Shepherd and Wedderburn LLP
  May 29, 2006 - Scotland

Pensions: The Straight and Narrow
  by Edwin Mustard

The 'moral hazard' provisions introduced by the Pensions Act 2004 could cause extra headaches for many corporate transactions unless steps are taken early to avoid potential pitfalls. Parties involved in corporate mergers, takeovers or even group restructurings may now need prior clearance from the Pensions Regulator to avoid being potentially liable for contributing towards a deficit in the defined benefit pension scheme of the target or investee company. A series of high-profile cases in recent years involving a healthy parent company walking away from the collapsing pension scheme of an insolvent subsidiary left many long-serving employees facing retirement with greatly reduced pensions benefits from their scheme. The Government's response, enacted in the Pensions Act 2004, reflects a shift towards making a whole corporate group responsible for pension promises made by any single company in the group, whether or not the other companies have had any previous involvement in the scheme. The Act aims to improve the security of final salary pension scheme members' benefits but money purchase schemes are not affected. The Pensions Protection Fund (PPF) – supported by a levy on final salary schemes – has been formed to compensate members of schemes that wind up with an insolvent employer that cannot afford to fund members' benefits. The 'moral hazard' regime acts as a deterrent to employers who – seeing the PPF as a safety net – might be tempted to abandon their schemes and offload pension liabilities onto the PPF. Operated by the new Pensions Regulator from their Brighton office, it has wide powers under the Pensions Act to serve enforcement measures known as contributions notices and financial support directions. Both forms of order allow financial redress to be obtained from those seeking to avoid their pension liabilities. A contributions notice orders a specified sum to be paid into a scheme. A financial support direction will require other arrangements to be put in place, such as bank guarantees, or spreading pension liabilities jointly and severally across a group of companies. Contributions notices are targeted as deliberate acts whose main purpose was to reduce the statutory pensions debt of a scheme or prevent the debt becoming payable. Anyone party to, or knowingly assisting in, such an act can be ordered to make good the deficiency, to the extent determined by the Regulator. Because they potentially push the scheme towards the PPF, seemingly routine transactions – such as large dividend payments or corporate restructurings – could be scrutinised by the Regulator. Financial support directions do not require deliberate evasion of liabilities. If a scheme employer is a service company or is 'insufficiently resourced' – tested by comparing its assets with those of other group members – the Regulator can require the scheme to be supported by other companies in the group, even where they have never participated in the pension scheme. The 'main purpose' requirement must be met before a contributions notice can be issued and as an inevitable consequence of wide drafting, the Regulator's net can be cast a long way in naming those potentially liable under either form of order. Apart from the scheme employer, they could include other companies within a corporate group and shareholders or groups of shareholders who control one-third of the employer company's voting shares. The test is very wide and could include banks and venture capitalists who take significant equity stakes and foreign parent companies. These potential liabilities will be a particular concern to outsiders looking at possible acquisitions of companies, or significant shareholdings. What transactions could the target company, or any others in its group, have been involved in that might give rise to a liability imposed by the Regulator? 'Due diligence' checks by professional advisers will assume even greater importance to take account of these new risks. But there is some comfort for those involved in corporate activity concerned about the new measures. Assurance can be obtained via a clearance statement from the Pensions Regulator that the action the company intends to take will not later be caught by the moral hazard powers. Clearance is voluntary and the Regulator has issued guidance on when it should be sought. Where such prior clearance is sought, the Regulator may query whether the scheme's trustees have been approached by the employer and if so establish that they are comfortable with the transaction proposed. While the Regulator will offer a 'clearance procedure' to give the green light to a transaction where liability might be incurred in relation to a particular scheme, those keen to conclude a deal will have to build in this and the possible need for an approach to the scheme's trustees at an early stage in planning the transaction.


Footnotes:
Edwin Mustard is a partner specialising in Pension Law with commercial law firm Shepherd and Wedderburn. +44 (0)131 473 5265