not entitled to a bonus or a pro-rata portion if he leaves employment prior to the bonus payment date.Caroline leading on this slide Also ensure that the clause stipulates that: - receipt of one bonus does not create entitlement to another; bonuses are only payable to those in employment and not under notice (given or received) or serving a probationary period. As the recent case of Rutherford v Seymour Pierce Ltd shows, there is no implied term that eligibility depends on continued employment at the payment date. Therefore if you do not expressly stipulate these terms in the clause wording you cannot rely on them being implied; and bonus entitlement does not accrue in the course of a year so the employee is not entitled to a bonus or a pro-rata portion if he leaves employment prior to the bonus payment date.

13. Express discretion: employee share plans - grant Paul leading on this slide � see script Paul leading on this slide � see script

14. Express discretion: employee share plans � normal exercise/vesting exercise or vesting is normally automatic; however, the remco/trustees may have a discretion whether to allow exercise/vesting, for example: - where there are difficulties with local securities laws; or the remco wishes to be satisfied that the company�s underlying financial performance justifies exercise/vesting. Paul leading on this slide � see script Paul leading on this slide � see script

15. Express discretion: employee share plans � early leavers automatic vesting/exercise for good leavers is usual; automatic lapse for bad leavers is usual; in the case of voluntary resignation, the remco typically has a discretion whether to allow vesting/exercise - clarity is essential; there may be a further discretion as to whether or not to apply pro-rating to awards. Paul leading on this slide � see script Paul leading on this slide � see script

16. Exercising express discretion: general body of case law on the exercise of discretion by employers; bonus cases establish that the employer�s decision can only be challenged if the employer acted irrationally or perversely; current trend: employee requires an 'overwhelming case� to persuade court that the level of his bonus payment is irrational/perverse (Keen v Commerzbank AG; Ridgway v JP Morgan Chase Bank National Association); test from bonus case law applies generally. Caroline leading on this slide An established body of case-law, which concerns bonuses, exists regarding how courts police the exercise of discretion by employers and trustees. Employees need to show that their employer exercised its discretion irrationally or perversely to challenge a bonus award. If we compare this test with the traditional employment test in the context of, for example, unfair dismissal where the question is whether the employer acted �reasonably�, it can be seen that the test of discretion clearly gives much more leeway to employers. The current trend is very helpful for employers. Two high-profile cases against investment banks in 2007 (Keen v Commerzbank AG v Ridgway v JP Morgan Chase Bank National Association) made clear that where an employee�s bonus depends on the discretion of the employer in fluctuating market and labour conditions, an employee requires an �overwhelming case� to persuade the court that the level of bonus payments is irrational or perverse. Accordingly there is a very high evidential threshold for the employee. Therefore in the current poor economic climate, companies have some key flexibility when allocating, for example, smaller bonus pots. The �irrational/perverse� test established in the bonus cases applies generally to the exercise of discretion in other contexts, for example as to whether to allow exercise/vesting under share plans (e.g. Mallone v BPB Industries) or in a pensions context. Caroline leading on this slide An established body of case-law, which concerns bonuses, exists regarding how courts police the exercise of discretion by employers and trustees. Employees need to show that their employer exercised its discretion irrationally or perversely to challenge a bonus award. If we compare this test with the traditional employment test in the context of, for example, unfair dismissal where the question is whether the employer acted �reasonably�, it can be seen that the test of discretion clearly gives much more leeway to employers. The current trend is very helpful for employers. Two high-profile cases against investment banks in 2007 (Keen v Commerzbank AG v Ridgway v JP Morgan Chase Bank National Association) made clear that where an employee�s bonus depends on the discretion of the employer in fluctuating market and labour conditions, an employee requires an �overwhelming case� to persuade the court that the level of bonus payments is irrational or perverse. Accordingly there is a very high evidential threshold for the employee. Therefore in the current poor economic climate, companies have some key flexibility when allocating, for example, smaller bonus pots. The �irrational/perverse� test established in the bonus cases applies generally to the exercise of discretion in other contexts, for example as to whether to allow exercise/vesting under share plans (e.g. Mallone v BPB Industries) or in a pensions context.

