Any reported case of His Honour Judge Hess addressing pensions and their pitfalls is required reading for matrimonial finance lawyers and T v T (variation of a pension sharing order and underfunded schemes) [2021] EWFC B67 (10 November 2021), although of narrower application than W v H (divorce financial remedies) [2020] EWFC B10), is no exception.
The decision itself, dismissing a Husband’s application under section 31(4A)(b), will be of limited use (few, if any practitioners, will encounter such an application and likely even fewer now) but the six figure costs order against Husband and the coruscating criticisms are chastening. Husband’s case was based on a fundamental misunderstanding about the pension’s value and the obvious solution to the parties’ problem (an internal transfer) had been lost on both parties. Of greatest interest and assistance, is the summary of procedures involved in the making and implementing of pension sharing orders and its analysis of “moving target syndrome”.
When the parties came before HHJ Hess in November 2021, the parties were both 53 and their children grown. They had separated in 2013 and divorce proceedings had commenced that same year. Wife (“W”) issued by way of Form A in 2014 and the matter had been determined by DJ Thomas at Final Hearing as long ago as 2015. As part of that order, the District Judge had awarded the Wife a Pension Sharing Order of 40% in respect of the Husband’s defined benefit pension with Company X. Overall, Wife had been awarded the principal capital asset in the form of the FMH and, taking all the assets together (including the pension Cash Equivalents (“ CEs”)), slightly more than 50% of the total assets. The FMH and pension had been broadly offset with a departure from equality, justified principally on account of Wife’s needs.. Whilst the final order had been subject to appeal in respect of the substantive periodical payments order to Wife, there had been no appeal against the pension/capital aspect of the decision and no suggestion that it was wrong.
Soon after judgment, however, there began an unfortunate series of events in respect of the Pension Share Order (“PSO”) that would lead to the hearing before HHJ Hess six years later. The order itself had been the subject of argument for many months. It was not perfected until May 2016 and only then after a contested hearing. Meanwhile, the appeal itself continued through until the end of 2016. The delay with the order and the appeal meant, rightly or wrongly, neither side applied for Decree Absolute. It followed that the PSO remained, all the while, without legal effect.
Independently of the legal proceedings, Company X produced a revised CE of some £1,795,362 in October 2016. This was considerably more than the £826,125 figure used at Court. Accordingly, the Husband began to consider that Wife would be receiving more than she should have done.
Then in December 2016, Company X, finding the scheme underfunded, announced a policy of a substantially reduced CE for external transfers (£722,138). Wife, for her part, thought that she could only receive an external transfer. This belief was based on a letter sent out by Company X but a letter written and sent at a time when the pension fund was not paying reduced CEs. And so, Wife began to think that she would be receiving less than she should.
The Husband might have taken the increase on the chin and hurried up with the Decree Absolute but he did not. For her part, the Wife had a simple remedy once the scheme became underfunded. As a matter of law, she could not have been forced to transfer her pension credit out of the fund on a reduced basis. An internal transfer would need to have been available to her for as long as there was a reduced CE for an external transfer. The Wife, however, had simply never known that she would have had that option available to her. At paragraph 44 of his judgment, HHJ Hess said:
“I now turn to the procedures involved when a pension fund against which a pension sharing order is to be made, or has been made, declares itself to be underfunded. A pension is underfunded if it has insufficient funds to meet in full its obligation to all members of the scheme. If the scheme is underfunded the pension trustees must decide if they wish to pay out only reduced CEs on external transfers from the fund – they may accordingly announce a reduction proportionate to the level of underfunding in the scheme. The trustees of the scheme are not obliged to reduce CEs where the scheme is underfunded – they will wish to consider issues such as the level of underfunding, the strength of employer’s covenants and any recovery plans that may be in place to decide if such a step is necessary. If they are offering only reduced CEs on external transfers, however, this will have implications for what they must offer a non-member spouse in relation to the implementation of a pension sharing order. In contrast to most other situations, the pension provider cannot insist on an external transfer if the pension credit offered is based on a reduced CE. The pension provider must first offer the non-member spouse an internal transfer using the full value of the member spouse’s CE (i.e. without applying any reduction of the member spouse’s CE attributable to the underfunding). In many cases this will be the solution preferred by the non-member spouse; but if, having received this offer, the non-member spouse would prefer an external transfer then, provided a full explanation is given by the pension provider as to the reasons for the underfunding and of the likely timescale for the elimination of the underfunding, the pension provider may offer an external transfer on the basis that the member spouse’s CE used in the calculation will be reduced proportionately with the extent of the underfunding. In such circumstances the percentage pension share will be implemented against a reduced CE.”
