England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		18th October 2004

Mr. Justice Lewison:

Introduction

1. Mr Roderick Armitage was born on 14 September 1943. On 1 December 1979 he joined Staveley Industries plc (“Staveley”), and rose to become Legal Director and Company Secretary. He left Staveley's employment on 1 May 1999, by which time he had attained the age of 55 years and 7 months. Mr Armitage had the good fortune to be a member of a final salary pension scheme which, nowadays, is a disappearing benefit of employment. However, he and Staveley disagree about how much pension he is entitled to.

The pension scheme

2. In March 1977 Staveley established the Staveley Industries Senior Officials Supplementary Benefits Scheme which subsequently became known as the Staveley Executive Pension Scheme (“SEPS”). I will call it SEPS throughout, although some of the key events took place before the change of name. The 1977 Scheme was amended in about 1996 with effect from 1 April 1995 by the adoption of new rules (“the SEPS rules”). On 7 September 1998 the trustees of SEPS transferred the assets of SEPS to the trustees of another of Staveley's pension schemes called the Staveley Industries Retirement Benefits Scheme (“SIRBS”). The trustees of SIRBS agreed to provide benefits to any remaining active members of SEPS on the terms of the SEPS rules. In fact Mr Armitage was the only remaining active member of SEPS.
3. SEPS was intended to be (and was) approved under Chapter I of Part XIV of the Income and Corporation Taxes Act 1970 as an exempt approved scheme. That meant that contributions to the scheme were deductible from income or corporation tax and that the assets held by the trustees of the scheme were also exempt from tax. However, in order to preserve SEPS' status as an exempt approved scheme, it had to comply with Inland Revenue limits on the extent of benefits that could be provided to pensioners. SEPS' status as an exempt approved scheme is an important part of the background against which the various documents must be interpreted. We will see in due course how the fiscal background impacted on the terms of the scheme.
4. SEPS defines a number of different categories of member. Mr Armitage was designated a “Category A” member.
5. Rule 4 (a) of the SEPS rules provides for the pension payable to members on retirement at Normal Retirement Age. Subject to deductions (which do not apply in Mr Armitage's case) the pension at Normal Retirement Age is two thirds of Final Pensionable Salary. Final Pensionable Salary is defined (in Mr Armitage's case) as the highest rate of a member's basic salary (including directors' fees) together with the highest average annual bonus received in a certain number of years, but excluding other emoluments. Rule 4 (c) provides for payment of pension to members who retire during the five years preceding Normal Retirement Age at Staveley's request, or with its consent. In such a case a member is entitled to an immediate pension at the full rate of two thirds of Final Pensionable Salary; but actuarially reduced to take account of early payment. “Normal Retirement Age” is defined by rule 1(q) as:

“a member's 60^th birthday or in the case of any member such earlier date approved by the Inland Revenue and notified to the member by the Employer following a change in the terms of employment of that member.”

6. Rule 11 provided for the annual increase of pensions on each Pensions Increase Date. The Pensions Increase Date is 1 January in each year. In the case of a pension payable to a member, the increase was to be:

“the Increase Percentage of the total of such pension and the pension (if any) payable to such member under any other retirement benefits scheme of the Group … immediately prior to such Pensions Increase Date.”

7. In the case of a Category A member the Increase Percentage was defined as 5 per cent. Accordingly, under the SEPS rules (leaving aside Inland Revenue limits) Mr Armitage was entitled, on early retirement, to a pension of two thirds of Final Pensionable Salary, actuarially reduced to take account of early payment, and increasing at the annual rate of 5 per cent compound.
8. Rule 20 said that the Scheme was designed for approval as an exempt scheme under the tax legislation. It went on to say:

“The Appendix to these Rules forms part of these Rules. It restricts the benefits that can be provided under the Scheme and the contributions that members can pay to the Scheme. The Inland Revenue require benefits and contributions to be limited to the amounts described in the Appendix as a condition of approving the Scheme.”

