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|Judgments - Equitable Life Assurance Society v. Hyman
HOUSE OF LORDS
Lord Slynn of Hadley Lord Steyn Lord Hoffmann Lord Cooke of Thorndon Lord Hobhouse of Woodborough
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
EQUITABLE LIFE ASSURANCE SOCIETY
ON 20 JULY 2000
LORD SLYNN OF HADLEY
I have had the advantage of reading in draft the opinion of my noble and learned friends Lord Steyn and Lord Cooke of Thorndon. For the reasons they give I too would dismiss the appeal.
The need to plan for retirement is for many a high priority. One of the most attractive methods of personal saving in the United Kingdom has been life assurance policies with profits. The tax advantages associated with them have encouraged their use as a method of saving for retirement by the self-employed and those in non-pensionable employment. Provided that policyholders take their retirement benefits in the form of a taxable annuity, they are entitled to tax relief on premiums. It is, however, a fact of life that the level of such retirement benefits is dependent on variable investment returns and annuity rates. This was the contextual scene against which the Society, and other life offices, sold policies containing guaranteed minimum annuity rates. On the face of it this may have seemed to investors an attractive way of reducing uncertainties in retirement.
Against this background a dispute arose out of the decisions of the directors of the Society of calculating final bonuses so as to allocate to a with-profits policyholder, whose policy contains provision for guaranteed annuity rates ("GARs"), a different final bonus at the maturity of the policy, depending on whether the policyholder ("the GAR policyholder") elects:
The purpose and effect of this practice is to equalise, so far as possible, the total value irrespective of the election the policyholder makes. The ground upon which the society seeks to justify this differential policy is article 65 of the articles of association of the Society which provides that the directors "shall apportion the amount of [the] declared surplus by way of bonus among the holders of participating policies on such principles, and by such methods, as they may from time to time determine." By mid-December 1998 a number of GAR policyholders had complained to the Personal Investment Authority Ombudsman. At the request of the Society he relinquished jurisdiction of the complaints to the High Court. By an originating summons dated 15 January 1999 the Society sought declarations affirming the validity of the decisions of the directors to apply differential bonuses to GAR policyholders for the stated purpose. On 5-7 July 1999 the action came on for trial before Sir Richard Scott V.-C. On 9 September he gave judgment granting declarations affirming the validity of the decisions of the directors. Mr. Hyman, a representative policyholder, appealed to the Court of Appeal. On 21 January 2000 the Court of Appeal allowed the appeal by a 2:1 majority: Equitable Life Assurance Society v. Hyman  2 W.L.R. 798.
The final resolution of the dispute will affect many policyholders. As at the beginning of 1999 there were about 90,000 policyholders holding with-profits policies of the Society that contained guaranteed annuity rates. Some 27,000 GAR policies had matured since October 1993. By contrast, there were about 290,000 non-GAR policyholders. Some 20,000 of these policies had matured since October 1993. These figures demonstrate the direct importance of the case. It may, however, be that the question before the House is also of wide commercial importance.
The genesis of the dispute
The Society is the oldest mutual life assurance society in the world. Its constitution is contained in its memorandum and articles of association. The principal activity of the Society is the transaction of life assurance, annuity and pension business. The Society conducts its business on a mutual basis for the benefit of "members," who are persons who hold "participating policies," i.e. "any policy which for the time being confers a present entitlement to participate in the profits of the Society." As at March 1999 the Society had some 425,000 members. It is the surplus arising on its with-profits fund which is potentially available for distribution to its with-profits policyholders. The value of the with-profits fund as at 31 December 1998 was £21 billion.
The applicable category of policies is UK pensions business, and only policies issued before 1988 in the following four sub-categories are relevant: (i) retirement annuity policies; (ii) individual pension plan policies, (iii) group pension plan policies, and (iv) transfer plan policies. These policies contain GARs.