17. Exercising express discretion: risks discrimination claims; burden of proof. Caroline leading on this slide In a speech last year (7 February 2009 at the Labour Regional Conference in Sheffield (BBC News)) Ms Harman described the discretionary bonus system as a �licence for unfairness and discrimination�. The risk for corporates in exercising discretion therefore tends not to be falling foul of the irrational or perverse test, but rather the risk of discrimination claims, which is always prevalent. The issue with discrimination claims is that once the employee has made out a prime facie case against the employer that discrimination has occurred, the burden shifts to the employer to prove that discrimination did not occur. Proving a negative is notoriously difficult � hence the importance of documenting the reasons for decisions and having a paper trail (which we will come onto). Caroline leading on this slide In a speech last year (7 February 2009 at the Labour Regional Conference in Sheffield (BBC News)) Ms Harman described the discretionary bonus system as a �licence for unfairness and discrimination�. The risk for corporates in exercising discretion therefore tends not to be falling foul of the irrational or perverse test, but rather the risk of discrimination claims, which is always prevalent. The issue with discrimination claims is that once the employee has made out a prime facie case against the employer that discrimination has occurred, the burden shifts to the employer to prove that discrimination did not occur. Proving a negative is notoriously difficult � hence the importance of documenting the reasons for decisions and having a paper trail (which we will come onto).

18. Exercising express discretion: bonuses Some factors to consider: establish objective, non-discriminatory criteria for the allocation of awards; paying a lion share to star performers (directly impacting the amount of award going to others) will need to be clearly justifiable in line with the criteria in order not to risk being irrational or discriminatory; document reasons for award/no award e.g. minutes of meetings; communicate to staff the reasons for the bonus award and the criteria on which it is being awarded. Caroline leading on this slide In the bonus context, to fend off claims and manage expectations employers should:- establish objective, non-discriminatory criteria for the allocation of awards; paying a lion�s share to star performers (directly impacting the amount of award going to others) will need to be clearly justifiable in line with the criteria in order not to risk being irrational or discriminatory; document the reasons for the award/no award, e.g. minutes of meetings (as discussed before, in light of the burden of proof in discrimination claims, this is very important) who makes the minutes is also important. It may seem obvious but they should be drafted by people in attendance at the meeting. How the minutes are circulated is also important, for example in terms of legal privilege. Care should be taken at the outset to understand �when and how legal privilege will attach to the document and when it will not�. communicate to staff the reasons for the bonus award and the criteria on which it is being awarded. Therefore, a balancing act is required: providing a sufficient level of detail regarding the criteria on which a bonus is awarded to fend off a potential discrimination claim, whilst not providing so much detail as to criteria so that the bonus becomes contractual. In practice where that line is drawn will be a decision very much dependant on the specific factual situation, the nature of the organisation and its priorities. Caroline leading on this slide In the bonus context, to fend off claims and manage expectations employers should:- establish objective, non-discriminatory criteria for the allocation of awards; paying a lion�s share to star performers (directly impacting the amount of award going to others) will need to be clearly justifiable in line with the criteria in order not to risk being irrational or discriminatory; document the reasons for the award/no award, e.g. minutes of meetings (as discussed before, in light of the burden of proof in discrimination claims, this is very important) who makes the minutes is also important. It may seem obvious but they should be drafted by people in attendance at the meeting. How the minutes are circulated is also important, for example in terms of legal privilege. Care should be taken at the outset to understand �when and how legal privilege will attach to the document and when it will not�. communicate to staff the reasons for the bonus award and the criteria on which it is being awarded. Therefore, a balancing act is required: providing a sufficient level of detail regarding the criteria on which a bonus is awarded to fend off a potential discrimination claim, whilst not providing so much detail as to criteria so that the bonus becomes contractual. In practice where that line is drawn will be a decision very much dependant on the specific factual situation, the nature of the organisation and its priorities.

