‘Super Priority’ of Financial Support Directions Overturned in Supreme Court of England and Wales

by Reed Smith
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Summary

Yesterday, the Supreme Court allowed an appeal against the decision of the Court of Appeal (14 October 2011) which, in certain circumstances in an insolvency situation, would have accorded “super priority” to a financial support direction made by the Pensions Regulator.

Referring to it as “the sensible and fair answer”, the Supreme Court held that liability arising under a financial support direction made after an insolvency event has occurred will rank pari passu (i.e. equally) with other unsecured creditors (rather than constituting an expense of administration as the Court of Appeal had previously held).

This is because, even where a financial support direction is made after the insolvency event, the liability should properly be considered as having arisen “by reason of any obligation incurred before” the insolvency event.

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

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

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.

Trustees of such pension schemes were given added protection for the benefits of their members when the Pensions Act 2004 created the Pensions Regulator and gave him 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.

High Court and Court of Appeal Judgments

Recent case law, sparked by the high-profile collapses of the Nortel and Lehman groups of companies, had expanded the effect of these powers even further when the Court of Appeal confirmed that liability for an FSD issued after insolvency ranked as an expense of insolvency.

This interpretation was widely viewed as not representing the intention behind the legislation. Nonetheless, this was the only way that the judges involved felt they could interpret the law (even if their comments suggested that they did so reluctantly).

On the basis of the High Court’s and the Court of Appeal’s interpretation, the additional powers introduced under the Pensions Act 2004 therefore not only gave trustees access to a wider group of companies for funding (as was previously known), but also, unexpectedly, could give any such liability a higher ranking position on insolvency than a Section 75 claim.

Yesterday's Supreme Court Judgment

The Supreme Court unanimously allowed the appeal against the judgment of the Court of Appeal and held that liability arising under an FSD made after an insolvency event has occurred will rank pari passu (i.e., equally) with other unsecured creditors.

The Supreme Court took the view, by reference to the Insolvency Rules 1986 (Rules 12.3 and 13.12), that the liability arising from an FSD made after the insolvency date still fell into the category of a “debt” of the insolvent company.

This was on the basis of one of the limbs of the definition of “debt” which states that “debt” includes “any debt or liability to which the company may become subject after [the insolvency date] by reason of any obligation incurred before [the insolvency date]” (Rule 13.12(1)(b)).

The Supreme Court referred to the fact that the insolvent entity was, prior to insolvency, a member of a particular group of companies (which made it possible to impose liability through an FSD) and held that this must amount to a sufficient “obligation incurred” prior to the insolvency event (as required under Rule 13.12(1)(b) quoted above).

In addition, the Supreme Court held that, for a company to have incurred an “obligation”, it must normally have taken, or been subjected to, some step or combination of steps which:

a) Had some legal effect (such as putting it under some legal duty or into some legal relationship) – in this case, being part of the relevant group of companies was sufficient; and

b) Resulted in it being vulnerable to the specific liability in question such that there would be a real prospect of that liability being incurred – in this case, the fact that the group of companies met the key criteria for the imposition of an FSD was sufficient.

Consideration must also then be given to whether it would be consistent with the type of liability being imposed to conclude that it gives rise to a “debt” under the Insolvency Rules.

The Supreme Court’s view was that all these requirements were satisfied in relation to the FSDs against the Nortel and Lehman groups of companies.

As such, the liability would be treated as a “debt” of the insolvent company and therefore given the same priority as any other unsecured obligation that existed prior to insolvency.

This, the Supreme Court held, was “the sensible and fair answer”, and the answer supported by the law. Comment was also made that there was no reason why there should be any distinction in the priority order of a Section 75 claim and the liability under an FSD/CN.

Conclusion

For trustees of pension schemes, the Supreme Court’s decision means that the unexpected extra protection that may have resulted from the Court of Appeal’s judgment in 2011 has been removed. To obtain any priority for scheme funding on insolvency which is above that of being an unsecured creditor (either on the basis of Section 75 or an FSD/CN), trustees will therefore need to continue to negotiate with their sponsoring employers to obtain extra security where this is warranted.

Lenders, borrowers and insolvency practitioners alike will generally welcome the judgment. The Supreme Court’s decision means that companies which have a potential FSD liability should not find their access to funding impaired for this reason alone as lenders will have greater certainty as to the value of their security and their ability to enforce it. Insolvency practitioners will be better able to assess the risk of appointments to companies with such exposures, and will therefore be more willing to take such appointments.

However, the judgment will no doubt give rise to some further debates as to the nature of provable debts where companies are in an insolvency procedure and indeed what should be considered a contingent liability prior to administration or liquidation.

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.

© Reed Smith | Attorney Advertising

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