Wednesday, March 26, 2008

When employees are transferred between retirement funds following the sale of business between their former employer and their new employer, those employees could end up losing out on investment returns, sometimes due to their own ill-informed choice, and the seller’s fund could be exposed unnecessarily to claims from transferring employees who are no longer its members.  Companies and fund trustees should take care to avoid those consequences to the extent that they can.
When a business, or part of it, is transferred as a going concern the employees engaged in that business automatically become the employees of the person buying that business, in terms of the Labour Relations Act.  The LRA also states that the buyer (the new employer) is allowed to transfer its new employees into a new retirement fund, but that transfer, unlike the employment transfer, is not automatic.  The change from being a member of the old employer’s retirement fund to becoming a member of the new employer’s retirement fund can only take place by means of a procedure set out in the Pension Funds Act, known as a “section 14 transfer”.
The rules of a retirement fund usually provide that membership of the fund by an employee will terminate when that employee’s employment terminates.  If the employee is engaged in a business which is sold as a going concern, then that employee’s employment with the old employer terminates automatically in terms of the LRA’s provisions as soon as the business is transferred. This was confirmed by the Supreme Court of Appeal in the case of Telkom v Blom.  In that matter the employees claimed that their service with their old employer (Telkom) had terminated in terms of the rules of Telkom’s pension fund, and that they should be entitled to withdrawal benefits even though they were automatically taken up into the business of a new employer and were to become members of that new employer’s pension fund.  The court agreed with Mr Blom and his colleagues, who became entitled to cash out their withdrawal benefits. While most employees may welcome access to that kind of cash windfall, the problem is that the benefit accrues to them for tax purposes and therefore results in an immediate tax liability. 
While the section 14 transfer is awaiting approval from the registrar of pension funds, the seller’s pension fund remains liable to the transferring employees for so long as withdrawal benefits have not been paid, even if the employment relationship with the seller has terminated in law.  The registrar has recognised this problem and recommends that transferor funds should amend their rules to ensure that transferring members are treated as “paid up” members, who have no entitlement to death and disability benefits arising after the transfer date.  Such a rule amendment would obviously require a fair deal of forward planning as it would itself need to be approved by the registrar before it could take effect.
As employee benefits lawyers know all too well, the seller and buyer in the sale of business transaction often only begin to consider the arrangements for a section 14 transfer towards the end, or even after the completion of, the business sale transaction.  In many cases, the result is that, because of the time involved in obtaining approval for a section 14 transfer, that transfer of membership between the retirement funds can only take place some time after the employees have already transferred (automatically) from the old employer (the seller) to the new employer (the buyer).
The obvious way of avoiding these consequences is to start making the necessary arrangements at an early stage in the sale of business process so that the “receiving fund” is in a position to take transfer of the members at the effective date of the business transfer.  Another way is to ensure that the rules of the seller’s fund do not provide for automatic termination of membership when employment ceases, but rather contain appropriate provisions to cater for a transfer of members in the context of a sale of business, for example, by granting the trustees the discretion to extend membership for the period necessary to give effect to the section 14 transfer.
In real life, sellers’ retirement funds seldom pay out withdrawal benefits in the circumstances discussed above, but generally only because the transferring employees are usually unaware of their entitlement to a withdrawal benefit, and do not claim it.  When they do, as was done by Mr Blom and his colleagues, the fund must pay. 
David Geral is a director at Bowman Gilfillan