19. Exercising express discretion: bonuses Fish v Dresdner Kleinwort Ltd; Would the court have decided differently if this had been a discretionary bonus? Caroline leading on this slide Of course, in the current economic climate, bonus awards are more sensitive than ever before. The very recent high-profile case of Fish v Dresdner Kleinwort Ltd is interesting in the current climate. The case concerned a contractual bonus. However, it is interesting to note how the Court disposed of the employer's arguments. The case concerned a claim by 5 senior banking executives for payment of substantial bonuses and severance payments, each in excess of one million Euro. Their employment was terminated after the investment bank incurred massive losses in the banking crisis. Their contracts provided that they shall at all times act in the best interests of their employer. Dresdner argued that due to this and the implied duty of good faith to their employer the employees were required to waive their contractual entitlement to payment of the sums. There was no contention that they had performed in breach of contract in the way they had performed their management functions. The High Court held that the trust and confidence duty and the employee�s duty to act in the best interests of the company could not be used by the employer to say that if it ceases to be in the best interests of the company to pay those moneys the employee will not get them. It also was not relevant that the employees (due to their senior positions) were fiduciaries. It cannot be that the employer can be released from its obligations to the fiduciary employee just because subsequent events make the bargain one which the employer would not have made had he foreseen those events. It would be interesting to know if the court would have decided differently if this had been a discretionary bonus. It probably would have done, if the discretionary nature of the bonus scheme had been drafted sufficiently well. Caroline leading on this slide Of course, in the current economic climate, bonus awards are more sensitive than ever before. The very recent high-profile case of Fish v Dresdner Kleinwort Ltd is interesting in the current climate. The case concerned a contractual bonus. However, it is interesting to note how the Court disposed of the employer's arguments. The case concerned a claim by 5 senior banking executives for payment of substantial bonuses and severance payments, each in excess of one million Euro. Their employment was terminated after the investment bank incurred massive losses in the banking crisis. Their contracts provided that they shall at all times act in the best interests of their employer. Dresdner argued that due to this and the implied duty of good faith to their employer the employees were required to waive their contractual entitlement to payment of the sums. There was no contention that they had performed in breach of contract in the way they had performed their management functions. The High Court held that the trust and confidence duty and the employee�s duty to act in the best interests of the company could not be used by the employer to say that if it ceases to be in the best interests of the company to pay those moneys the employee will not get them. It also was not relevant that the employees (due to their senior positions) were fiduciaries. It cannot be that the employer can be released from its obligations to the fiduciary employee just because subsequent events make the bargain one which the employer would not have made had he foreseen those events. It would be interesting to know if the court would have decided differently if this had been a discretionary bonus. It probably would have done, if the discretionary nature of the bonus scheme had been drafted sufficiently well.

20. Exercising express discretion: factors for Remcos to consider Remcos should: give proper consideration to the matter; keep within any limits on the scope of the discretion; keep minutes of proceedings; be able to produce rational reasons for the decision. Paul leading on this slide � see scriptPaul leading on this slide � see script

21. Exercising express discretion: incentive awards Factors to consider for early leavers: what is the reason for the employee�s departure? have options already become exercisable? has an indication already been given to the employee that exercise/vesting will be allowed? will the decision set a precedent for the future? what disclosure to shareholders may be required? Paul leading on this slide � see script Paul leading on this slide � see script

22. Exercising express discretion: pension scheme trustees Trustees should: act in the �best� interests of the beneficiaries of the scheme; in certain circumstances take into consideration the interests of the sponsoring employer; exercise the power for the purpose for which it is given; give proper consideration to the matters which are relevant; exclude from consideration matters which are irrelevant. Marcus leading on this slide Bullet points 1 and 2: The best interests of the beneficiaries of a scheme are usually the best financial interests of those beneficiaries. In Cowan v Scargill Megarry V-C stated ��under a trust for the provision of financial benefits, the paramount duty of the trustees is to provide the greatest financial benefits for the present and future beneficiaries�. Beneficiaries can include active, deferred and pensioner members, recipients of death benefits (such as spouses, civil partners, dependants and children) and, in some circumstances the employers participating in the scheme. Bullet points 3,4 and 5: Edge v Pensions Ombudsman Chadwick LJ on the duty to act impartially ��.is no more than the ordinary duty which the law imposes on a person who is entrusted with the exercise of a discretionary power: that he exercises the power for the purpose for which it is given, giving proper consideration to the matters which are relevant and excluding from consideration matters which are irrelevant. If pension fund trustees do that, they cannot be criticised if they reach a decision which appears to prefer the claims of one interest � whether that of employers, current employees or pensioners � over others. The preference will be the result of a proper exercise of the discretionary power�.Marcus leading on this slide Bullet points 1 and 2: The best interests of the beneficiaries of a scheme are usually the best financial interests of those beneficiaries. In Cowan v Scargill Megarry V-C stated ��under a trust for the provision of financial benefits, the paramount duty of the trustees is to provide the greatest financial benefits for the present and future beneficiaries�. Beneficiaries can include active, deferred and pensioner members, recipients of death benefits (such as spouses, civil partners, dependants and children) and, in some circumstances the employers participating in the scheme. Bullet points 3,4 and 5: Edge v Pensions Ombudsman Chadwick LJ on the duty to act impartially ��.is no more than the ordinary duty which the law imposes on a person who is entrusted with the exercise of a discretionary power: that he exercises the power for the purpose for which it is given, giving proper consideration to the matters which are relevant and excluding from consideration matters which are irrelevant. If pension fund trustees do that, they cannot be criticised if they reach a decision which appears to prefer the claims of one interest � whether that of employers, current employees or pensioners � over others. The preference will be the result of a proper exercise of the discretionary power�.