9. Paragraph 1 of the Appendix limited the initial pension to 1/60^th of Final Remuneration for each year of Pensionable Service, with a maximum of 40. Final Remuneration is the subject of an elaborate definition which includes (amongst other things) benefits in kind that were assessable to income tax. Thus the definition of Final Remuneration in the Appendix differed from the definition of Final Pensionable Salary in the rules. Paragraph 3 of the Appendix limited increases in pensions to 3 per cent for each complete year or if greater, in proportion to any increase in the Index since the pension commenced. The Index was the retail prices index (“RPI”). The limitation on annual increases was a cap. It did not provide an entitlement. The entitlement was 5 per cent under the SEPS rules. Thus if, for example, RPI in a particular year was 7 per cent, Mr Armitage would be entitled to a 5 per cent, not a 7 per cent, increase in his pension.
10. I must note two further points at this stage. First, Normal Retirement Age for the purposes of the Appendix was the age of 60; and this could not be changed without Inland Revenue approval. Second, a note to the Appendix said that in any case where the Inland Revenue (either generally or in a particular case) permit payment of a higher sum than that described in the Appendix, SEPS could pay the higher sum. In Mr Armitage's case (because he had joined the pension scheme before March 1987; and would have completed more than ten years of service to Normal Retirement Date at age 60) his maximum permitted pension at age 60 under Inland Revenue rules would have been two thirds of Final Remuneration, rather than 1/60^th for each year of Pensionable Service.

The letters

11. On about 16 July 1992 Mr Armitage received two letters: one from Staveley and one from the management committee of SEPS. The letter from Staveley read, so far as material, as follows:

“I am writing to confirm that the Board has reduced your retirement age for the purpose of your service contract to your 58^th birthday.

Your pension entitlement will be calculated as though the term Normal Retirement Age used in the rules of [SEPS] is this age. If it is not possible to pay the whole of the pension out of the Scheme because of Inland Revenue limits, then the balance will be paid by Staveley Industries.”

12. The letter from the Management Committee read so far as material as follows:

“I refer to the Company's letter to you of 16 July 1992 informing you that for pension purposes your Normal Retirement Age will be your 58^th birthday. I am pleased to be able to tell you that the Management Committee of [SEPS] has agreed that your benefits under the Scheme should be augmented as far as is reasonably practicable to this end under clause 18 of the Scheme's governing documents, within Inland Revenue limits. The exact level of pension that the Scheme can provide will depend on your earnings and inflation in the period up to your retirement; but the likelihood is that an element of the overall pension promise will have to be met from the Company.”

The rival contentions

13. Mr Armitage says that the letter from Staveley had contractual effect. He says that the effect of the contract is that, as against Staveley, he is entitled to a pension calculated under the SEPS rules, as if “Normal Retirement Age” had been defined as his 58^th birthday. At this stage in the calculation, any limits imposed by the Inland Revenue (either on the amount of the initial pension or the rate of annual increase) must be ignored. The calculation must be repeated annually. If that calculation results in an entitlement which exceeds the amount allowed by the Inland Revenue, then although the trustees of SEPS cannot pay more than allowed by the Inland Revenue, Staveley must pay a top up pension equal to the excess. The consequence of this is, according to Mr Armitage, that he is entitled to an annual compound increase of 5 per cent on the whole of his pension, payable partly under SEPS and partly by Staveley.
14. Staveley agrees that the letter had contractual effect. But it says that the letter only dealt with the effect of reducing Mr Armitage's Normal Retirement Age under the SEPS rules. It says that the problem which arose as a result of reducing Mr Armitage's Normal Retirement Age was that his initial pension entitlement would potentially be greater than that permitted by the Inland Revenue limits. It was that excess that Staveley agreed to top up. If Mr Armitage's Normal Retirement Age had not been reduced, he would not have been entitled to a guaranteed annual increase of 5 per cent; he would have been limited to the increase allowed by the Inland Revenue. Consequently, there is no reason to read the letter as committing Staveley to an annual increase of 5 per cent, if an increase of that amount exceeded applicable Inland Revenue limits. However, Staveley does not say that the top up pension is payable at a fixed rate. It accepts that the top up pension is to be increased annually; but at the level of increase permitted by the Inland Revenue.

