In a much-awaited judgment, the UK Supreme Court has decided
that the liability of a company in administration or liquidation to
contribute to an under-funded pension fund following a Financial
Support Direction or a Contribution Notice is a provable debt
ranking equally with other unsecured creditors. Crucially, it is
not an expense of the administration or liquidation which would
cause it to rank ahead of all creditors (except fixed charge
holders) and even the administrator's or liquidator's own
remuneration.
This is a very helpful decision for all stakeholders in an
insolvency process (e.g. debtors, creditors and insolvency
practitioners) as it brings certainty after several unsettled years
over the treatment of these pension liabilities which, because of
their size, fundamentally alter the centre of gravity of any
administration or liquidation.
As well as overturning the first instance and Court of Appeal
judgments, the Supreme Court also decided that various other cases
were wrongly decided and has readjusted common law back to an
earlier view of what constitutes a "provable debt" (i.e.
a debt which can be claimed in an English insolvency
process).
The Issues
The names Lehman and Nortel are now synonymous with vast
corporate failures which have been litigated over repeatedly. The
Pensions Regulator had issued Financial Support Directions
("FSD") to support under-funded employee pension schemes
after the groups' administrations in respect of
pension deficits which arose before the administrations. The
question for the Court to deal with here related to how these FSDs
should be categorised and ranked within the
administration.
Pensions. The Pensions Regulator has the power to
require certain members in the same group as an employer under a
defined benefit pension scheme to provide financial support for any
defined benefit pension scheme which appears to be, and to have
been for some time, in substantial deficit. There is a lengthy
process set out in statute detailing how the Pensions Regulator
should go about this but, in summary, after due investigation, the
Pensions Regulator may issue an FSD which obliges other group
companies to provide reasonable financial support to the pension
scheme and, if such support is not forthcoming, to issue a
Contribution Notice ("CN") for a set amount to be paid.
The length of the process and nature of the Pensions Regulator
means that FSDs and CNs are often not issued until after the
company is in administration or liquidation. Despite this, neither
the pensions nor the insolvency legislation defines how these
liabilities are to be categorised in an insolvency.
Insolvency. The statutory order of priority for
payments out of the company's assets is:
- Fixed charge creditors;
- Expenses of the insolvency procedure (including officeholder's fees);
- Preferential creditors;
- Prescribed part creditors (ordinary unsecured creditors claiming against a maximum pot of £600,000);
- Floating charge creditors;
- Unsecured provable debts;
- Statutory interest;
- Nonprovable liabilities; and
- Shareholders.
The pension liabilities could be considered to be one of three
options. First, they could be unsecured provable debts;
second, an expense of the insolvency; or third, nonprovable
liabilities. If the third, there was a further argument that the
Court had discretion to order the administrator to treat them as
either provable debts or an expense.
A further issue was that debts were provable only if they existed
at the time of the company entering administration or liquidation.
Where an FSD was issued before administration, it was common ground
that that liability would be a provable debt. However, as noted
above, the Pensions Regulator often issued an FSD or CN only after
entry into a formal insolvency procedure, so not being clearly
provable.
First Instance and Court of Appeal
The first instance Court and Court of Appeal found that the
liabilities were expenses in the administration. However, it seems
that they felt constrained by prior case law to rule out treating
the liabilities as provable debts as the liabilities under the FSD
arose after the companies had entered administration. Then, left to
decide between being unprovable debts or expenses, the courts opted
to categorise the liabilities as expenses.
The practical impact of those decisions was that the sums in
question were so large as to wipe out totally any return to the
unsecured creditors (other than possibly through the prescribed
part) and would rank ahead even of the officeholder's fees.
This would have had a huge effect on the viability of
administration for companies with pension deficits.
Supreme Court
The Supreme Court held unanimously that the "fair and sensible
answer" was that a liability under an FSD or CN issued after
formal insolvency should be treated as a provable debt. The Court
provided various supporting arguments, but the crux of it boiled
down to equality between creditors and equality of treatment before
and after insolvency. Reasons for the Court's decision
included:
- The pension trustees were entitled to receive the sum by law, but that did not provide any greater or lesser priority than other unsecured creditors.
- An FSD or CN issued before insolvency would be a provable debt as would a debt to a pension scheme (a "s75 debt" as it is commonly known) where no FSD or CN had been issued. It would be "arbitrary" for the characterisation of the debt to turn on when or whether an FSD or CN were issued, especially as the decision to issue would be based on the state of affairs before an insolvency event.
- If the liability were an expense, the Pensions Regulator might wait until after an insolvency event to issue an FSD or CN because it would give a greater return as an expense rather than a provable debt.
- It seemed unlikely that Parliament intended the liabilities to rank behind provable debts. The length of the process to issue an FSD and CN meant that they would almost always be issued in respect of insolvent companies. If they were unprovable debts ranking behind the unsecured creditors, then very few FSDs and CNs would ever be satisfied.