23. Exercising express discretion: pension scheme trustees trustees should not impose burdens which imperil the continuity and proper development of the employers� business or the employment of the members who work in that business; the main purpose of the scheme is not served by putting an employer out of business. Marcus leading on this slide Principles set out in Edge v Pensions OmbudsmanMarcus leading on this slide Principles set out in Edge v Pensions Ombudsman

24. Exercising express discretion: pension scheme trustees Should trustees give reasons to employers? yes, trustees and employers should have a frank and open dialogue on all scheme matters. Should trustees give reasons to members? trustees are not obliged to give reasons for their decisions to members; the actual decision, but not the reasons, should be recorded in the trustees' minutes; a note should be kept of the evidence considered by the trustees in coming to their decision. Marcus leading on this slideMarcus leading on this slide

25. Case study CEO of PLC departs to rival. How to exercise discretion in relation to his long-term incentive plan (LTIP) and bonus? Caroline leading on this slide Morrisons - Marc Bolland�s departure to M&S how to exercise discretion in relation to his LTIPs and bonus not in employment on relevant date but MB had sought assurances about the exercise of discretions on his departure market perception � attract new CEO/incentivise remaining executives M&S � not want to pay out unvested LTIPs and bonus if possible process played out in press against backdrop of highly publicised corporate governance reforms Mention here that if the employee is moving to a new employer and the current employer refuses to allow options to be exercised/awards to vest or refuses to grant a bonus, the employee may look to a new employer for the value of the compensatory awards and bonus. Commercially, the new employer may think that it has no option but to pay these to secure the recruitment. By far the largest part of Marc Bolland�s package was the compensation for the forfeiture of the Morrisons� LTIP awards and bonus, amounting to �7.5m. Also mention the fact that (as in the bullet points above) it was important to consider the impact this could have on incentivising remaining executives � who may lose confidence if no award is paid out.Caroline leading on this slide Morrisons - Marc Bolland�s departure to M&S how to exercise discretion in relation to his LTIPs and bonus not in employment on relevant date but MB had sought assurances about the exercise of discretions on his departure market perception � attract new CEO/incentivise remaining executives M&S � not want to pay out unvested LTIPs and bonus if possible process played out in press against backdrop of highly publicised corporate governance reforms Mention here that if the employee is moving to a new employer and the current employer refuses to allow options to be exercised/awards to vest or refuses to grant a bonus, the employee may look to a new employer for the value of the compensatory awards and bonus. Commercially, the new employer may think that it has no option but to pay these to secure the recruitment. By far the largest part of Marc Bolland�s package was the compensation for the forfeiture of the Morrisons� LTIP awards and bonus, amounting to �7.5m. Also mention the fact that (as in the bullet points above) it was important to consider the impact this could have on incentivising remaining executives � who may lose confidence if no award is paid out.

26. Exercising express discretion against the employee's interests � potential consequences Marcus leading on this slide The potential consequences for exercising a discretion against the employee�s interests are: Potential exposure to claims; Publicity/reputation risk; As highlighted in the Morrisons case study, the potential impact on other employees who may feel demoralised or lose confidence in their employer and the potential impact on a new employer. All these show the importance of being able to explain and evidence the decision.Marcus leading on this slide The potential consequences for exercising a discretion against the employee�s interests are: Potential exposure to claims; Publicity/reputation risk; As highlighted in the Morrisons case study, the potential impact on other employees who may feel demoralised or lose confidence in their employer and the potential impact on a new employer. All these show the importance of being able to explain and evidence the decision.

