UK: DB Funding – The Legal Practicalities

Last Updated: 12 July 2013
Article by Clive Weber

TPR's additional statutory objective for funding purposes namely sustainable employer growth (included in Pensions Bill 2013) coupled with TPR's latest policy statement on funding DB schemes (issued May 2013) means 'employer covenant' remains very much in the spotlight. TPR's new statutory objective belatedly recognises two of its existing statutory objectives namely protecting members and the PPF.

Actuaries and benefit consultants have commented extensively on the above developments and rightly so. However, in this article we look at funding from the legal perspective and in particular procedural issues which can cause difficulties.

Because of the complexities funding discussions sometimes extend over the full 15 month statutory period before the Valuation is signed and schedules of contributions and recovery plans completed.

Some 'legal' thoughts:

1. Release of financial information by the employer to the trustees

Information about the employer needs to be collected and interpreted by trustees to assess the employer's covenant. Trustees' covenant advisers will wish to obtain this information from various sources e.g. via the employer's finance director and auditors. Before releasing information the employer will want to ensure there is a sufficient confidentiality agreement in place. Swiftly reaching agreement on the terms of such an agreement is important. The terms may be more extensive than an existing agreement between the employer and the trustees.

2. Release of trustees' covenant report to the employer and employer's advisers

The employer will want to see the covenant report prepared by the trustees' covenant adviser.

Before the trustees' adviser will release its report to the employer and to the employers' advisers, the trustees' covenant adviser will usually require a hold harmless letter ("HH letter") to be signed by the employer and by the employer's advisers. For instance, to ensure the information is not used for non-valuation purposes.

Frequently there are legal issues over the content of the HH letter. Although there is, we understand, a standard HH letter published by the Institute of Chartered Accountants, in our experience even where the draft HH letter is said to be based on the Institute's standard there are often material variations from the standard.

Two thoughts here:

2.1 It would be helpful for HH letters more closely to conform to the Institute's standard (this assumes the standard represents market practice – we would be interested in Accountants views on this). If HH letters were more standard, this would speed the process of signing the HH letter, facilitating swifter release of information.

2.2 The content of the HH letter should be addressed early in the process, so that information can be swiftly released and not delayed by legal negotiations on the content of the HH letter.

3. Employer response:

The trustees having permitted release of their covenant adviser's report, the employer will then usually respond either with comments on the report and/or with its own proposals.

In either event the trustees may request sight of the employer's own covenant report or advice. From the trustees' perspective this is not an unreasonable request (the trustees having disclosed their own adviser's report on a redacted or unredacted basis). However employers and their advisers may take a different view!

4. What is the lawyer's role in all of this?

To act in the client's interest but, we suggest, taking care to do so in a proportionate and sensible way. The earlier in the process the mechanics for the release of information and safeguards are addressed the better. Getting into disputes on confidentiality agreements and/or HH letters before valuation discussions start is unhelpful and should be avoided if at all possible.

The goal is for the employer and the trustees to try to reach agreement on funding. This is either actual agreement where the funding legislation requires agreement, or consultation with the employer with a view to agreement where trustees have power unilaterally to set contributions. Confidentiality agreements and HH letters should be ancillary aids and not obstacles.

5. More generally, TPR's test is what can the employer reasonably afford – what does this mean?

From the legal perspective, covenant advice has three main components, namely facts, forecasts and the covenant adviser's opinions. One person's reasonable affordability may be another person's unreasonable demand.

The key from the legal perspective is for the parties to carry out, and document as they go along, a thorough process, hopefully resulting in agreement. The smooth flow of information, not delayed by any unnecessary arguments over confidentiality agreements and hold harmless letters, oils the wheels of the process. Early referral to legal advisers of draft confidentiality agreements and draft HH letters is helpful. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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