Approach to interpretation

15. Both Mr Topham, who appeared for Mr Armitage, and Mr Hitchcock, who appeared for Staveley, agreed on the principles of interpretation that I should apply. They are to be found in a number of well-known cases, including Mettoy Pension Trustees Ltd v. Evans [1990] 1 WLR 1587, Investors Compensation Scheme v. West Bromwich BS [1998] 1 WLR 896 and National Grid plc v. Mayes [2001] 1 WLR 864, to all of which I was referred. In brief:

i) The words of the letters must be interpreted in the light of the background;

ii) The background includes the rules of SEPS and the fiscal limitations on pensions that can be paid without jeopardising the status of SEPS as an exempt approved scheme;

iii) The interpretation must be one that is practical and purposive, rather than detached and literal;

iv) If more than one interpretation is possible, the correct choice may depend on the practical consequences of choosing one interpretation rather than another;

v) If one would conclude from the background that something must have gone wrong with the language, the law does not require judges to attribute to the parties an intention that they plainly could not have had;

vi) If detailed semantic and syntactical analysis of words in a contract leads to a conclusion that flouts business commonsense, it must be made to yield to business commonsense;

vii) The ultimate question is what meaning would be conveyed to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the date of the contract.

16. It is clear, of course, that the court must not construct, from the background alone, a contract that the parties never made. The court's conclusion must reflect the language of the document it is interpreting. As Mummery LJ put it in Commerzbank AG v. Price-Jones [2003] EWCA Civ 1663:

“The aim of construction is to determine from the documents, read, of course, in their factual setting, what the parties agreed. It is not the function of the court to substitute for the agreement of the parties what it thinks would have been the sensible commercial agreement for the parties to have made.”

17. He added:

“I agree with Mr Hollander that the Deputy Judge paid insufficient attention to the actual language of the documents. He placed far too much reliance on what, in the surrounding circumstances, would have been the sensible commercial agreement between the parties. In the result he constructed from the context alone a contract that the parties in their respective situations might have made. In doing so he has not construed the language of the two letters in which the terms of the contract were in fact formally expressed. Of course, the context of a contract matters as an aid to construction, but it should not be used to construct a contract which does not properly reflect the language employed in formal contractual documents.”

18. Sometimes the court has to resort to the implication of a term in order to ascertain the true meaning of the contract, taken as a whole. But there are strict fetters on the court's ability to imply terms. Broadly, the court may not imply a term unless either it is necessary to give business efficacy to the contract, or the term is so obvious that it goes without saying. In Philips Electronique Grand Public SA v. British Sky Broadcasting Ltd [1995] 1 EMLR 472 Bingham MR warned:

“The question of whether a term should be implied, and if so what, almost inevitably arises after a crisis has been reached in the performance of the contract. So the court comes to the task of implication with the benefit of hindsight, and it is tempting for the court then to fashion a term which will reflect the merits of the situation as they then appear. Tempting, but wrong.”

19. Thus whether a term is to be implied must be judged as at the date of the contract.

Background

20. There are relatively few additional pieces of background. In July 1992 Mr Armitage was nearly 49 years old. He had been employed by Staveley for over 12 years. If he continued in employment until the age of 60 he would have been employed for about 23 years; and if he remained in employment until the age of 58 he would have been employed for about 21 years. He might or might not have been expected to take early retirement, but it would have been on the cards.
21. Under the rules of the scheme (taking into account the reduction in normal retirement age but disregarding Inland Revenue limits) it could have been expected that his pension on retirement at the age of 58 would have been 2/3rds Final Pensionable Salary. But the reduction in the normal retirement age under the scheme did not affect the Inland Revenue limits, which worked on the basis of a normal retirement age of 60. But for a person in Mr Armitage's position, the maximum pension permitted by the Inland Revenue at age 60 was 2/3rds of Final Remuneration. I emphasise that Final Pensionable Salary and Final Remuneration are not the same: the latter is greater than the former. Thus the applicable Inland Revenue limit at retirement at age 58, which was the maximum that SEPS could pay, would have been:

N/NS x 2/3 x FR where:

i) N is the number of years actual service

ii) NS is the number of years potential service to age 60 and

iii) FR is Final Remuneration (according to the Inland Revenue definition).