27. Exercising express discretion: the current climate The scope of discretion in the current climate: scrutiny of executive pension remuneration which is not linked to performance; current corporate governance reforms: increasing regulation over bonuses and incentive awards; therefore will the scope of discretion decrease as remuneration becomes ever more linked to very clear personal and company performance targets? Marcus leading on this slide. From the pensions perspective briefly mention examples in the press such as RBS. There is increasing regulation over the award of bonuses (e.g. the Walker review, FRC Report, FSA Remuneration Code, ABI Guidance, also shareholder approval to grant awards (e.g. PIRC (the Shareholder Voting Guidelines 2006 published by Pensions Investment Research Consultants) requires prior shareholder approval for annual bonuses if they are not subject to predetermined performance criteria). NB: ABI guidance on share based remuneration: rem report review including how discretion has been exercised, and shareholder authority for significant exercise of discretion. In the context of this regulation, will the scope of discretion decrease as bonuses/incentive awards become ever more linked to very clear personal and company performance targets? Paul � to discuss your view from an incentives perspective � now and more particularly after you have asked the question on the next slide. Marcus leading on this slide. From the pensions perspective briefly mention examples in the press such as RBS. There is increasing regulation over the award of bonuses (e.g. the Walker review, FRC Report, FSA Remuneration Code, ABI Guidance, also shareholder approval to grant awards (e.g. PIRC (the Shareholder Voting Guidelines 2006 published by Pensions Investment Research Consultants) requires prior shareholder approval for annual bonuses if they are not subject to predetermined performance criteria). NB: ABI guidance on share based remuneration: rem report review including how discretion has been exercised, and shareholder authority for significant exercise of discretion. In the context of this regulation, will the scope of discretion decrease as bonuses/incentive awards become ever more linked to very clear personal and company performance targets? Paul � to discuss your view from an incentives perspective � now and more particularly after you have asked the question on the next slide.

28. �Quasi� discretion decisions made by employers in relation to the operation of pension arrangements; employers responding to requests from employees in relation to their working arrangements. Marcus leading on this slide The second type of discretion we highlighted at the start was what we have termed �quasi� discretion. If you recall this is where no express discretion is conferred in so many words but the employer has a decision or a choice to make, and the freedom to do so within the confines of the commercial and legislative sphere in which it operates. Arguably there is always a sense in which discretion (in this sense) is used by an employer. For example the age-old, familiar, employment test is �has the employer acted reasonably� or, put another way, do the employer�s actions fall within the �range of reasonable responses�? This is the test for unfair dismissals, dealing with misconduct, carrying out disciplinaries etc. Of course, although the legal test in this context is one of reasonableness, inevitably in deciding which �reasonable� course to take, the employer in a sense exercises its discretion. In exercising discretion in this way, employers and trustees very much take commercial considerations into account. So for example deciding which pension arrangements to give will very much be governed by commercial concerns. Marcus leading on this slide The second type of discretion we highlighted at the start was what we have termed �quasi� discretion. If you recall this is where no express discretion is conferred in so many words but the employer has a decision or a choice to make, and the freedom to do so within the confines of the commercial and legislative sphere in which it operates. Arguably there is always a sense in which discretion (in this sense) is used by an employer. For example the age-old, familiar, employment test is �has the employer acted reasonably� or, put another way, do the employer�s actions fall within the �range of reasonable responses�? This is the test for unfair dismissals, dealing with misconduct, carrying out disciplinaries etc. Of course, although the legal test in this context is one of reasonableness, inevitably in deciding which �reasonable� course to take, the employer in a sense exercises its discretion. In exercising discretion in this way, employers and trustees very much take commercial considerations into account. So for example deciding which pension arrangements to give will very much be governed by commercial concerns.

