Canada: Allocating Risks & Responsibilities for Pension Plan Sponsors and Their Service Providers

Article by Jeremy Forgie, ©2005 Blake, Cassels & Graydon LLP

One consequence of the ever-increasing volume of litigation in the pension area is a clear trend towards more formal documentation of plan sponsor and service provider relationships and, within that documentation, an increasing focus on limitation of liability.

Limitation of liability provisions, including exculpatory clauses and indemnities, have been a relatively common feature for many years in pension trust and custodial services agreements. Now these provisions are being included in professional service provider contracts required by actuaries, auditors and investment managers.

There are essentially three approaches which may be followed by a service provider in attempting to limit its liabilities under a contract with a plan sponsor.

The first approach may be described as a provision which limits and specifies the scope of the service provider’s duties and obligations. From the perspective of the service provider, the contract should clearly set out the specific responsibilities and scope of the responsibilities to be performed by the service provider and correspondingly which responsibilities and liabilities remain with other parties. The objective behind these types of provisions is to permit the service provider to argue that in the first instance it had strictly limited responsibility, authority and duties.

The second approach is a provision which does not limit the scope or breadth of the duties or obligations of the service provider; rather, it limits the amount of damages that may flow from a breach by the service provider of its obligations under the agreement. For example, it is becoming increasingly common for service provider contracts to contain numerical limits on liability including caps which are tied to fees paid to the service provider. The objective behind such a provision is to limit the financial exposure of the service provider to a specific dollar amount regardless of the reasons relating to the claim made against the service provider.

The third approach is an exculpatory clause, also sometimes referred to as an exemption clause, immunity clause, exclusion clause or even indemnity clause. An exculpatory clause does not limit the scope of duties of the service provider; rather, it relieves the service provider from liabilities arising from its acts and omissions. Indemnities are often connected to an exculpatory clause. The objective of an exculpatory clause (whether it stands on its own or operates in conjunction with an indemnity) is to ensure that regardless of the nature of the duty imposed on the service provider, it simply will not be liable for various types of liabilities arising from its performance under the agreement.

All three approaches to limiting liability may be used by service providers in a wide range of agreements including actuarial engagement letters, investment management agreements, pension trust agreements and custodial services agreements. They are also often included in benefits administration agreements between plan sponsors and third party administrators.

Enforceability of Contractual Exculpatory Clauses. Hunter Engineering Company Inc. v. Syncrude Canada Ltd., the 1989 decision of the Supreme Court of Canada, is widely considered to be one of the leading cases in Ontario dealing with the circumstances in which a contractual exculpatory clause will or will not be enforced.

In deciding whether an exculpatory clause is enforceable, the majority in Hunter concluded that the first task of the court is to determine whether the exculpatory clause applies in the factual circumstances. The majority held that an exculpatory clause which on its natural and true construction clearly evidences an intention by the parties that it apply in the event of a fundamental breach is, prima facie, to be enforced. The majority also held that in some circumstances exculpatory clauses should not be enforced, notwithstanding their clear terms.

Although the results of court decisions in various provinces across Canada since Hunter have tended to be fact-driven, a review of the decisions since Hunter appears to lead to the following conclusions:

• In determining the scope of exculpatory clauses (prior to considering their enforceability), such clauses will be strictly construed against the parties seeking to rely upon them and will not be interpreted so broadly as to indemnify a party from failing to provide the very thing provided for in the agreement.

• An exculpatory clause, however broadly drafted, will not be interpreted to limit damages for fraud.

• In deciding whether or not to enforce an otherwise applicable exculpatory clause, consideration will be given by the court as to whether or not the defendant has been guilty of bad faith or sharp or unfair dealing.

• Inequality of bargaining power has not been an essential precondition to finding unenforceability of an otherwise applicable exculpatory clause.

Exculpatory Clauses in Fiduciary Relationships. In the case of a relationship which is fiduciary in nature, there is, in addition to the general contract law considerations described above, the further issue of whether contracting out of a fiduciary obligation is itself a breach of fiduciary duty and whether public policy requires that there exist a minimum level of duty or a set of core responsibilities from which the parties cannot be relieved.

In reviewing a service provider contract (particularly with respect to a service provider who may not fall into an obvious fiduciary category), it is important to remember some basic concepts relating to the co-existence of a contractual relationship and a fiduciary relationship. The first is that the existence of a contract does not necessarily preclude the existence of fiduciary obligations. Second, fiduciary obligations can also be found based on a reasonable expectations analysis where the facts surrounding the relationship may give rise to fiduciary obligations even if the pure contractual terms of the relationship do not indicate a fiduciary obligation.

Considerations Under Pension Benefits Legislation. The requirements of pension benefits legislation may also affect the terms of a contract between a service provider and a plan administrator, including the limitation of the service providers’ liability under such a contract. For example, under the PBA, Section 22 establishes a standard of care for a plan "administrator" and its agents.

The question arises, therefore, whether in a particular situation reliance on an exculpatory clause could be challenged on the basis that it would amount to a "contracting out" of the statutory standard of care imposed under the PBA on "agents" of the plan administrator. In order to consider whether such a challenge could succeed, it would be necessary to consider whether a service provider is an "agent" of the plan administrator for the purposes of Section 22 of the PBA and the scope of the agency. If the act or omission which is being challenged falls outside the scope of the agent’s responsibilities or if the service provider is not an "agent" at law or is not an "agent" of the plan administrator, the standard of care imposed under subsection 22(8) should not be applicable.

Use of Exculpatory Provisions by Trustees. Exculpatory clauses are commonly used in pension trust and custodial agreements. As in the case of other service providers, the objective of the trustee is to relieve itself from liability by raising the level of culpability required in order for personal liability to attach to the trustee. In effect, the exculpatory clause is used to exempt the trustee from liability for acts or omissions except where such acts or omissions arise out of negligence or gross negligence or wilful default and to ensure that the trustee does not have liability for simple negligence, error in judgment or technical mistake.

The critical legal issue is how far an exculpatory clause could go in protecting a trustee from liability relating to its own conduct. There is debate among legal commentators as to the extent to which an exculpatory clause in favour of a trustee should be effective in circumstances short of fraud or gross negligence. In the author’s view, there is clear authority in the case law which supports the view that a trustee (including a professional trustee) should be able to significantly limit its liability through the use of exculpatory clauses.

A plan sponsor will need to consider its legal responsibilities as sponsor and administrator when it negotiates limitation of liability provisions in service provider contracts. Clearly there are both practical and legal considerations.

If a plan sponsor agrees to significant limitation of liability provisions in its various service provider contracts, it could be giving up potential remedies and means of recovery against its service providers in the event that the plan sponsor (or its pension plan) suffers a loss or incurs liabilities relating to the performance of services by the service providers. In very basic terms, a plan sponsor may increase its risks if it has agreed to broad limitation of liability provisions (including exculpatory clauses) with each of its actuarial consultant, investment managers, plan auditor and plan trustee.

As in many other aspects of plan governance, a plan sponsor or administrator will be in a better legal position if it can demonstrate that it engaged in an objective process in the selection of a service provider which takes into account not only the contractual terms requested by that service provider but also factors such as the qualifications of the service provider, the quality of the services offered, avoidance or control of conflicts of interest and reasonableness of fees relating to the services the service provider would provide.

Bearing in mind the increase in pension-related litigation, including the prevalence of class action proceedings which frequently include various service providers in addition to the plan sponsor, plan sponsors and their service providers will continue to be concerned about negotiating and documenting service provider liability. Limitation of liability in pension service provider contracts is a serious issue that is here to stay.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.