For those who, like Mr Armitage, enjoyed what are known as 'Pre 17 March 1987 Continued Rights', the Inland Revenue permits an alternative method of calculating the limit, if higher than the limit on the N/NS formula.

22. If Mr Armitage were to retire early, his scheme entitlement would be N/NS x 2/3 x FPS x AR where:

i) N is the number of years actual service

ii) NS is the number of years potential service to age 58

iii) FPS is Final Pensionable Salary (according to the definition in the SEPS rules) and

iv) AR is an actuarial reduction for early payment (and hence is less than 1).

23. The formula for calculating the maximum Inland Revenue limit would remain the same (although the value of N would change because of the reduced number of actual years' service). Accordingly, in the case of early retirement, although Mr Armitage's pension would be actuarially reduced, his maximum entitlement under the Inland Revenue cap would not. Moreover the remuneration to be taken into account is not the same in each calculation. On the other hand, the denominator in the fraction N/NS would be greater by 2 in the Inland Revenue limits than in Mr Armitage's scheme entitlement.
24. Thus, as the company's letter recognised, it was not inevitable that Mr Armitage's scheme entitlement to pension would exceed Inland Revenue limits.
25. In 1992 inflation was still a major worry. Although the double-digit inflation rates of the 1970s had gone, annual inflation in the three years preceding 1992 had exceeded 5 per cent. 1992 saw the summer of high interest rates as a means of combating inflation. This was driven partly by the United Kingdom's membership of the ERM and the high interest rates set in Europe in order to combat the inflationary pressures caused by the reunification of Germany. Shortly after the letters were written, in September 1992, the United Kingdom made a sudden exit from the ERM. That in itself is not, of course, relevant, but it helps to remember the mindset at the time. Reasonable people in the summer of 1992 might have thought that inflation would stay at the levels of the preceding years; might surpass those levels, or might diminish.

The possible interpretations

26. It is common ground that under the terms of the company's letter, it was obliged to pay an initial top up pension to Mr Armitage equal to the difference between:

i) his entitlement to an initial pension under SEPS (disregarding rule 20 and the Inland Revenue limits on the initial pension) and

ii) the amount which SEPS could pay by way of initial pension in accordance with the Inland Revenue limits.

27. The disagreement related to what, if any, annual increase Mr Armitage was entitled to. Under SEPS, the position is clear. Mr Armitage was entitled to an annual increase capped at the greater of 3 per cent or RPI since inception. Mr Hitchcock submitted that under the terms of the letter there were four possible interpretations:

i) the top up pension was payable at a fixed rate;

ii) the top up pension would be increased in line with permitted Inland Revenue limits; that is at the rate of 3 per cent per annum or RPI since inception if greater;

iii) the top up pension would be increased at the rate of 5 per cent per annum, which, ignoring Inland Revenue limits, was the entitlement under SEPS;

iv) the top up pension would be increased not only by 5 per cent per annum of the top up pension itself, but also by the difference between an annual 5 per cent increase on that part of the aggregate pension payable out of SEPS and the annual increase allowed by the Inland Revenue.