The business of the Society is managed by its directors. The entitlement of with-profits policyholders to participate in the profits of the Society is given effect to by the declaration and payment of bonuses. Bonuses are determined by directors in the exercise of a discretion conferred upon them by article 65 of the articles of association. It provides as follows:
While it was necessary to set out the whole of article 65 the discretion of the directors invoked by the Society to justify the differential policy adopted by the directors is set out in the italicised words of paragraph (1). The provisions of paragraph (2) are not directly relevant. Paragraph (3) deals with the amount of any bonus, and gives the directors an "absolute discretion" in that particular respect.
It is necessary to describe the current bonus system of the Society. Although article 65 only requires consideration to be given to the declaration of bonuses every three years, the practice adopted by the directors since 1986 is to declare bonuses annually. There is agreement on the following facts. Two types of bonus are involved. First, there are annual or declared bonuses (sometimes called reversionary bonuses). These bonuses have been part of the Society's bonus system for many years. They are allotted irrevocably to policies when declared, whereupon they constitute a vested legal entitlement of the policyholder. Such bonuses are reversionary in the sense that the benefit of them is enjoyed at a future date when the policy matures. Secondly, there are final bonuses. These bonuses are sometimes called terminal bonuses. They are not allotted when announced, but only vest on a policy's maturity. The directors pass resolutions setting final bonuses for each year. If a policy matures during the year (and prior to any adjustment being made), a final bonus is automatically allotted to the policy pursuant to the terms of the resolution. Prior to maturity of a with-profits policy, final bonuses are provisional only and do not represent a legal entitlement of the policyholder. Upon maturity of a with-profits policy, the final bonus at such level as is then prevailing pursuant to the director's then current final bonus resolution (if any) becomes irrevocable, and thereupon such final bonus constitutes a vested legal entitlement of the policyholder.
The Society's bonus philosophy is summarised in the statement of facts and issues. It is to deliver, as far as possible, to each with-profits policyholder his asset share. "Asset share" is an actuarial concept widely used amongst life offices. It is the share of the with-profits fund notionally attributable to a particular policy and represents the premiums (net of initial charges) paid under such policy together with the smoothed investment return generated by the Society on such premiums over the period of time for which they have been invested with the Society.
It is now necessary to describe the Society's policy documentation. For this purpose there was before the Vice-Chancellor and the Court of Appeal five relevant policies of Mr. Hyman all of which contained guaranteed annuity rates. These policies serve as the model for the purpose of considering the issues in the action. Counsel have referred their Lordships to the detailed provisions of the model policy. It guarantees no particular level of final bonuses. A description of the detailed terms of the policy is to be found in the judgment of Lord Woolf M.R. (now Lord Chief Justice), at p. 807G-810H. It is unnecessary to repeat that description. The Society also produced a great deal of ancillary information for the information and assistance of policyholders. It is unnecessary to discuss this ancillary material.
It is common ground that a fall in current annuity rates led to the decision of the directors which is under challenge. Before October 1993 the Society's current annuity rates were always above the guaranteed annuity rates. The operation of the GAR provisions produced retirement benefits of a lower value than those which could be obtained by the with-profits policyholders electing to take their benefits in fund form and using those benefits to purchase an annuity at current rates (either from the Society or from another life office). The policyholders therefore elected to take the latter option. In October 1993, as a result of falling interest rates, the GARs began for the first time to exceed the Society's current annuity rates. This position continued until May 1994 when current rates again exceeded GARs. In May 1995 GARs once again began to exceed current rates. Thereafter, GARs continued to exceed current rates by an increasing amount. By September 1998 GARs were approximately 25% higher than current annuity rates. It is an agreed prediction that if and insofar as interest rates remain low, conditions in which GARs are liable to exceed current rates are likely to persist. The fall in market annuity rates to a level below those guaranteed has made the guarantees expensive to honour. The directors' response to the fall in current annuity rates below GARs was to allot different levels of final bonus to policyholders with GARs depending upon whether or not they wished to elect to take benefits in fund form or the contractual annuity calculated by reference to the GARs in their policies. The reasoning behind this decision was apparently that the differential policy achieves fairness between GAR and non-GAR policyholders by equalising the financial result of different forms of policy. This course of action was first adopted in an amending directors' bonus resolution made on 22 December 1993.
