Restructurings that involve companies which participate in defined benefit pension schemes now involve an examination of various potential pitfalls. These pitfalls were created following the introduction of the Pension Protection Fund (PPF), which will take over underfunded pension schemes of insolvent employers. The Government was concerned that the safety net of the PPF might encourage employers to be less diligent in the funding of their pension schemes and so gave the Pensions Regulator powers to ensure schemes were funded properly.
The regulator may issue contribution notices and financial support directions which require the recipient to contribute to, or support, a pension scheme. The regulator can issue a contribution notice if an employer, or a person associated or connected with that employer, commits an act or omission which has the aim of reducing the amount paid, or the amount due, to a pension scheme. A financial support direction can be served on an employer, or a company associated or connected with the employer, or a shareholder where the employer has insufficient resources to support the scheme.
It is therefore crucial in any restructuring to examine who might become associated or connected with the employer and therefore be at risk of receiving either a contribution notice or a financial support direction.
At risk by association
Restructurings regularly involve lenders swapping debt for equity. Such transactions have become less attractive because a shareholder that controls a third of the voting power will be considered an associate. One solution might be to ensure that the lender receives shares conferring on it less than one-third of the votes. However, the legislation provides that, where two or more shareholders together control more than a third of the voting power, they are together associates. There is no guidance on what ‘together’ means, but we expect that in practice a court would hold that this covered shareholders who were in the same group of companies and shareholders and who liaised with one another before exercising their votes in the same way.
Even if a restructuring did not confer any voting power, a lender might also become an associate of a borrower if the borrower’s directors were accustomed to act in accordance with its instructions. Lenders must therefore take care not to influence their borrowers’ boards of directors, otherwise they will be at risk of having to contribute to shortfalls in underfunded pension schemes.
Another structure that will expose a lender to risk is taking a share charge. Exercising that share charge will normally result in the lender becoming a shareholder with voting rights. Other options for obtaining security should therefore be examined.
Minimising the risks
If the lender cannot avoid becoming an associate, the risk of receiving a contribution notice or financial support direction can be reduced. The regulator can only issue financial support directions if it is reasonable to do so and by taking into account various factors. These factors are: the relationship the proposed recipient has with the employer (including whether the proposed recipient had control of the employer); the value of any benefits received from the employer; any connection or involvement with the scheme; and the financial circumstances of the proposed recipient.
Most banks will be regarded as having deep pockets by the regulator, although this is not a reasonable argument for financial support directions to be served on a bank. The regulator would have to find a closer relationship between the proposed recipient and either the scheme or the employer. On this basis, if the lender will become an associate as the result of a restructuring, it should do what it can to keep a distance between itself, the employer and the employer’s pension scheme.
Contribution notices can only be served where there is an act or omission which has as its purpose the reduction of the amounts paid or due to a scheme. Although it should be fairly straightforward to avoid such acts or omissions, the list of transactions relevant to the regulator is surprisingly long. These are set out in a guidance note and include transactions that involve a change in priority order, so that the pension creditor might receive a reduced dividend in the event of insolvency, returns of capital and changes in the control structure that weaken the employer covenant.
Restructurings might involve these types of transaction. Changes to security packages occur regularly. Granting additional security over new money is not a problem, but granting security over a significant proportion of the assets of the group or the employer could be a concern.
Where the restructuring involves a transaction that might attract a contribution notice, the parties can apply for clearance from the regulator so that it becomes clear that the regulator will not later require them to contribute to the pension scheme. An application for clearance will generally only be considered by the regulator if it is supported by the trustees. Trustees are being encouraged by the regulator to seek additional security for the pension scheme when they are in a position to negotiate. This means that, where there is a transaction that might attract a contribution notice, various concessions may need to be made to the trustees in order to obtain clearance.
Occasionally, a restructuring will only succeed if the pension liability is compromised. This can be done by agreement with the trustees through a scheme of arrangement or a company voluntary arrangement. Where trustees enter into a compromise, they prejudice the scheme’s eligibility for the PPF. Where the restructuring involves a compromise, the trustees will therefore wish to discuss the proposed compromise terms with the PPF. The PPF will therefore end up with a seat at the negotiating table because the trustees will be unable to agree any deal in the absence of its prior approval by the PPF.
The recent changes to pensions law have therefore produced a variety of occasions when pensions liabilities may influence a restructuring significantly. Early identification of the relevant matters and contact and negotiation with the regulator will thus be crucial to achieving a successful outcome in many ongoing and future restructurings.
Joe Bannister is an insolvency partner and Katie Banks a pensions artner: both at Lovells