Pensions lawyers are flavour of the month. In June the Pensions Regulator finally awoke from its three-year slumber to take the corporate world by storm. It told Bermuda-based Sea Containers, which owns Sea Container Services, the UK company responsible for running Great North Eastern Railway (GNER), that it must take responsibility for its subsidiary’s pension scheme deficits (www.the lawyer.com, 19 June).
Not only did this show the regulator as a force to be reckoned with, but it placed pension considerations firmly at the centre of all corporate transactions.
Corporate lawyers have always sought input from their pensions colleagues when working on a transaction, but the regulator’s newfound activity means the concerns of pension fund members and trustees will have greater weight in all transactional negotiations.
Indeed, by putting the onus on parent company Sea Containers (advised by Kirkland & Ellis) to fund its subsidiary’s two pension scheme deficits, the regulator has made a move that will have wide-reaching implications in the transactional world.
The two lawyers at the heart of the Sea Containers move were Hammonds partner Simon Price and Sacker & Partners partner Nick Couldrey, who represented the trustees of Sea Containers’ two pension schemes. Together they went to the watchdog’s determinations panel to support its plan to issue Sea Containers with a financial support directive (FSD).
Effectively this gives the company a month to guarantee the schemes’ security. If it fails to come up with a suitable payment plan, the regulator will take formal action to ensure it does. From the regulator’s point of view, because Sea Containers is the parent of Sea Container Services, it is responsible for it.
Not only is this the first time the Pensions Regulator has employed this moral hazard provision but, more importantly, it shows pension trustees, companies and potential buyers of companies that the regulator will exercise its powers in appropriate cases.
“This will make people think more carefully about how they deal with pension scheme issues in transactions,” says a City partner. “There is lots of private equity activity going on and one of the big issues is the position of company pension schemes. Hopefully this will result in members’ interests being properly protected in takeover transactions.”
Although the impact of the regulator’s decision will be wide-reaching, its reasoning is hardly contentious or unexpected, says Sackers’ Couldrey.
“It’s very important from the regulator’s point of view because it shows it can and will act,” he says. “That reinforces the message that everybody needs to take pensions seriously. The legislation was brought in with the 2004 Pensions Act, but since then the pensions regulator hasn’t been seen to act. It was getting a reputation as being a toothless tiger, but this proves that isn’t the case.”
However, while the Sea Containers case has provided some headline-grabbing work for Hammonds and Sackers, it is fair to say that the regulator will take such action only in very specific cases.
Roderick Morton, pensions partner at Herbert Smith, points out that the FSD was issued to Sea Containers for a very specific purpose: to recover money for the pension fund trustees upon the company’s insolvency. The watchdog has not taken this step before because FSDs are aimed at companies that are not resourced sufficiently to meet their liabilities, a situation that does not arise often.
That said, many recent buyouts, such as Kohlberg Kravis Roberts’ (KKR) acquisition of Alliance Boots, have been financed with considerable amounts of debt. Sea Containers, it should be noted, is owned by a consortium of hedge funds that took on masses of debt that could not ultimately be repaid. The concern in private equity takeovers, and increasingly in hedge fund buyouts, is that the buyer will load the acquisition company with debt, meaning any payments due to pension schemes will be less secure if the company then becomes insolvent.
However, the regulator will only put pressure on a parent or purchasing company to ensure enough money is being paid into a pension fund if the target does not have sufficient reserves itself. Sufficient reserves effectively equate to having assets equal to or greater than the scheme’s deficit on a buyout basis. Clearly, on this calculation, Alliance Boots has more than enough assets for KKR to avoid the threat of the watchdog’s FSD.
And yet the actions of Alliance Boots’ pension scheme trustees – advised by Sackers partner Peter Lester and Ashurst corporate head Adrian Clark – have the potential to be just as wide-reaching as those of the regulator itself.
Essentially, all companies are required by the regulator to value their pension deficit using guidelines set out in International Accounting Standard 19 (IAS 19). Under IAS 19 the cost of providing employee benefits has to be recognised in the period when the benefit is earned by the employee, rather than when it is paid or payable.
Under advice from Lester and Clark, plus Clark’s Ashurst colleague, finance partner Mark Vickers, Alliance Boots trustees demanded the KKR-led consortium buying the company go beyond the value placed on the deficit under IAS 19 to fully ensure the rights of scheme members were safeguarded.
Trustees made their demands after AB Acquisitions, the bidding vehicle comprising KKR and Alliance Boots executive deputy chairman Stefano Pessina (advised by Clifford Chance), had not clarified the contributions it would make towards the pension fund’s deficit.
The pension fund had threatened to use its power as Alliance Boots’ largest creditor to put a stop to the acquisition if the future security of the scheme was not safeguarded. With the acquisition being funded through a complex loan agreement with a syndicate of banks, trustees did not want that debt to affect the scheme in the event of Alliance Boots becoming insolvent.
On a deficit of around £1bn, AB Acquisitions agreed to contribute £418m in instalments over the next 10 years, with a bank guarantee and a specific security package put in place to back the cash instalments. AB Acquisitions also agreed to provide an additional £600m security package designed to protect the long-term benefits of the members.
According to Herbert Smith’s Morton, this action from the trustees promises to be a real precedent-setter.
“The regulator said as long as schemes get IAS 19, that’s fine,” he says. “For the trustees to go further is a big shift.”
As private equity and hedge funds continue to jostle for ownership in an unrelenting takeover market, the rights of pension schemes and their members have finally been given credibility.
Whether the action taken against Sea Containers will be repeated with other companies is largely irrelevant. The fact is that the noise created by the case, and the almost concurrent victory for the Alliance Boots pension trustees, will be enough to ensure pension issues remain at the forefront of all future transactions.
For Sackers, which played a key role in both landmark cases, its future as the leader on pensions advice is secure. Hammonds and Ashurst, too, will be able to leverage off the kudos earned through their roles for Sea Containers’ and Alliance Boots’ pension trustees. Anyone else wanting a piece of the action would be advised to move now.