The originating summons
Against the background sketched in outline, the Society issued the originating summons already mentioned. In amended form it sought declarations in the following terms:
Mr. Hyman was selected as the representative defendant. The court duly made a representation order. The eventual outcome of the action will bind all GAR policyholders and former GAR policyholders. This is subject to the qualification that GAR policyholders will not be precluded from pursuing claims for relief based upon allegations as to the particular circumstances in which policies were sold to individuals.
The GAR policyholders did not claim any legal right to have any particular level of bonuses declared or any particular capital value attributed to their policies. Instead they challenged the principle of differential bonuses decided upon by the directors.
The Vice-Chancellor's decision
The Vice-Chancellor came to the conclusion that the practice adopted by the Society was valid. The core of the reasoning of the Vice-Chancellor was as follows at paragraph 100:
He added, at paragraph 103, that the directors' decision "to allot final bonus on . . . a basis that used asset share as a yardstick for the value of benefits taken rather than as a yardstick for the capital sum by reference to which the amount of the annuity taken was calculated, was, in my judgment, a decision well within their discretion."
The decision of the Court of Appeal
Lord Woolf M.R., now Lord Chief Justice, and Waller L.J. concluded that the appeal ought to be allowed and granted a negative declaration contrary to that sought by the Society in paragraph 1 of its amended originating summons. The leading judgment was given by Lord Woolf. The following passage contains the essential reasons for his decision, at p. 815E:
Waller L.J. held that on a proper construction of the policy the Society had not been entitled to allot a final bonus which was conditional upon the form in which the benefits under the policy were taken. There is, however, a passage in the judgment of Waller L.J. which gave the Society some comfort. He said, at p. 833F-G:
In argument this was described as the "ring-fencing issue." Morritt L.J. dissented. He concluded, at p. 828F:
The Court of Appeal gave leave to the Society to appeal to the House of Lords.
Given the difference in approach which surfaced in the judgments in the Court of Appeal, the statement of facts and issues records that the issues which arise, or in the case of issue (2), arguably arise, are as follows:
(2) whether the directors of the Society have exercised the discretion vested in them under article 65 of its articles of association in an improper manner, in allotting or otherwise making available different amounts of final bonus to GAR policyholders according to whether they elected to take an annuity to which the GAR would apply or benefits in fund form to which the GAR would not apply, so as to equalise, so far as possible, the total value of their benefits irrespective of which election they made.
Furthermore, depending on the decision on the principal issues, it may be necessary to consider whether it is open to the Society to proceed along the lines of the suggestion made by Waller L.J. in the passage set out above.
The argument of the Society
Counsel for the Society submitted that there is no contract between the Society and its GAR policyholders which prevent the Society from allotting different amounts of final bonuses depending on the form in which GAR policyholders elect to take their benefits. She pointed out that counsel for Mr. Hyman did not assert any breach on the part of the Society. She said that the allotment of different amounts of bonuses is not inconsistent with the contractual scheme. In particular GAR policyholders have not been deprived of what was guaranteed to them, namely payment of annuity of an amount not less than that derived from the application of rates contained in Table B to the GAR policy to the accumulation value of their premiums. She emphasised that the discretion in article 65(1) is in the widest possible terms. And no issue of irrationality arises. Counsel said that there were no grounds for restrictively construing the discretion in article 65 or implying a relevant restriction. She said that there were no grounds upon which the exercise of the discretion of the directors can be challenged as improper. She invited your Lordships to uphold the reasoning of the Vice-Chancellor and Morritt L.J.
A subsidiary point
The Society submitted in the courts below that the final bonus allotted to those taking an alternative benefit insofar as it exceeds the amount of the final bonus payable to those taking the guaranteed annuity is not a related bonus within the terms of the policy. This argument was rightly rejected by the Vice-Chancellor and all members of the Court of Appeal. It did not appear to be in the forefront of the Society's oral arguments in the House. It is devoid of merit. Nothing more need be said about it.
