Insolvency: When the levy breaks

Can Chapter 11 ever be the more attractive option? The Pension Protection Fund’s levy on defined pension schemes may go some way towards making this a reality. Carolyn Swain reports

The newspapers have been full of it: far from being the season of goodwill, the column inches devoted to the predicted economic slowdown, its likely severity and the most vulnerable sectors, increased exponentially in the run-up to Christmas.

One area that has not been highlighted is the impact of the pension levy on defined pension schemes and their sponsoring employers, especially in terms of insolvency.

Under Section 175 of the Pensions Act 2004 the Pension Protection Fund (PPF) imposes a levy on all defined benefit pension schemes. The pension levy has two components: the scheme-based levy and the risk-based levy.

The first is calculated according to the number of members in the scheme.

The controversial risk-based levy has by far the greatest impact, representing 80 per cent of the total levy. The risk referred to is that of the sponsoring employer becoming insolvent and failing to maintain contributions to the scheme, thus making the scheme the responsibility of the PPF.

That risk is calculated by Dun & Bradstreet using credit and other commercial information about the sponsoring employer. From that it assesses the likelihood that the employer will enter into some form of insolvency during the next year. For 2007-08, if a scheme was funded to 125 per cent of its liabilities, then the risk-based levy would not apply.

The levy invoices started to be sent out in mid-October 2007 and are rumoured to be more than four times last year’s levy. The levy must be paid within 28 days of the invoice to avoid vigorous debt collection processes. There is little scope for appeal: the pension scheme will have to demonstrate that, on the information given to Dun & Bradstreet previously, the insolvency risk has been calculated incorrectly.

Challenging the methodology used by Dun & Bradstreet is impossible – realistically, an appeal may only have some chance of success if a key piece of information has been overlooked or the figures do not add up. Information not provided before this financial year’s cut-off date of 31 March 2007 cannot be submitted in support of an appeal on this year’s levy.

The future outlook

The news does not get any better for next financial year. As mentioned above, this year, if a scheme is funded to 125 per cent of its liabilities, then it will not have to pay a risk-based levy. Not so for the 2008-09 or 2009-10 levy years.

The PPF has announced in the Pension Protection Levy Policy for those years that it is raising this hurdle to 140 per cent. The PPF has justified the change on the basis that even well-funded schemes could pose a long-term risk.

Whether such policy changes have been triggered by the economic downturn is unclear. However, what is certain is that many employers will now be caught in the net and must, as a matter of urgency, review their funding arrangements with the pension scheme and look to bring the total funding cover as close to 140 per cent as possible.

The employer only has three months to act – the data about the sponsoring employer and the funding of the scheme must be submitted on or before 31 March 2008, otherwise it will be discounted.

Whether a company can afford to provide more funding in the current economic climate is, of course, a moot point. The situation is likely to be exacerbated by the current lending climate as banks are scrutinising requests for loans more closely. Stock market volatility may also mean that the pension scheme deficit is larger than anticipated.

A further concern

While the ‘can’t pays’ may find themselves forced into formal insolvency as a result, with the pension scheme then falling into the PPF’s remit, the ‘won’t pays’ should be equally alert to the possibility that the Pension Regulator (PR) may require the sponsoring employer and/or associated companies to contribute to the underfunded pension scheme, pursuant to Section 43 of the Pensions Act 2004.

Under Section 43, the PR can issue a financial support direction on any associated party (as defined in Section 435 of the Insolvency Act 1986) if, a) the employer is insufficiently funded, or b) is a service company, where they consider it to be reasonable to do so. Subsidiaries in a group and their parent would be deemed associates of each other.

Sea Containers

The PR’s lack of public action has been read by some as a sign of weakness. However, the well-known case of Sea Containers (2007) has changed that perception somewhat. In June 2007 the PR issued a financial support direction (FSD) against Sea Containers Limited (SCL), a Bermudian company. Its subsidiary, Sea Containers Services Limited (SCSL) was the contributing employer in two deferred benefit schemes with a combined deficit of around £143m. SCL was a contributory to only one of these schemes.

In September 2006 SCL gave notice to the scheme that it was no longer willing to contribute to it. In October 2006 the PR warned SCL that it was considering issuing an FSD under Section 43(2) of the Pensions Act 2004 on the basis that the employer was a service company and the schemes were plainly underfunded.

Matters dragged on with much debate about whether it was ‘reasonable’ for the PR to issue such an FSD. This culminated in a two-day oral hearing in June 2007. Both SCL and SCSL had gone into Chapter 11 a few weeks after the first warning shot was fired by the PR.

At the hearing SCL argued that the FSD would place it in the invidious position of not being able to comply with it if the US court did not allow the FSD claim in the Chapter 11 proceedings.

The panel determined that it was still reasonable for the PR to issue the FSD and that, while the issues regarding the Chapter 11 proceedings might have some bearing on whether it would be reasonable to issue a contribution notice if the US court refused to allow the claim, it was no reason to prevent the issue of the FSD. SCL has appealed and that appeal will be heard sometime in 2008.

In this case, while an FSD has been issued, it has been a slow process and is still continuing – even if the appeal is unsuccessful, the options of an appeal on a point of law or judicial review are also present.

The intervening Chapter 11 proceedings also cause more problems for the PR. SCL will be prevented from making any such payment unless either the US Bankruptcy Court or the creditors’ committee agree to the payment being made. Since that would diminish the pot available to them, it is difficult to see why they would consent in any event.

So what then? The PR could issue a contribution notice to compel payment, and again it will have to consider whether it is reasonable to do so. Of course, this time around it may be more difficult to justify a contribution notice if a foreign court has already rejected the claim. In any event, any appeal process could be drawn out for some years.

Plainly, for some employers, defined benefit pension issues are likely to dominate board room discussions during 2008. The unpalatable truth for some may well be that, if they cannot reorganise their ongoing liabilities to the scheme through belt-tightening exercises, it may be better to go through a formal insolvency process.

There may even be an increase in companies resolving to migrate part of their assets or operations to the US so that they can put their houses in order through the Chapter 11 process, without having to treat the pension scheme as a super priority unsecured creditor, as is currently required under English law.

Carolyn Swain is a partner at Halliwells