Discussion

28. The justification for the first interpretation hinged on the use of the phrase “your pension entitlement” in the letter. The letter did not refer to annual increases at all. Since the letter was concerned only with the effect of reducing Normal Retirement Age from 60 to 58, the parties did not have annual increases in mind. If Mr Armitage's top up pension were payable at a fixed rate, its real value would, over the course of time, be eroded by inflation. Mr Hitchcock said that although this was a possible interpretation, it was a harsh one, and he did not invite me to adopt it.
29. The justification for the second interpretation was that it was Staveley's intention to stand shoulder to shoulder with SEPS; and that the top up pension would be paid pari passu with Mr Armitage's entitlement under SEPS, as limited by the Inland Revenue's permitted increases. This was the primary interpretation for which Mr Hitchcock contended.
30. The justification for the third interpretation was that the letter dealt only with the top up pension. If Inland Revenue limits were to be ignored in the calculation of the initial top up pension, it was a possible inference that the parties intended that Inland Revenue limits should similarly be ignored in calculating the annual rate of increase of the top up pension. Mr Hitchcock was not enthusiastic about this interpretation, but it represented his fall-back position. Mr Topham was not enthusiastic about this interpretation either, but it also represented his fall-back position.
31. The fourth interpretation was that for which Mr Topham primarily contended. He said that the first sentence of the relevant paragraph of the letter required the calculation of Mr Armitage's pension entitlement under SEPS without regard to Inland Revenue limits (i.e. on the footing that rule 20 had been excluded from the rules). So far as Mr Armitage's initial pension was concerned, this was common ground. It is a necessary implication because without it the reduction in Normal Retirement Age (for the purposes of SEPS) would have had no meaningful effect. In addition, since it was not possible to change the definition of Normal Retirement Age for the purposes of the Inland Revenue limits, it would not have been possible to read the changed date into the provisions of the Appendix. Mr Topham went on to say that Mr Armitage's pension entitlement was not just his entitlement to an initial pension of two thirds final salary; it was also an entitlement to an annual increase of 5 per cent. The second sentence was unambiguous. It said that if the whole of Mr Armitage's pension entitlement could not be paid out of SEPS because of Inland Revenue limits, then Staveley would pay the difference. The “whole” of Mr Armitage's pension entitlement must include both his initial pension and also the 5 per cent compound annual increases to which he was entitled under SEPS. This was reinforced by the letter from SEPS itself, which referred to Mr Armitage's “overall pension promise”. Since payment by Staveley would not be payments out of an exempt approved scheme, the limitations on payments imposed by the Inland Revenue were irrelevant. Moreover, there was nothing in the second sentence which indicated in terms that, having excluded the effect of rule 20 for the purpose of making the calculation required by the first sentence, it should somehow be brought back in again in calculating annual increases. On the contrary, the second sentence expressly requires Staveley to make payments in excess of Inland Revenue limits. Staveley should be held to the clear words of its bargain.
32. Mr Topham also refuted any suggestion that this interpretation was uncommercial. He stressed that at the date when the letters were written, inflation had, historically, been running at more than 5 per cent per annum. If it continued to run at that level, then the increases in pension permitted by the Inland Revenue would exceed Mr Armitage's fixed entitlement to 5 per cent under the scheme. In that event, Staveley could look forward to bearing a decreasing proportion of the overall pension, since SEPS would be able to pay part of the top up pension (or increases on the top up pension) as well. It cannot have been the intention, he says, that once the initial pension and the initial top up pension had been calculated the link with SEPS should be broken. That would mean that Staveley were committed to payment of the top up pension, together with its independent annual increases, even if there were “slack” within SEPS. The overriding intention was that as much as possible of Mr Armitage's aggregate pension should be paid by SEPS. This is reinforced by the terms of SEPS' own letter which said that Mr Armitage's “overall pension promise” would be augmented “so far as practicable” under SEPS.
33. Mr Hitchcock criticised this interpretation as ignoring all the background against which the letter was written. The letter was focussing on a specific problem; namely: what would be the consequences of reducing Mr Armitage's Normal Retirement Age? It was contemplated that doing this might push his initial pension entitlement above the applicable Inland Revenue limit. But it cannot have been the intention to give Mr Armitage a benefit (namely an untrammelled 5 per cent annual increase on his initial pension) which he could never have enjoyed under SEPS. Although Staveley could lawfully have promised to pay Mr Armitage an amount which he could never have been paid under SEPS, it was a very unlikely intention; and would have represented a radical change in the whole basis of Mr Armitage's pension entitlement for no good reason. There is no reason to suppose that Staveley intended that the top up pension should behave in any different way (in terms of annual increases) from the pension payable under SEPS. It must, therefore, have been Staveley's intention that the top up pension should be subject to the same cap as the pension payable under SEPS. Moreover, the letter also contemplated that Mr Armitage might not be entitled to a top up pension at all, since the reduction in normal retirement age might not push his pension over the Inland Revenue limits. It would be absurd to attribute to the parties an intention that in that event Mr Armitage would have a guaranteed 5 per cent annual increase, even though Staveley was not liable to pay an initial top up pension. Yet that is the consequence of Mr Armitage's preferred construction.
34. Mr Hitchcock relies heavily on the background. But he also relies on the opening part of the letter, which, he says, makes it clear that the whole object of the exercise was to deal with the consequences of a reduction in Normal Retirement Age, and nothing else. He also draws attention to the parties' perception that the bulk of Mr Armitage's pension would be paid out of tax exempt assets in the hands of the trustees of SEPS, which would necessarily be subject to the Inland Revenue limits. This is contemplated by the language of the letter itself, which contemplates payments by Staveley as no more than a possibility.
35. Although Mr Hitchcock relied heavily on the background, he recognised the difficulty of teasing his preferred construction out of the words of the letter. But, he said, this was a case in which additional wording should be implied. The legal basis for the implication was that it was so obvious that it went without saying. He said that the letter should be read as if it said:

