How times change. Final salary (sometimes called ‘defined benefit’) occupational pension schemes now not only dictate the course of takeovers (witness the recent bids for Marks & Spencer and WHSmith), but at the other end of corporate life can have a major impact on company failure. The issue of final salary scheme shortfalls has been well publicised in the media and on the political stage following a number of high-profile cases in which companies have been unable to fund a significant deficit in scheme assets, leaving employees exposed.
The Government has introduced reforms to seek to address the problem, some of which are set out in the Pensions Bill currently going through Parliament. However, the law of unexpected consequences will almost certainly apply, resulting in unwanted side effects for the restructuring and insolvency profession.
The Pension Protection Fund (PPF), modelled on the US Pensions Benefit Guaranty Corporation, is designed to provide assistance to members of underfunded final salary schemes which terminate after April 2005 without a solvent employer to bail them out. The PPF will be funded by a levy on schemes, the amount of which will depend partly on the risk of a claim being made on the PPF. The greater the risk of a claim, the greater the likely levy. While one can see some sense in risk-weighting PPF levies, it is not difficult to see a downward spiral for weaker schemes and companies.
Should a scheme qualify for PPF assistance, it will effectively be absorbed into the PPF, which will then administer it, paying benefits up to the agreed compensation levels. The PPF will become a creditor of the company in place of the scheme itself. However, the PPF will not be bound by a company voluntary arrangement or scheme of arrangement unless it specifically agrees to this, potentially making restructuring a more difficult task. The current draft legislation gives the PPF unprecedented power to control the restructuring process and to gain an advantage over other creditors.
Restructuring and insolvency professionals will also have to consider the so-called ‘moral hazard’ provisions in the bill. Clauses 35-46 provide for the new Pensions Regulator to issue contribution notices and financial support directions to any “connected” or “associated” party (defined in Insolvency Act terms) of a company involved in a final salary scheme. In essence, these new provisions will allow the regulator to require a wide range of companies and individuals to make good a final salary deficit – even if they were not directly involved in the scheme. The moral hazard provisions will apply to companies going through a restructuring or insolvency process and may extend to the professionals who have been called in to assist.
The regulator will be able to issue a contribution notice where it believes there has been a deliberate act or failure to act at any time since 11 June 2003 designed to prevent the recovery of any part of the ‘buyout’ deficit in a final salary scheme. The buyout deficit reflects the amount needed – usually very significant – to provide all accrued scheme benefits via insurance policies.
One particular concern is whether exiting a company from participating in a group final salary arrangement could, of itself, justify the issue of a contribution notice. Under current legislation (until the new funding regime in the Pensions Bill comes into force), the exiting company would be liable for its share of the scheme shortfall, but only calculated on the (weak) statutory minimum funding requirement (MFR) basis. This produces a relatively small deficit figure, much lower than the buyout basis. However, a contribution notice could require the exiting company, and any associated or connected parties, to pay the buyout shortfall.
This issue has already come before the courts in the case of T&N & Ors v Royal & SunAlliance, heard on 13 July 2004. In that instance, the administrators of T&N and 11 subsidiary companies wished to cause the subsidiaries to withdraw from the T&N Retirement Benefits Scheme. They were entitled to do so lawfully, and the MFR deficit from the exiting employers in these circumstances would be in the region of £19m. If the administrators delayed, the trustees could have altered their investment policy in the scheme to a ‘gilts-matching’ one, so increasing the MFR deficit at a stroke to some £210m. Or the trustees could have wound the scheme up, so creating a shortfall on a full buyout basis of some £875m. It was clearly to the advantage of the general body of creditors of the group to minimise the claim of the trustees as far as possible, but the administrators were concerned that at some future time the regulator might regard this as behaviour warranting a contribution notice against them or others.
The administrators could not risk a contribution notice and asked the court for directions as to whether or not their proposed actions would breach the prospective legislation, notwithstanding that it was still in a draft form. It was a very unusual situation indeed. Nevertheless, the court decided that it would consider the terms of the Pensions Bill, as they were intended to be retrospective in effect. The court found that the course of action proposed by the administrators was not unfair in accordance with the principle in ex parte James. It went on to find that, notwithstanding the main purpose of the subsidiaries withdrawing from the scheme was to minimise the deficit, the administrators would, having regard to the ‘moral hazard’ provisions, be acting in good faith.
Although most comment has been about the impact of contribution notices, in many ways financial support directions are of equal concern. Here there is no ‘moral’ test. Rather, the regulator will be able to issue an order where, as a matter of fact, the company responsible for a final salary scheme is found to be a service company or “insufficiently resourced” (as defined in the legislation) and unable to ensure the proper funding of the scheme. The order may require a parent company guarantee of, or joint and several group liability for, the scheme buyout shortfall.
Those involved in the restructuring and insolvency of companies will also have to bear in mind that in certain circumstances the regulator will have the power to apply to the court for an order under Section 423 of the Insolvency Act 1986 (transactions defrauding creditors).
The Pensions Bill has not yet passed through all of the parliamentary stages prior to enactment. A number of interested parties continue to lobby the Government with a view to forcing amendments to the bill, such that it does not adversely impact on the restructuring and insolvency profession. We will have to wait and see how successful that lobbying is.
Ken Titchen is a finance partner and Francois Barker a pensions partner at Hammonds