29. Quasi discretions: pension arrangements Examples of topical quasi employer discretions: is continuation of final salary pension provision viable? what pension provision should be offered in the light of changes to be introduced from April 2011? what pension provision should be offered where employees draw a pension and continue to work? Marcus leading on this slide Opening point: The first two bullet points relate to employer discretions in the context of the commercial environment i.e. point 2 of our �meaning of discretion� � freedom to make certain choices among those available within a commercial environment. Generally: Most decisions (subject to legislation) affecting cost will either be given to employers, or require the employer�s consent before being exercised. Employers� use of discretion is subject to the Imperial implied obligation of good faith. In exercising that obligation of good faith, the employer could have regard to its own financial and other interests in the future operation of the scheme. However, the Company was obliged to exercise its rights with a view to the efficient running of the scheme and not some collateral purpose. Bullet point 1: the options for employers to consider are closure to new entrants; total closure to future accrual and intermediate options e.g. changes to the benefit structure of the DB scheme. Bullet point 2:In the light of the tapering away of tax relief on pension contributions from April 2011, employers are considering other pension options for their high earners such as EFRBs. NB this year�s budget where the Government has said that it will be looking at tax-avoidance involving the use of trusts and other arrangements. Budget Report states The Government also announces future action to tackle the use of arrangements to reward employees through the use of trusts or other intermediaries, with the purpose of avoiding, deferring or reducing liabilities to income tax and NICs or avoiding restrictions on pensions tax relief. The Government will consider options for tackling these avoidance arrangements with the intention of introducing any necessary legislation to take effect from April 2011. Bullet point 3: this relates to flexible retirement and the options open to employers once employees work beyond the normal retirement age. Options include: offer nothing; same arrangements carry on or provide pension provision but on a DC basis rather than DB.Marcus leading on this slide Opening point: The first two bullet points relate to employer discretions in the context of the commercial environment i.e. point 2 of our �meaning of discretion� � freedom to make certain choices among those available within a commercial environment. Generally: Most decisions (subject to legislation) affecting cost will either be given to employers, or require the employer�s consent before being exercised. Employers� use of discretion is subject to the Imperial implied obligation of good faith. In exercising that obligation of good faith, the employer could have regard to its own financial and other interests in the future operation of the scheme. However, the Company was obliged to exercise its rights with a view to the efficient running of the scheme and not some collateral purpose. Bullet point 1: the options for employers to consider are closure to new entrants; total closure to future accrual and intermediate options e.g. changes to the benefit structure of the DB scheme. Bullet point 2:In the light of the tapering away of tax relief on pension contributions from April 2011, employers are considering other pension options for their high earners such as EFRBs. NB this year�s budget where the Government has said that it will be looking at tax-avoidance involving the use of trusts and other arrangements. Budget Report states The Government also announces future action to tackle the use of arrangements to reward employees through the use of trusts or other intermediaries, with the purpose of avoiding, deferring or reducing liabilities to income tax and NICs or avoiding restrictions on pensions tax relief. The Government will consider options for tackling these avoidance arrangements with the intention of introducing any necessary legislation to take effect from April 2011. Bullet point 3: this relates to flexible retirement and the options open to employers once employees work beyond the normal retirement age. Options include: offer nothing; same arrangements carry on or provide pension provision but on a DC basis rather than DB.

30. Quasi discretions: employment context Examples of quasi discretions: flexible working requests? time off for training requests? NB: the government has consulted on the future of the right to request time off to train. Its response to the consultation is currently scheduled to be published in December 2010; requests to work beyond the normal retirement age? NB: in July 2010 the government announced it is planning to phase out the default retirement age of 65 from April 2011, with transitional arrangements covering the period until 1 October 2011. Under this proposal the current "right to request working beyond retirement" procedure will be removed; Caroline leading on this slide Over the last few years, a new series of rights for employees have been enacted. On the one hand, therefore, the employment relationship seems more regulated than ever before. Discretion, in the strict express sense, has no formal role to play in relation to these rights. On the other hand, the nature of the legislative framework is such that in reality (for example due to the ease by which an employer can establish one of the legislative grounds for refusing a request or the employer does not need to explain why it is refusing a request), an employer is able to exercise a significant degree of discretion as to whether or not to grant an employee�s request. Therefore indirectly, arguably the role of discretion is in practice gaining a certain prominence. Flexible working requests give a wide ability to an employer to justify the refusal to grant a request, in other words one could argue that the grounds of refusal of a request are sufficiently wide that an employer should be able to bring most �business reasons� for refusal of a flexible working request under one or other of them. Therefore so long as the employer sufficiently explains which permitted ground applies and why, refusing a request should not give rise to a breach of its obligation under the right to request flexible working itself. Similarly, the new time off for training requests follow the flexible working request model. In relation to the current duty to consider an employee�s request to work beyond the normal retirement age, an employer simply has a duty to consider the employee request and follow the relevant procedure. There is no obligation on an employer to give reasons for refusing a request. Indeed it is the only area of employment law which allows employers to terminate an employee�s employment so freely without giving any proper reason. Therefore again the scope for discretion is wide. Equalities Minister, Harriet Harman, has recently proposed to remove the current default retirement age of 65 at which employees can be fairly dismissed. In proposals with potentially far-reaching consequences for employers, she has advised that employees approaching the age of 65 should have the right to request flexible working. They would have the option to choose to work beyond 65 but would not be forced to. It will be interesting to see what the employer�s duties will be in this context. If the model follows that of flexible working, will employers in reality have a discretion regarding how to act? It will also be interesting to see whether in reality this will be any different to the current duty to consider, and therefore whether blanket policies denying requests in practice will operate. GO TO NEXT SLIDE Caroline leading on this slide Over the last few years, a new series of rights for employees have been enacted. On the one hand, therefore, the employment relationship seems more regulated than ever before. Discretion, in the strict express sense, has no formal role to play in relation to these rights. On the other hand, the nature of the legislative framework is such that in reality (for example due to the ease by which an employer can establish one of the legislative grounds for refusing a request or the employer does not need to explain why it is refusing a request), an employer is able to exercise a significant degree of discretion as to whether or not to grant an employee�s request. Therefore indirectly, arguably the role of discretion is in practice gaining a certain prominence. Flexible working requests give a wide ability to an employer to justify the refusal to grant a request, in other words one could argue that the grounds of refusal of a request are sufficiently wide that an employer should be able to bring most �business reasons� for refusal of a flexible working request under one or other of them. Therefore so long as the employer sufficiently explains which permitted ground applies and why, refusing a request should not give rise to a breach of its obligation under the right to request flexible working itself. Similarly, the new time off for training requests follow the flexible working request model. In relation to the current duty to consider an employee�s request to work beyond the normal retirement age, an employer simply has a duty to consider the employee request and follow the relevant procedure. There is no obligation on an employer to give reasons for refusing a request. Indeed it is the only area of employment law which allows employers to terminate an employee�s employment so freely without giving any proper reason. Therefore again the scope for discretion is wide. Equalities Minister, Harriet Harman, has recently proposed to remove the current default retirement age of 65 at which employees can be fairly dismissed. In proposals with potentially far-reaching consequences for employers, she has advised that employees approaching the age of 65 should have the right to request flexible working. They would have the option to choose to work beyond 65 but would not be forced to. It will be interesting to see what the employer�s duties will be in this context. If the model follows that of flexible working, will employers in reality have a discretion regarding how to act? It will also be interesting to see whether in reality this will be any different to the current duty to consider, and therefore whether blanket policies denying requests in practice will operate. GO TO NEXT SLIDE

