UK: The Pensions Trap: Issues for Private Equity Investors

Pensions are increasingly a major focus in the acquiring and running of businesses. This articlealerts private equity investors to the implications of incoming pensions legislation and acts as a reminder of pensions related issues generally.

Key points

  • Private equity investors and their management companies could be liable to contribute to final salary pension scheme shortfalls.
  • MBOs and other acquisitions made by business transfers no longer wholly escape obligations to provide the pension entitlements of transferring staff.
  • New funding rules are to apply to final salary pension schemes which will require greater contribution levels by investee companies.

The Pensions Act

The Pension Act 2004 (the "Pensions Act") received Royal Assent on 19 November 2004 and is expected to come into force from April 2005. Some of the features of most importance to the private equity industry are discussed below.

The "Moral Hazard" provisions

The Pensions Act includes provisions which are designed to prevent groups of companies from abandoning their pension liabilities by ring fencing them in one company. Inevitably the scope of these so-called "moral hazard" provisions is far wider.

These provisions give the new Pensions Regulator (the "Regulator") the power to extend liability from the employing company to any "associated" or "connected" person or company, other than a private individual, including:

  • other group companies;
  • any shareholder with at least one third shareholding (for example, a significant private equity investor); and
  • any employer of a director of the company, such as a manager of private equity funds which appoints a special director to an investee company’s board.

Under these provisions, the Regulator will have the power to issue the following orders:

Contribution notice – where the Regulator believes a main purpose of any act or omission was to reduce or eliminate the liability on the employing company to contribute the deficit into a pension scheme on its termination, a contribution notice may be issued requiring the company or an associated or connected party which was involved in that act or omission to pay the shortfall into the pension scheme. The Regulator has powers to issue a contribution notice within six years of any act or omission occurring after 27 April 2004; and

Financial support direction – where the Regulator believes the employing company of the pension scheme is insufficiently resourced or if it is a "service company", the Regulator can require an associated or connected party to provide "financial support." This may include the assumption of some or all of the ongoing liabilities of the pension scheme. A "service company" is one whose main purpose is to employ a group’s workforce.

Advance clearance may, however, be sought in respect of actions that could, potentially, give rise to a contribution notice or to confirm that the Regulator will not issue a financial support direction at any particular time. However, any clearance obtained could be jeopardised if circumstances change or the Regulator becomes aware of relevant undisclosed facts. The clearance procedure should therefore allow some advance comfort to be obtained but may not be entirely reliable, particularly in relation to a financial support direction where relevant circumstances can swiftly change.

The government has reiterated that it intends that these moral hazard provisions should only be used in extreme circumstances and that, most of the time, the Regulator should be able to deal with funding concerns without resorting to them. However, a deepening of public concern over pension provision may increase the pressure on the Regulator to use all the powers at its disposal to ensure that schemes are fully funded, even at the expense of third parties.

Asset sales

It is established law that on an asset sale, employees’ terms and conditions of employment transfer to the transferee company, except in relation to occupational pension schemes.

However, under the Pensions Act, a transferee company will be required to establish an occupational or stakeholder pension scheme and pay a specified level of contributions into that scheme for transferring employees. This right will apply not only for employees who are presently members of an occupational scheme, but also those who are or will become eligible to join one.

The Pension Protection Fund

A new fund will be established to provide pension benefits where a pension scheme is underfunded due to an employer’s insolvency. The fund will assume the assets and liabilities of these pension schemes, and the underfunding will be met by a levy on all pension schemes which will be based on the size of each scheme and its level of funding. It is expected that this scheme will be very expensive to run and that the levies, particularly those payable by underfunded schemes, will become very high. The ultimate liability for this levy will lie with the employing company, which must fund the pension scheme and its expenses.

General pensions issues to consider

Because pensions has become a driving force in many investments, it is valuable to consider the substantive issues in relation to pension schemes. A summary of the most compelling issues relating to a salary related or defined benefit pension scheme are set out below.

Funding levels

It is always possible to obtain an actuarial valuation to give a recent assessment of the funding levels of a scheme. However, there are many different bases for the assessment of assets and liabilities based on different assumptions about the future of the scheme and external factors such as inflation and mortality rates. The statutory minimum funding level at present is the Minimum Funding Requirement ("MFR"), but following the Pensions Act there will be a new "scheme specific" minimum funding basis, details of which are still awaited. This means that the minimum possible contributions to pension schemes will increase.

Even a scheme that is fully funded on the new basis will not have the ability to buy pension benefits in full for all its members. This is because the so called "buy-out" valuation method assesses the amount that is needed to allow benefits to be bought in full at that time and this, given the substantial cost of annuities to secure those benefits, is always a much higher figure than other valuation bases.

Closing or winding up of pension scheme

The term "closed pension scheme" can mean a number of different things, but is increasingly used to describe a scheme under which members are no longer earning any further benefits but which is not winding up.

A scheme that is winding up is required, so long as that winding up commenced on or after 11 June 2003, to assess its liabilities on the full "buy-out" basis. Any deficit on that basis becomes a debt immediately due from the employing company.

Before a scheme is closed it is important to assess whether the closure will trigger a wind up thereby imposing this substantial immediate debt on the employer. Even if no wind up is triggered, closure may shift the power to trigger the wind up to the hands of the trustees who will then have a very strong negotiating position in demanding very substantial sums from the employer.

Accounting for pensions

Disclosure in the new accounting standard in relation to pensions, FRS17, will shift disclosure items from the notes to the financial statements for accounts from 2005. This will mean that deficits or surpluses in defined benefit schemes will be accounted for in the balance sheet and movement in that amount will be accounted for through the profit and loss account and the statement of recognised gains and losses. The FRS17 calculation of the deficit or surplus is on a different basis from the present statutory minimum basis or the full "buy-out" basis and may vary to some extent with the accounting policies of the company.

Asset transfers

As well as the change to pension rights on asset transfers included in the Pensions Act, the European Court of Justice has recently held that certain employee benefits under pension schemes, in particular certain early retirement provisions, will transfer under an asset sale. This will mean that, in addition to the new contribution obligations under the Pensions Act, the employees have a right to demand that the new employer provides those particular benefits, even if the other pension benefits are not provided to them. The cost of this can be substantial and it is not clear how the court expects this to work in practice. In extreme circumstances, the purchaser may be forced to establish its own scheme to ensure that these benefits are replicated.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.