The Wife had continued to think that an external transfer was her only option. Her misunderstanding was then compounded by her application for “a declaration of the Court that the 40% share …also applies to the uplift of the value [of the fund]”. That application was misconceived from the outset. The Court could never have made such a declaration. The Husband, however, did not resist the application as misconceived and point out the availability of an internal transfer. The Husband, instead, issued an application under section 31 (4A) (b) for a variation of a pension sharing order. There had still been no Decree Absolute so such application was, on the face of it, still open to Husband.[1]
[1] Decree Absolute (“DA”) was eventually pronounced in December 2017. It is axiomatic that H did not die between DA and the hearing before HHJ Hess but, as the learned Judge recognised, the Wife would have lost out considerably had he done so.
Company X then actually reversed their policy in reducing CEs for external transfers in April 2018. Perhaps remarkably, matters did not end there. To the contrary, Husband pursued his application. He argued at Final Hearing that the PSO should be varied downwards and Wife be awarded 17% on the basis that this was the sum that Wife could have expected back in 2015 (adjusted for inflation). Husband’s case statement in May 2021 read:
“DJ Thomas clearly offset the pension. He analysed outcome in terms of capital value of the pension. His intention was to achieve a result which gave W £330,450 in capital terms. That outcome can be achieved by varying the PSO to provide for such percentage as equates to £330,450 plus, it is accepted, an uplift for inflation. It is a matter for the court’s discretion as to which of the various indices is used to calibrate the uplift.”
Undoubtedly, the CE had increased. In August 2021, the CE stood at some £2.5 million. Importantly, the increase was almost entirely the result of changes in actuarial assumptions over time.
Paragraph 41 of the judgment reads,
“This case involves an extreme example of what is often called ‘moving target syndrome’. To understand what that is, it is necessary to know that in H v H [2010] 2 FLR 173 Baron J said:-
“although the court may calculate the percentage by taking the precise capital sum that seems appropriate and undertaking a calculation to determine the relevant percentage, the result contained in the order must be specified only in percentage terms and not ‘such sum as will give such percentage’. The latter seems to me to be a method of calculation as opposed to an order”.
This dicta is binding and any pension sharing annex should go no further than stating the percentage of the member spouse’s pension rights which are to be transferred to the non-member spouse as a pension credit. It should not include any formula for the production of a certain level of income or for a particular monetary sum to be transferred”.
HHJ Hess continued to set out the implementation sequence (the judgment itself contains a very useful diagram). That is, the sequence of dates from valuation date (the date the pension was valued for the original court final hearing) to transfer day (the day the order takes effect) to the start of the implementation period of four months to the valuation day (within the implementation period).
