When is a total deficit not a total deficit? Another turn of events for pension contributions

by Reed Smith
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Summary

On 18 December 2013, judgment of the High Court in England and Wales was handed down in a case relating to the insolvency of Lehman Brothers companies (In the Matters of Storm Funding Limited (In Administration) and Others [2013] EWHC 4019 (Ch)).

The judge held that, where multiple group companies are potential targets for the Pensions Regulator’s power to issue contribution notices, the aggregate total of the contributions required by those notices was not limited to the amount required to fully fund the deficit in the relevant pension scheme under section 75 of the Pensions Act 1995 (Section 75).

Although such a limit still applies in relation to a single contribution notice, this judgment means that, where there is more than one target for the Pensions Regulator’s powers, each of the contribution notices it could issue to those targets can be for the full amount of the Section 75 funding deficit.

Background: Protections for a Pension Scheme’s Funding Position on Insolvency

Prior to the Pensions Act 2004, trustees could look to Section 75 of the Pensions Act 1995 as the key statutory protection on the insolvency of a sponsoring employer.

Section 75 is designed to provide protection for members of a defined benefit pension scheme when the sponsoring employer(s) of that pension scheme suffers insolvency. Section 75 does this by giving the trustees of such a pension scheme a statutory claim for the cost of securing the benefits promised by the pension scheme. That claim is against the entity that employed the members under the pension scheme. However, despite Section 75 being the key “last resort” protection for pension scheme benefits (and in the absence of any other security negotiated by the trustees), the statutory claim only gives trustees ranking as an unsecured creditor of the insolvent employer.

Members of such pension schemes were given added protection when the Pensions Act 2004 gave the Pensions Regulator powers to issue financial support directions (FSDs) and contribution notices (CNs). This gave trustees comfort that the Pensions Regulator could, through issuing an FSD or a CN, give them access to the financial resources of entities other than just the employers under the pension scheme. This power was designed primarily to be used against companies in the same group where assets of the group were held away from the sponsoring employer company and out of reach of the trustees of pension schemes.

This Week’s High Court Judgment

The appointment of administrators in relation to Lehman Brothers Limited (LBL) on 15 September 2008 gave rise to a liability of £119 million (under Section 75) to the Lehman Brothers Pension Scheme (of which LBL was a sponsoring employer). The £119 million liability is a provable debt in the administration of LBL, and it is currently unclear as to what recovery will be made in relation to that debt.

Were the Pensions Regulator to seek to issue a CN in relation to this case, its power to issue a CN would be limited such that its amount could not exceed the liability under Section 75 (i.e., in this case, £119 million). However, there may be circumstances in which the Pensions Regulator has the power to issue a CN to more than one company or individual.

In the Storm Funding case, the High Court held that the legislation only limits the amount of each CN to the liability under Section 75. As a result, the Pensions Regulator could issue multiple CNs each for the total liability under Section 75 (assuming that to do so would be within the other limits placed on the Pensions Regulator’s power – such as the requirement for it to be reasonable for the Pensions Regulator to impose liability on the person to pay the sum specified in the notice).

The judge also held that, as well as issuing CNs which, in aggregate, amount to more than the liability under Section 75, it would also be possible for such sums that exceeded the liability under Section 75 to be recovered under those CNs.

Conclusion

The judgment in this case identified what could be seen as an oversight in the legislation, which only imposes a limit on an individual CN (rather than an overall, aggregate limit on all CNs issued in relation to a particular pension scheme).

However, the judge was clear in his view that “if it were intended that the total amount to be specified in the [multiple CNs] should not exceed [the liability under Section 75]…one would expect to see such limit expressly provided”. The judge was not, therefore, prepared to imply any such limit, despite the administrators’ arguments that he should.

This means that, where the insolvency process is drawn out (as in the case of Lehman Brothers), the Pensions Regulator could use, where relevant, multiple CNs to obtain funding for an amount above the liability under Section 75, so as to permit the actual scheme deficit to be recovered. One reason that the Pensions Regulator might seek to do this is that the liability under Section 75 is a calculation undertaken at a point of time. The actual amount required to fully fund the pension scheme can then (and often will) fluctuate significantly. Indeed, in the case of the Lehman Brothers Pension Scheme, the liability is estimated to have increased from £119 million (certified under Section 75), as at 15 September 2008, to being in the range of £214 million - £275 million by the first half of 2013.

Furthermore, this raises the possibility that, where a sponsoring employer in a group enters an insolvency process and a liability under Section 75 arises, potentially all the companies in the group could each be liable under a CN for the total Section 75 amount. This could result in each company in the group being pushed into insolvency because of the sponsoring employer’s insolvency.

As a result of this judgment, it could also be possible for the Pensions Regulator to be more creative in ensuring full recovery of the liability under Section 75. If, for example, the Pensions Regulator knew that the dividend payable from each company in a group of insolvent companies would be pennies in the pound, it could seek to issue a CN to each company for the full liability under Section 75. This would be on the basis that this could then ensure that the “inflated” total claim would result in dividends equalling (or exceeding) the Section 75 liability.

Given the potential impact this could have on insolvencies that involve groups of companies and defined benefit pension schemes, it will be interesting to see whether the Pensions Regulator issues any statement of its intended practice relating to the issuing of multiple CNs in reaction to this judgment (as it has done before).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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