“Your pension entitlement will be calculated as though the term Normal Retirement Age used in the rules of [SEPS] is this age. If it is not possible to pay the whole of the pension out of the Scheme because of Inland Revenue limits, then the balance resulting from this reduction will be paid by Staveley Industries but in all other respects the terms of your overall pension promise will be as they would have been under the scheme rules.”

36. I do not mean to be critical of the drafting (and I certainly must not be sidetracked into construing the suggested implied term) but I do not think that this fits the bill. Any sum paid by Staveley (as opposed to SEPS) would not have been a payment out of an exempt authorised scheme. Consequently the Inland Revenue limits would not have applied to any payment made by Staveley. Thus to say that the terms of Mr Armitage's overall pension promise would be the same as it would have been under the scheme rules must, necessarily, mean the scheme rules without the cap, since the cap would not apply to a payment made by Staveley. Put another way, the scheme rules gave Mr Armitage an entitlement to a 5 per cent annual increase, capped, if applicable, by the Inland Revenue limits. But since the top up pension is not paid out of the scheme, the cap does not apply. Moreover, this implied term suggests a continuing link between the top up pension and the amount that SEPS was able to pay, which is not what Mr Hitchcock wants at all.
37. I have not found the choice between the rival interpretations an easy one. Mr Topham relies heavily on what he says is the plain meaning of the words. I have no real doubt that, with the benefit of hindsight, the interpretation for which Mr Armitage contends represents a generous benefit at Staveley's expense. A guarantee of 5 per cent annual increases, which Mr Armitage could not have enjoyed under SEPS, bears no apparent relationship to the change in his pension entitlement under consideration in the letter. On the other hand, if inflation had continued to run at the rates prevailing in the years preceding 1992, it would not, in retrospect have been so generous. Indeed there is the possibility that it would not have cost Staveley anything at all. But as Viscount Simon said in British Movietonews Ltd v. London and District Cinemas Ltd [1952] AC 166 at 185:

“The parties to an executory contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate - a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to execution, or the like. Yet this does not in itself affect the bargain they have made.”

38. It might be possible to reformulate the implied term so as result in the interpretation that Mr Hitchcock says is the right one. But the greater the difficulty in formulating the implied term, the less obvious the implication becomes. Equally the more complex the implied term becomes, the less obvious it becomes. I do not consider that this is a case in which I can properly imply a term.

Conclusion

39. I recognise the force of Mr Hitchcock's points about the background. But in the end, the primary source of the parties' legal rights and obligations is to be found in the words they used. If I accede to Mr Hitchcock's argument I would, I think, be making a contract for the parties, albeit one which, with the benefit of hindsight, would have been a more sensible one for Staveley to have made.
40. In my judgment, for the reasons given by Mr Topham, the natural reading of the letter leads to the conclusion that it means what Mr Armitage says it means. I do not think that, trying to recreate the mindset of the parties in 1992, that meaning produces a result which should lead me to conclude that something “must” have gone wrong with the language and that the natural meaning of the words attributes to the parties an intention that they “plainly” could not have had. The meaning for which Mr Hitchcock contends does, to my mind, and with the benefit of hindsight, produce a more sensible bargain, but that for which Mr Topham contends is not so extreme as to “flout business commonsense”.
41. I propose, therefore, to make the declaration sought in the claim form.