On 24 July the UK's Supreme Court handed down a judgment which clarifies a question about where defined benefit pension liabilities rank on group insolvency. The Court overturned a number of previous decisions made by lower courts and reached a conclusion that supports the rescue culture of UK insolvency law.
In summary terms, the order of priority for using an insolvent company's assets to meet its liabilities is as follows:
Creditors with fixed charges
Expenses of the insolvency proceedings - referred to as 'super priority'
Creditors with floating charges
Unsecured creditors with 'provable debts'
Unsecured creditors with 'non-provable debts' - referred to as the 'black hole', and
Depending on the extent of the company's insolvency, the company's assets may well be sufficient to pay the liabilities in the highest levels of priority in full; the unsecured creditors at level (5) will be treated pari passu as a class and expect to receive just a percentage of their claim; and nothing will normally be left for levels (7) or (8) - which is why level (7) is known as the 'black hole'.
The question for the Court was whether pension liabilities resulting from a financial support direction (FSD) issued by the Pensions Regulator (tPR) after insolvency proceedings had commenced fall within categories (2), (5) or (7). The High Court and the Court of Appeal had ruled that they fell within category (2). The Supreme Court overturned those earlier decisions and ruled that they fall within category (5). This is good news or bad news depending on one's point of view.
For trustees of schemes within an insolvent group (and the scheme members) it is bad news insofar as they might have hoped the earlier decisions to be upheld and allow them to retain super priority at level (2). At the same time, things could have been much worse because they might have found their claims relegated to the black hole at level (7). Recognising this, tPR has issued a press release welcoming the Supreme Court's decision that FSDs are effective in an insolvency. Overall, therefore, ending up at level (5) is no bad thing and a fair way of treating the pension scheme relative to other unsecured creditors.
For everyone else, the decision is good news because the earlier decisions had turned the pension scheme into the elephant in the room so far as an orderly insolvency process is concerned.
It should be emphasised that the decision relates to claims arising from an FSD against a group company and not a statutory debt due from a scheme employer under section 75 of the Pensions Act 1995 (s75 debt). The law has always been clear that in relation to a s75 debt trustees are unsecured creditors at level (5) of the insolvency order of priority where the insolvent company is a scheme employer.
FSDs can be issued by tPR against companies in a group which are not themselves scheme employers liable for s75 debts but where a scheme employer is a service company or 'insufficiently resourced'. Essentially, an FSD enables tPR to force other group companies to support the scheme.
So far, very few FSDs have been issued and only ever where the group has suffered insolvency. Nevertheless the decisions of the High Court and Court of Appeal which have now been overturned would have enabled tPR, by issuing an FSD, to cause havoc in a group insolvency by elevating a pension scheme liability from level (5) in the insolvency order of priority in relation to a scheme employer to level (2) in relation to other group members.
Overall the Supreme Court's decision is therefore welcome and ends more than two years' uncertainty since the High Court's decision in this case in December 2010.