31. Quasi discretions: employment context the flipside of discretion: dangers for employers (risk of discrimination and trust and confidence claims); analogy to classic bonus cases � key risk is discrimination claims. Caroline leading on this slide This is because the flipside of discretion for employers is the danger for employers in exercising their discretion � that is exposure to discrimination claims and claims that the employer is breaching its duty of trust and confidence to the employee. This can in fact lead employers to operate blanket (unwritten) policies not to grant any requests, as in this way they cannot be exposed to discrimination or trust and confidence claims. Of course, operating blanket policies of refusal in this way defeats the whole purpose of the legislation. This has particularly been the case with the duty to consider in the context of retirement. In all the cases above, the correlation (in terms of the employee�s recourse against his employer) with the classic use of discretion in the bonus cases is clear. This is because, with the exception of fit notes, the ability for the employee to argue breach of trust and confidence by the employer may be difficult in practice given that the legislation allows the employer significant leeway to act. The main way in which employees can challenge employers� decisions is therefore if they can base their challenge on grounds of discrimination � again as seen above in the context of bonuses. Caroline leading on this slide This is because the flipside of discretion for employers is the danger for employers in exercising their discretion � that is exposure to discrimination claims and claims that the employer is breaching its duty of trust and confidence to the employee. This can in fact lead employers to operate blanket (unwritten) policies not to grant any requests, as in this way they cannot be exposed to discrimination or trust and confidence claims. Of course, operating blanket policies of refusal in this way defeats the whole purpose of the legislation. This has particularly been the case with the duty to consider in the context of retirement. In all the cases above, the correlation (in terms of the employee�s recourse against his employer) with the classic use of discretion in the bonus cases is clear. This is because, with the exception of fit notes, the ability for the employee to argue breach of trust and confidence by the employer may be difficult in practice given that the legislation allows the employer significant leeway to act. The main way in which employees can challenge employers� decisions is therefore if they can base their challenge on grounds of discrimination � again as seen above in the context of bonuses.

32. Influencing the exercise of discretion by another where employers influence the exercise of discretion by pension scheme trustees; where employers influence the exercise of discretion by the trustees of an employee benefit trust (EBT). Marcus leading on this slide The last sense in which we are looking at discretion today is where the employer can influence the exercise of discretion by another person. For example, where employers influence the exercise of discretion by pension scheme trustees and where employers influence the exercise of discretion by the trustees of an employee benefit trust.Marcus leading on this slide The last sense in which we are looking at discretion today is where the employer can influence the exercise of discretion by another person. For example, where employers influence the exercise of discretion by pension scheme trustees and where employers influence the exercise of discretion by the trustees of an employee benefit trust.

