The Court of Appeal handed down its judgment on 14 October 2011 unanimously upholding the first instance decision that a Financial Support Direction (FSD) issued by the Pensions Regulator to an entity after it has commenced insolvency proceedings will rank as an expense of the administration, therefore affording it super-priority over floating charge holders and other unsecured creditors. This decisions has significant implications for lenders to groups with UK defined benefit pension plans if any of their security is taken as a floating charge.

This Client Alert is a follow-up to the client alert we published following the High Court decision in December 2010, which can be found here.

Nortel and Lehman Brothers both operated large occupational pension plans, which were estimated to have deficits of £2.1 billion and £1.25 million respectively. Both groups went into administration after which the Pensions Regulator started the process of issuing FSDs to a number of companies (but not the employer companies themselves) within the Nortel and Lehman Brothers groups.

Usually a pension deficit ranks as a provable debt of the employer entity and therefore would rank pari passu with that company's other unsecured creditors. This is expressly provided for in the relevant legislation. However, the legislation dealing with FSDs does not contain any similar provision.

The Court of Appeal re-visited the question of whether the liability imposed by an FSD after the commencement of an insolvency process would be either (i) a provable debt, and therefore would rank pari passu with the unsecured creditors; (ii) an expense of the administration, and therefore would rank above the floating charge holders and unsecured creditors or (iii) not payable until after all other creditors have been paid, which in reality would mean it would not be paid at all and would, therefore, fall down the 'black hole.' Nortel's administrators argued that the liability would be a provable debt, whereas Lehman's administrators argued in favor of the 'black hole' outcome.

In agreement with the reasoning of the High Court judge, the Court of Appeal held that in accordance with insolvency legislation, the FSD would need to be deemed to be a contingent liability prior to the administration in order to qualify as a provable debt. In the Court's view, this could not be said to be the case because, until the FSD is issued, there is no more than a possibility that the regime will be invoked and no company other than the employer is under any legal obligation to the pension plan before the FSD is issued.

Turning then to consider whether the liability could be classified as an expense of the administration, the Court of Appeal upheld the High Court's reasoning which followed the general rule laid down in Re Toshoku1, which sets out that where statute imposes a financial liability which is not a provable debt, then it will constitute a necessary disbursement of the liquidator or administrator and will therefore rank as an expense and above floating charge holders and unsecured creditors.

While conceding that this super-priority of FSDs may seem anomalous, the Court of Appeal stated that "it would be a good deal more odd if the liability under a contribution notice has a lower priority than that of the [ordinary pension deficit], being relegated to the black hole." This would be the only alternative left because it was clear that the liability could not be a provable debt.

In a response to the Court of Appeal decision, the Pensions Regulator has said it welcomes the clarity offered by the decision but has stressed that it recognizes its obligation to act reasonably and have regard to those directly affected by its powers, when exercising its discretion. It acknowledges the "importance of the UK having an effective restructuring and rescue process" and states it has "no intention of frustrating its proper workings."

Nevertheless, commentators have expressed concern about the impact this decision will have on the UK's rescue culture at a time of strained economic circumstances. It is expected that the administrators will appeal the decision to the Supreme Court.

Footnotes

1. Re Toshoku Finance UK plc [2002] UKHL 6, [2002] 1 WLR 671.

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