As for why the liability under the FSD and CN should be treated
as a debt arising before insolvency, and therefore provable, the
Court held that the obligation for the liability occurred before
the date of insolvency. The Court noted that it was
"dangerous" to try to suggest a "universally
applicable formula" to test whether a pre-insolvency
obligation was sufficient to create a post-insolvency liability.
Nonetheless, it expressed the view that for an obligation incurred
pre-insolvency to rank as a provable debt, a company must have
taken or been subject to one or more steps which (i) had some legal
effect and (ii) resulted in it being vulnerable to the specific
liability, with a real prospect that the liability would be
incurred. If both of those tests were met, the Court should then
consider whether it would be consistent with the regime which
imposed the liability that the steps would give rise to the
obligation. If the answer is yes, the obligation ranks as a
provable debt.
Applying that test to Lehman/Nortel, for the first
limb, the Supreme Court found that all the relevant companies had
been members of the group for at least two years before the
commencement date of the administration (the look-back period for
the Pensions Act), creating a legal relationship. As for the second
limb, at the commencement date of the administration, the groups
both had under-funded pension schemes, which had been in deficit
for more than two years and so were exactly the type of companies
which would be the targets of an FSD. Having satisfied itself as to
those parts of the test, the Court referred back to its earlier
arguments (above) as to why it was consistent with the pensions
regime to impose a liability ranking as a provable
debt.
Earlier Authorities. The Court dismissed various
of the earlier authorities, reverting to the 19th century approach
endorsed by the report which led to the Insolvency Act that, where
possible, all debts and liabilities should be incorporated into the
formal insolvency and discharged. The judge noted that those
liabilities should include all "contracts, liabilities,
engagements and contingencies of every kind" and cited various
further amendments of the insolvency legislation which widened the
class of creditors.
Other Comments
Despite deciding that a claim in an administration or liquidation
could only be a provable debt or an expense, not both, the Court
took the opportunity to consider what constituted expenses and
whether it had a residual discretion to impose a ranking on a claim
since it had heard full argument on both points.
Expenses. Again, with caveats about creating
a general rule, the Court suggested that a disbursement would be an
expense if it arose out of something done in the administration
(normally by the administrator) or imposed by statute on the
administrator as part of the administration. The Court emphasised
that any such liability would be one which was incurred as part
of the administration rather than merely incurred during the
period of the administration. Additionally, there would either be a
clear or reasonably assumed statutory intention that such a
liability should rank ahead of provable debts.
The Residual Discretion of the Court. The third
limb of the question was: If the Court had found that the pension
liabilities were neither provable debts nor expenses, could the
Court order that they be treated as such? This idea was firmly
quashed by the Court as being "wrong in principle" and
"highly problematic in practice". It would be wrong for
the Court to overrule statute and problematic because of the
confusion to officeholders that it might cause and court
applications by disgruntled creditors seeking a higher ranking.
Further, the Court held that it could not sanction a course which
was outside an administrator's statutory power, such as varying
creditors' rankings.
The Future
Not only does this decision bring certainty after two and half
years of court proceedings, it also brings clarity as to where
pension liabilities will rank in an insolvency. Additionally it
settles that pension liabilities are provable debts whether or not
an FSD or CN are issued and whether or not they are issued after
insolvency proceedings. This will help creditors and debtors in
insolvency contingency planning and bring certainty to consensual
restructurings. More broadly, it provides a useful test for
establishing what is a provable debt and overrules a diverging line
of judgments.
How Will the Pensions Regulator React to Being an Unsecured
Creditor? As the Pensions Regulator had stated publicly
that it would not use its powers to issue FSDs and CNs arbitrarily
despite the first instance and Court of Appeal decisions, we do not
think that the Supreme Court decision will have a material impact
on the Pensions Regulator's negotiating position in consensual
restructurings. This is not to say the Pensions Regulator will be
sitting on the sidelines in other aspects of insolvencies, such as
pre-packaged administration asset sales.
There has been disquiet that in some pre-pack administrations, the
administrators accept a sale price which is enough to cover the
secured creditors and their fees, but do not appear to push harder
for the unsecured creditors. The Secretary of State for Business
has recently commissioned a report to investigate pre-pack
administrations, specifically their transparency and the returns
delivered for creditors. It is possible in light of this decision,
and the findings or recommendations of the report on pre-pack
administrations, that the Pensions Regulator will play a more
active part in challenging sales where the unsecured creditors get
only a token return. This may be especially true where the
potential targets of an FSD or CN are also insolvent, so
contributions from them will be minimal. Should the Pensions
Regulator adopt a more robust attitude, administrators and
purchasers may have to pay more attention to the outcome for
unsecured creditors or risk challenges to administration
sales.
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