Paragraph 43 reads,
“It is a consequence of the above that the value of the pension credit actually transferred as a result of a pension sharing order will usually not be the precise amount contemplated by the judge deciding the level of the percentage to be included in the pension sharing order and annex. Hence the expression ‘moving target syndrome’, which is described in Hay, Hess, Lockett and Taylor on Pensions on Divorce: A Practitioner’s Handbook (3rd edition at p.124) as follows:-
’Once a pension sharing order is made, its implementation will in due course take place by reference to the percentage identified in the order. The percentage will not, however, be applied against the CE valuation figure which the court will have had before it on the day the order was made. Instead it will be applied to a fresh CE valuation figure of the shareable rights. This fresh valuation will be made by the pension provider as at ‘the valuation day’. The valuation day will ordinarily be some months after the court hearing and will be a date selected by the pension provider within a four month implementation period. This leads to the difficulty which has been identified as “Moving Target Syndrome”. The valuation of the pension against which the pension sharing order is to be enforced may be quite different at the time of implementation from the valuation identified by the parties and the judge at trial. Commensurately, the level of the pension credit may also be quite different. Often this will not matter very much as the use of a percentage figure in the order will ensure that both parties will share proportionately in any increase or decrease in the value. Especially if the percentage of the pension sharing order to be executed is not very far away from 50% and the movements in value are relatively modest market fluctuations then little injustice will be done by the moving target, a fact observed by Baron J in H v H (Financial Relief: Pensions) [2010] 2 FLR 173 on the facts of that case. There may, however, be cases where significant injustice might be done by a moving target. It may be that some event, such as a significant drawdown from the fund, or a pay rise or fall for a member spouse holding a defined benefit scheme, between the date of the valuation and the date of the court hearing, which undermines the reliability of the CE used at court. The problem is the same for events which occur between the date of a hearing and the date an order is approved if, for example, the judge reserves judgment for a lengthy period. The same applies in the period between the order being made and its taking effect. In some cases changes occurring between the date of the order taking effect and its implementation can also cause a similar difficulty; but it should be remembered that the rights which are valued are those which the member spouse has at the date the order ‘takes effect’, also known as “transfer day”, so changes occurring at this point are less likely to make a significant difference. There are cases, however, where there might be significant differences. For example, there might be a significant change in market conditions or valuation methodology in the course of the process of making and implementing a pension sharing order’”.
As to the application? A pension sharing order can be varied. This is in limited circumstances but is clearly provided for by section 31 (2) (g). The application must have been made before the pension sharing order took effect and before Decree Absolute. That an application can only be made within such a narrow window naturally limits the circumstances that could give rise to an application (consider that the usual period between final order and the PSO being no more than 28 days). Indeed, the circumstances are so circumscribed that the authors of Duckworth consider the mischief of section 31 (2) (g) to have concerned matters arising in drafting and which could just as equally be dealt with under the slip rule (i.e. the section is otiose). There are (or rather, were) no reported cases. Most tellingly, HHJ Hess states, “I cannot personally recall coming across one before.” They are, says the Judge’s own text book, “very rare beasts”.
Nevertheless, faced with precisely such an application, HHJ Hess considered the relevant legal principles to be the same as variation applications in respect of capital (i.e. per Bodey J in Westbury v Sampson [2002] 1 FLR 166 and Birch v Birch [2017] UKSC 53). That is, variation of overall quantum is a power to be used sparingly in a few cases given the importance of finality. HHJ Hess noted the approach of Mostyn J in BT v CU [2021] EWFC 87 (where the single route to changing overall quantum was by way of satisfying all Barder conditions) but preferred that of Bodey J. Applied to the present case, the Husband could only succeed if the “anticipated circumstances have changed very significantly, and/or for cogent reasons rendering it quite unjust or impracticable to hold the payer to the overall quantum of the order originally made.”
A change of CE alone could not possibly justify such a variation, gets “nowhere near” and would fail a much lower test. Nothing remarkable had happened to the parties’ financial resources, needs or obligations. The application failed for three main reasons. In the first (para 61),
H appeared to have a fundamental misunderstanding of what the CE of a defined benefit pension fund represents: “The CE of a defined benefit pension fund is an actuarially calculated figure which seeks to establish what sum of money would be needed to invest to produce the income benefits which the fund is obliged to meet for a set period, i.e. the remainder of the recipient’s actuarially predicted life span. As market conditions change and gilt yields change (as they appear to have done between 2015 and 2021 on the evidence I have from LCP) more money will need to be invested to produce the same income benefits. The income benefits rise with inflation, but the money needed to produce that income stream for a prolonged period may rise by substantially more than inflation, as it has done in this instance. By suggesting that the wife should have her entitlements fixed now at the cash sum contemplated in 2015, even if the cash sum is given some inflationary growth, the husband is to my mind ignoring the fact that that cash sum will, as a result of the very changes in market conditions and gilt yields which have driven the increased CE, purchase commensurately lower income benefits than they would have done had the pension credit been transferred in 2016. To my mind a variation of the nature sought by the husband on the argued basis from 40% to 17% would be very unfair to the wife for similar reasons as those firmly, and in my view correctly, set out by Baron J in H v H [2010] 2 FLR 173”.
