New clauses included in the draft Pensions Bill have the potential to cause serious damage to corporate activity for companies and groups that operate defined benefit (typically final salary) pension schemes.
These clauses are so wide-ranging in their potential scope that they could attach new financial liabilities - possibly running into millions of pounds - to sister companies, parent companies (whether UK or overseas), individual shareholders, directors and shadow directors. They create significant uncertainty for banks and other lenders and investors with a stake in - or who are considering taking a stake in - companies with DB schemes. Some elements are retrospective in nature, potentially allowing actions or omissions since June 2003 to be attacked.
In this article we consider the terms of these draft clauses and comment on the impact they may have, unless the Government relents from its current position and softens their effect while the Bill continues to pass through Parliament.
The Retrospective Clauses - ‘Anti-avoidance’
These clauses complement the steps taken in June 2003, when the Government announced it would regulate to ensure that any solvent employer that sought to terminate its DB scheme would have to pay for all members' benefits to be secured in full with an insurance company - the so-called ‘Buy-out Debt’. For many companies, the Buy-out Debt would dwarf their current scheme funding obligations and for some would, if triggered, cause the immediate insolvency of the company.
The clauses allow the new Pensions Regulator, taking office from April 2005, to direct any entity that is ‘connected’ or ‘associated’ with a scheme employer to pay the Buy-out Debt that would have been due had the scheme wound up. The order can be made where the Regulator believes that an act or omission has occurred since June 2003 which the Regulator believes had as its main purpose the intention to avoid or reduce the employer's Buy-out Debt liability. The entity attached can be a company or individual. The Regulator must conclude that it is reasonable in all the circumstances to make the order.
Comment
Any group restructuring or debt settlement deal since June 2003 which had as its main purpose the compromise, containment or avoidance of the Buy-out Debt will be potentially vulnerable to attack. Those in the firing line include other group companies, trustees, individual directors and major shareholders, among others. The breadth of the clause is deliberately designed as a ‘catch all’ - but this very breadth makes the planning of legitimate group restructurings and other corporate activity very difficult to achieve without accepting some risk that the actions or omissions involved could be questioned by the Regulator.
Directions requiring ‘Financial Support’
The Regulator can also make a direction which attaches the liabilities of one group company to one or more other group companies, in a way that clearly pierces the ‘corporate veil’. Again, the entities in the firing line include all companies or individuals ‘connected’ or ‘associated’ with the employer concerned.
This power arises where the original employer is part of a corporate group and has insufficient assets to meet its ‘Buy-out Debt’ were such a debt to arise (it is not necessary for the debt actually to have arisen for this direction to be made).
In a typical scenario, the group service company may employ the scheme's active members and be nominally responsible for scheme funding - but in reality will be dependent on financial support from its parent or from other operating companies in the group. This direction would allow the funding obligation to be imposed by the Regulator directly on one or all of such other companies.
The ‘financial support’ required may take the form of an indemnity or bank guarantee. If such support cannot be put in place - and there may be sound accounting, legal and practical reasons why this cannot be done - the Regulator can trigger the debt and order it to be paid by the group company or companies (or other entities) concerned.
Comment
This is a direct breach of the principle of limited liability. While no doubt well-intentioned, it seems destined to cause huge disruption to UK corporate activity and to act as a major deterrent to overseas investors. What US company would be willing to take a stake in a UK company if, by doing so, the US parent would potentially become directly liable to pay the UK subsidiary's pension debts?
Group pension schemes and sales of subsidiaries
The Government has also moved to amend the Bill so that the Buy-out Debt can be triggered when a subsidiary leaves a group pension scheme (for example, following a sale of the shares in the subsidiary). No winding-up need occur. In future, after April 2005, when a subsidiary is sold, appropriate ‘financial support’ must be put in place for that subsidiary's share of the notional Buy-out Debt that would have arisen if the pension scheme had then wound up. Until now, any debt payable would have been at the much lower statutory level of the MFR (Minimum Funding Requirement). Again, this financial support may take the form of an indemnity, guarantee or some other form of security - but if it is not forthcoming the debt can be triggered and the bill presented to the departing subsidiary. (The actual method of calculating the debt can be varied by the Regulator - it may or may not be the full Buy-out Debt.)
Comment
Very little detail has been given in the new provisions, with much still to be set down in Regulations, but again the effect seems likely to be severe for those large corporate groups planning to dispose of subsidiaries. The parent company will need to be able to put up ‘financial support’ to cover the cost of the full Buy-out Debt, or risk having the debt triggered - in a move that seems likely to make share disposals more difficult and costly to achieve.
Business sales and pensions issues
The Pensions Bill will require any company that acquires a business whose employees were, until the sale, actively participating in a ‘defined benefit’ pension scheme, to provide either a new defined benefit scheme or a defined contribution (company scheme or stakeholder plan) alternative with a minimum employer contribution of 6 per cent.
Comment
Arguably, European court rulings already show that business-acquirers - whether through contracting, outsourcing or transactions - automatically inherit some liability to provide DB benefits, where employees have previously been members of a DB scheme. But this Bill provision recognises this liability clearly in a UK statute for the first time, and may be the opening step in a journey towards the complete removal of the ‘pensions exception’ to TUPE transfers.
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.