33. Influencing the exercise of discretion by another: pension scheme trustees setting the pension scheme investment strategy; determining the pension scheme funding. Marcus leading on this slide Bullet point 1: One particular example of a trustee power which can significantly affect the interests of the employer is the trustees� power of investment. In a balance of cost scheme, any failure but the trustees to obtain reasonable returns on investment of the pension fund will result in the employer having to make greater contributions to the scheme to fund the promised benefit. Section 35 PA 1995 requires the trustees to secure that a written statement of investment principles is prepared and maintained governing the decisions about investments and the statement should be reviewed and revised at intervals � at least every 3 years and without delay after any significant change in investment policy. Investment regs state that before a statement is prepared, trustees must obtain and consider the actuary�s advice and consult the scheme�s sponsoring employer. To comply with their duty to consult, trustees should allow the employer sufficient time to make representations and should ensure that they consider suggestions with an open mind. The consultation process does not require the consent of the employer (indeed this is prohibited). Clearly this is an area where the employer will want to influence the exercise of the trustees discretion on not only setting the ongoing investment strategy for the scheme but also the investment strategy for the pension scheme following a transaction. If there is a stronger employer covenant following a transaction then the employer will want to influence the trustees to adopt a riskier investment strategy. Bullet point 2: Set out the overriding statutory funding requirement which is set out in the PA2004. A scheme must have �sufficient and appropriate assets to cover its technical provisions�. Trustees are required to prepare, and from time to time review and if necessary revise a statement of funding principles. The statement must record any decisions by the trustees about the actuarial methods and assumptions to be used for calculating the scheme�s technical provisions and the manner in which, and the period within which any failure to meet the SFO is to be made good. Where an actuarial valuation shows that the SFO is not met on the effective date, i.e a shortfall, the trustees are required to prepare a recovery plan, or if there is already a recovery plan in place, to review and revise the existing plan as necessary. Trustees must also prepare, and from time to time review and if necessary revise, a schedule of contributions. This must be done within 15 months of the effective date of each actuarial valuation. The schedule must be signed by the trustees and make provision for signature by the employer in order to signify his agreement to the matters included in it. TPR can get involved where the trustees and the employer cannot reach agreement on the schedule of contributions.Clearly this is a very important area where the employer will want to be fully involved with the funding decisions of the pension scheme.Marcus leading on this slide Bullet point 1: One particular example of a trustee power which can significantly affect the interests of the employer is the trustees� power of investment. In a balance of cost scheme, any failure but the trustees to obtain reasonable returns on investment of the pension fund will result in the employer having to make greater contributions to the scheme to fund the promised benefit. Section 35 PA 1995 requires the trustees to secure that a written statement of investment principles is prepared and maintained governing the decisions about investments and the statement should be reviewed and revised at intervals � at least every 3 years and without delay after any significant change in investment policy. Investment regs state that before a statement is prepared, trustees must obtain and consider the actuary�s advice and consult the scheme�s sponsoring employer. To comply with their duty to consult, trustees should allow the employer sufficient time to make representations and should ensure that they consider suggestions with an open mind. The consultation process does not require the consent of the employer (indeed this is prohibited). Clearly this is an area where the employer will want to influence the exercise of the trustees discretion on not only setting the ongoing investment strategy for the scheme but also the investment strategy for the pension scheme following a transaction. If there is a stronger employer covenant following a transaction then the employer will want to influence the trustees to adopt a riskier investment strategy. Bullet point 2: Set out the overriding statutory funding requirement which is set out in the PA2004. A scheme must have �sufficient and appropriate assets to cover its technical provisions�. Trustees are required to prepare, and from time to time review and if necessary revise a statement of funding principles. The statement must record any decisions by the trustees about the actuarial methods and assumptions to be used for calculating the scheme�s technical provisions and the manner in which, and the period within which any failure to meet the SFO is to be made good. Where an actuarial valuation shows that the SFO is not met on the effective date, i.e a shortfall, the trustees are required to prepare a recovery plan, or if there is already a recovery plan in place, to review and revise the existing plan as necessary. Trustees must also prepare, and from time to time review and if necessary revise, a schedule of contributions. This must be done within 15 months of the effective date of each actuarial valuation. The schedule must be signed by the trustees and make provision for signature by the employer in order to signify his agreement to the matters included in it. TPR can get involved where the trustees and the employer cannot reach agreement on the schedule of contributions.Clearly this is a very important area where the employer will want to be fully involved with the funding decisions of the pension scheme.

34. Influencing the exercise of discretion by another: EBT trustees  the trustees must make their own decisions; tax/residency implications for trustees if they are told what to do by the company; but the company can issue a letter of wishes. Paul leading on this slide � see script Paul leading on this slide � see script

35. Conclusion express discretion may be seen less often; but �quasi discretion� by employers is on the rise.

36. The soul of discretion Caroline Carter, Paul Randall and Marcus Fink