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10 March 2010
Legal methods of closing down company benefit systems
Restrictions on closing down company pensions
For employers that have founded an employee pension scheme, circumstances may arise in which it is desirable to dissolve this system. The question may thus arise whether and to what extent this might be possible. Against the background of the global financial crisis, companies face ever-growing pressure to reduce their cost burden. In particular, obligatory contributions to the Pensions Security Association (which pays pensions to former employees of insolvent employers) are likely to more than double due to the recent insolvency of some large entities in Germany. The only way to reduce this cost burden is to close down the company pension scheme. This update reviews the legal possibilities and limitations of taking such a step.
Legal methods of closing down company benefit schemes
The requirements for a legally effective closure of the pension scheme depend on the legal basis of the respective pension commitment.
Where the pension commitment is based on individual contractual consent, mutual consent is required whereby the employee and employer must conclude an agreement to cancel the pension scheme. However, with respect to legally vested benefits pursuant to Section 2(1) of the Act on the Enhancement of Occupational Old-Age Pensions, in case of termination of the employment relationship, the restrictions of Section 3 of the act must be observed.
Where a works agreement is the legal basis of the pension commitment, it is possible for the employer to close the scheme under the general provisions of the Works Council Constitution Act. No reason for dismissal is required. Following the expiry of the general legal three-month notice period, the works agreement has no after-effects. A collective bargaining agreement that grants pension benefit entitlements will be terminated on the date agreed in the agreement. Where no such date has been agreed upon, the agreement may be terminated or a new collective bargaining agreement reached.
Restrictions on closing down company pension systems
The Federal Labour Court has developed a complex grading system – the so-called 'three grades' model – to differentiate between the legal methods of closing down company pension schemes and the potential legal scope of such a closure. The model aims to build worker confidence by affording more stringent protection with regard to the closure or limitation of the right to future pension benefits to those employees who need it most.
Accumulated entitlements (first grade)
The amount the employee has accumulated due to past loyalty enjoys the highest level of protection. This amount is equal to the amount that, under law, would be non-lapsable according to Section 2(1) of the Act on the Enhancement of Occupational Old-Age Pensions in case of the employee's termination of employment prior to the insured event (eg, the employee reaching the stipulated retirement age or the employee becoming permanently unable to work).
The level of protection afforded to this grade is due to the fact that the amount draws on the services hitherto rendered and on past loyalty. Thus, legal practice allows encroachment on this share of entitlement only where there are compelling reasons to do so. Such reasons include an oversupply contrary to plan or a non-foreseeable and extraordinary additional burden. Thus, in most cases vested benefits are protected and cannot be reduced.
Growth rates (second and third grades)
The second and third grades refer to the question of whether entitlements based on improved performance can be terminated. The jurisdiction differs between growth rates due to salary increase or period of service.
Growth rates depending on salaries (second grade)
Entitlement shares due to income-dependent growth rates enjoy relative stringent protection. Thus, where an insured event occurs, the entitlement is dynamic and changes in accordance with salary development. The second grade refers to the employee's confidence that the calculation basis will cover future salary developments up to the insured event.
According to jurisdiction, an encroachment on these entitlement shares is possible only for a valid reason. This would apply where the unchanged continuance of the pension plan would result in an impairment of the company's substance in the long term.
Growth rates depending on years of service (third grade)
Pension growth rates depending on years of service enjoy only marginal protection, since for years of service which are yet to be fulfilled, the employee is yet to demonstrate his or her loyalty. According to legislation, encroachment on such growth rates is allowed where an objective and proportionate reason exists. Thus, an employer may freeze growth rates if it can prove a reason free of any arbitrariness that easily can be reconstructed. A company's difficult economic situation would be acknowledged as such a reason.
The employer is entitled to close down a pension scheme system due to the general provisions of the kind of legal transaction it has chosen. Once a pension scheme structure has effectively been closed down, employees who joined subsequently are entitled to no claims or pension benefits. Existing entitlements, however, enjoy a protection of confidence. The more worthy of protection the entitlement, the more stringent the requirements to justify an encroachment.
For further information on this topic please contact Marion Bernhardt, Bjoern Gaul, Reiner Kurschat or Bernd Roock at CMS Hasche Sigle by telephone (+49 221 77 16 128), fax (49 221 77 16 252) or email (email@example.com, firstname.lastname@example.org, email@example.com, or firstname.lastname@example.org).
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