It is difficult now to believe that before 1992 UK defined benefit pension schemes could be set up on the basis that employers could fund them as they pleased and exit without paying any funding shortfall. Sophisticated arrangements to assess and monitor an employing group’s ability to pay were unfamiliar. Ability to pay was hardly relevant where there was no payment obligation.
The pendulum has now swung in the opposite direction. For those companies running defined benefit schemes (from which 12-million or so people still benefit), particularly those whose schemes are big enough to rival their own net worth, there is a pressing need for clarity as to which commercial actions could now result in funding obligations.
There are various legal routes to extracting pension scheme funding. Before schemes became regulated, these depended on the terms of the scheme’s trust deed
– mainly, who had the power to set contributions. That still matters, but overriding legislation can change the decision-maker from the employer to the trustees or the Pensions Regulator.
Since 2005 the Pensions Regulator has also had the power to demand contributions directly in some circumstances, regardless of what the trust deed says. But the Pensions Regulator can go after not just employers that participate in the pension scheme, but also their group companies and company directors.
These powers initially caused great concern to employers. A voluntary clearance process was introduced whereby the Pensions Regulator could be asked to give binding advance confirmation that it would not exercise its powers in relation to a given set of facts. Since that time, and with experience of clearance applications in practice, lawyers had generally become comfortable with identifying situations where clearance was a good idea.
That has now changed, at least pending further clarification from the Pensions Regulator. ;In ;April ;this ;year ;the Government announced a proposed change in the law, to take effect from 14 April, giving the Pensions Regulator new powers to require contributions in relation to non-insured buyout solutions – typically, transactions where an operating company is relieved of its pension scheme, or the scheme’s liabilities are transferred out to another scheme, and the scheme is then operated by a third party for profit.
The published policy view was not that those solutions were necessarily a bad thing, but that the Pensions Regulator needed new powers to ensure that members’ benefits were not put at risk.
At the same time, the Pensions Regulator published a statement to the effect that it would not use these future (undrafted) powers until the new legislation was approved, except in relation to certain specified transactions. However, this statement made no reference to the policy intent.
On 20 October draft legislation was finally laid before Parliament. Again, there is no reference to the policy intent (the regulation of non-insured buyout solutions). Instead the powers are to apply to any act or failure to act that “has detrimentally affected in a material way the likelihood of accrued scheme benefits being received”. This includes acts or failures to act of employers, their direct and indirect parents and subsidiaries, and directors.
In principle this test could catch anything that weakens the finances of the pension scheme or its sponsoring group. Examples include: an employer or its subsidiary granting security over assets, giving a guarantee, or incurring or increasing debt, whether or not as part of a takeover or sale/purchase; return of capital by the employer, either intra-group or to ultimate shareholders; migration of an employer, or its parent or group, to an overseas jurisdiction; a significant change towards return-seeking investments in pension scheme investment strategy; and a pension scheme merger.
It is possible that the final legislation and/or code of practice will clearly limit the new powers to non-insured buyout solutions. Pending that, where employers with defined benefit schemes want to take action that might fail the material detriment test, they should consider carefully the risk of Pensions Regulator intervention and whether to apply for clearance in advance.
Charles Cameron and Sandeep Maudgil are partners at Slaughter and May