The approach to be adoptedMy Lords, much of the argument focused on the minutiae of the policy. The detailed provisions are, as I have pointed out, set out in the judgment of Lord Woolf. It is important, however, as Lord Woolf observed to keep firmly in mind what the real issue is, namely whether the Society is entitled to declare a differential final bonus because the current annuity rates have fallen below the GAR: at p. 807H. Insofar as it is necessary to rule on the effect of the terms of the policy taken by itself, I would uphold the submissions of counsel for Mr. Hyman. He put the matter as follows. The terms of the policy require the guaranteed rates in Table B of the policy to be used to calculate the contractual annuity. The effect of the Society's current practice is that they are not. The rates in Table B are conveniently referred to as the "guaranteed" rates. They are the rates which must be used in computing the annuity. The alternative of taking an annuity at the Society's current market rate arises only if the contractual annuity is renounced. What the Society currently does is to start from a capital fund attributable to the policyholder and to calculate an annuity from that capital fund at current annuity rates. It then grants that annuity to a policyholder who wishes to take his annuity at the higher contractual rate. This means that the contractual annuity rate is not being used as an element in the calculation of the contractual annuity. The only annuity rate which determines the annuity is the current rate. The only function of the contractual annuity rate is to calculate what the final bonus would have to be in order to justify the payment of no more than an annuity at the current rate. Unless the policyholder has elected to take a current rate annuity this is inconsistent with the rights of the GAR policyholder. While I accept this description of the position under the policy, it does not conclude the matter in favour of GAR policyholders. After all, participating policyholders become members of the Society. Their policies must be read subject to the powers and decisions of the directors in respect of the declaration and payment of final bonuses. If properly construed the powers of the directors under article 65 are wide enough to override the terms of the guaranteed annuity rates, the GAR policyholders can have no valid complaint. On the other hand, if article 65 expressly or impliedly contains a prohibition on directors exercising their discretion to override or undermine guaranteed annuity rates, the Society's practice is invalid. Beyond that there can be no liability on the Society. It follows that there are not two separate principal issues but only one. In the circumstances of the present case one never reaches the question whether the power was exercised for an improper or collateral purpose: see Howard Smith Ltd. v. Ampol Petroleum Ltd.  A.C. 821. Everything hinges on the meaning of article 65.
The meaning of article 65
It is necessary to distinguish between the processes of interpretation and implication. The purpose of interpretation is to assign to the language of the text the most appropriate meaning which the words can legitimately bear. The language of article 65(1) contains no relevant express restriction on the powers of the directors. It is impossible to assign to the language of article 65(1) by construction a restriction precluding the directors from overriding GARs. To this extent I would uphold the submissions made on behalf of the Society. The critical question is whether a relevant restriction may be implied into article 65(1). It is certainly not a case in which a term can be implied by law in the sense of incidents impliedly annexed to particular forms of contracts. Such standardised implied terms operate as general default rules: see Scally v. Southern Health and Social Services Board  1 A.C. 294. If a term is to be implied, it could only be a term implied from the language of article 65 read in its particular commercial setting. Such implied terms operate as ad hoc gap fillers. In Luxor (Eastbourne) Ltd. v. Cooper  A.C. 108, 137 Lord Wright explained this distinction as follows:
It is only an individualised term of the second kind which can arguably arise in the present case. Such a term may be imputed to parties: it is not critically dependent on proof of an actual intention of the parties. The process "is one of construction of the agreement as a whole in its commercial setting": Banque Bruxelles Lambert S.A. v. Eagle Star Insurance Co. Ltd.  A.C. 191, 212E, per Lord Hoffmann. This principle is sparingly and cautiously used and may never be employed to imply a term in conflict with the express terms of the text. The legal test for the implication of such a term is a standard of strict necessity. This is how I must approach the question whether a term is to be implied into article 65(1) which precludes the directors from adopting a principle which has the effect of overriding or undermining the GARs.