Secondly, if a higher CE is a windfall as Husband perceived it to be (and such premise is “illusory if one views a pension as an income producing asset”) then the Husband had ignored the fact that he was also benefitting from the windfall and indeed keeping even more (60%) of that windfall. Indeed, the District Judge had included CEs in the asset schedule and Husband’s overall asset figure had increased more than Wife’s.
Thirdly, the Husband was “substantially the author of his own misfortune”. Husband had not applied for Decree Absolute despite being petitioner and then blocked Wife’s own attempt and then made an application triggering the effect of section 31 (4A) (b). It was largely Husband’s own actions that he had prevented the pension sharing order from taking effect for more than six years. “By doing this he has left open the possibility of moving target syndrome more than in most cases and if he feels he has lost out by it then he is very substantially the author of his own misfortune”.
The Husband was penalised heavily. The application of the revised paragraph 4.4 of FPR PD28A is worth noting. It had been common ground that FPR 2010 Rule 28.3(5) to (8) applied and the Judge duly directed himself to both paragraph 4.4 and the judgment of Mostyn J in OG v AG [2020] EWFC 52, quoting:
“The revised para 4.4 of FPR PD28A is extremely important. It requires the parties to negotiate openly in a reasonable way… and so, the wife will herself suffer a penalty in costs for adopting such an unreasonable approach…It is important that I enunciate this principle loud and clear: if, once the financial landscape is clear, you do not openly negotiate reasonably, then you will likely suffer a penalty in costs. This applies whether the case is big or small, or whether it is being decided by reference to needs or sharing.”
Bearing this in mind, HHJ Hess concluded:
“In my view this is a clear case where the husband has taken an unreasonable view of the case from the outset and has pursued it to the bitter end. I have rejected his case and he has entirely lost. In my view he has failed to negotiate openly in a reasonable way and, by pursuing the variation application he has placed himself firmly in at least one of the categories identified in FPR 2010 Rule 28.3(7) (whether it was reasonable for a party to raise, pursue or contest a particular allegation or issue)”.
The Husband was ordered to pay costs of £100,000, summarily assessed. The Wife’s costs had been some £130,000 and the sum ordered against Husband would have been greater but for Wife’s misconceived application The level of costs incurred were described as a tragedy for the family and a shaming indictment of the legal system. With its judicial astonishment at the profession’s ability to get pensions wrong, T v T duly takes its place in a fine tradition that extends at least back to Martin-Dye v Martin Dye (and long before the PAG report).
There is a postscript to the judgment worth noting. The PAG report (albeit discretely at paragraphs 41 – 44 of Appendix V) had warned of the potential for error arising out of the discretionary paragraph F of the pension sharing annex. At paragraph F, the lawyer or non-member spouse is required to tick the box to inform the scheme whether the non-member spouse receive an external or internal transfer upon the making of the PSO where both options are available. The PAG report recommended the removal of section noting: “Given the complexity of this issue, the availability of internal transfer options generally and the pension scheme’s legal obligation to offer an internal transfer if a scheme reduction factor is imposed, which could be after the annex has been sent to the court for approval, then the non-member spouse couldn’t possibly be in an informed position to make this decision, nor could their lawyers without breaking the law.” In the present case, W’s lawyers had ticked the external transfer box when they had not needed to. Whilst the pension administrators had seemed to require W to tick the external transfer box, she had not needed to because, at the time, there had been no choice to make. Subsequently, the administrators had offered reduced CEs but it is a matter of conjecture as to whether the pension administrators would have actually offered an internal transfer. HHJ Hess considered a sobering counterfactual for advisors: if the PSO had been implemented in 2017 but the Wife had not been offered an internal transfer by the pension then she might well have suffered a substantial loss simply because her lawyers had ticked the external transfer box. For now, Section F remains. HHJ Hess concludes that the recommendations for its removal are “given extra force by the facts of the present case.” It is repeated: “Family Lawyers would be well advised in the meantime not to tick either boxes in section F ”.
