It is rare for a week to go by without another large pension fund deficit hitting the headlines. It is easy to sympathise with the plight of the pensioners involved in these situations, but the wider issue at play over the first year of operation of the Pensions Act 2004 is the piercing of the corporate veil within groups of companies with a view to making group assets liable for pension liabilities anywhere within the group. The exposure to these liabilities is having a profound effect on bidders for UK companies.
The relevant parts of the Pensions Act 2004 came into force in April 2005. The most far-reaching aspect is the exposure to the risk of a financial support direction (FSD) against a holding company and other members of a corporate group under Section 43 of the 2004 act. FSDs may be made by the Pensions Regulator at any time requiring financial support to be given to an under-funded pension scheme anywhere within the group of companies in question. From the point of view of existing groups of companies, pension liabilities can, on occasions, be treated in virtually the same way as other debts, hence the regulator’s coining of the phrase ‘pension creditor’. However, these liabilities are now capable of going through the corporate veils of all group members. In corporate acquisitions, it is the exposure of the successful bidder though FSDs to the deficits in the pension fund of the target that is having such a dampening effect on bids or, at least, the values ascribed to targets.
Examples of the negative perception surrounding the impact of these pension liabilities abound, such as Permira’s decision to walk away from its bid for WH Smith (£670m market capital compared with £250m pension deficit) and the disintegration of a consortium (reportedly including Apax and Time Warner) considering a bid for ITV.
FSDs are not the only problem for a bidder or a holding company wishing to dispose of a subsidiary with a pension fund in deficit. Section 38 of the act enables the regulator to issue a contribution notice on the employer, or an associate of the employer, of certain schemes imposing a liability to contribute to the assets of the scheme in deficit. Although this is not nearly as far reaching as an FSD, there has been a lot of worry among bidders that it might bite on their exit from the transaction. Although an acquisition will inevitably carry the assumption of the risk (usually contingent), it will often be the exit that will crystallise the risk into an actual liability.
Inevitably, bidders have been looking to their advisers for help in assessing their potential exposure and in exploring creative solutions before exposing themselves to what may be a long-term risk that is difficult to shed. Many advisers have been bleak about the different solutions that have been kicked around. The statutory clearance procedure has been helpful, particularly with the Pensions Regulator’s commitment to deal speedily with transactional clearances. Nonetheless, clearance is never a foregone conclusion. The bottom line remains that catering for the target’s pension deficit is likely to create a new and significant liability for bidders. Targets are still coming to terms with the reduction in value these pension liabilities have caused them.
These are early days for the new regime and it is difficult to be too firm about where it will take the market, although some lessons are already clear. The first is that risk assessment on the way into a transaction now needs much more careful attention than previously. The second is the need for bidders to prepare a proposed exit route. Taking the pain of upfront costs in getting early advice has come back into fashion and is now being thought of as an investment rather than an easily available saving.