This briefing looks at the “period of grace” provisions that can apply in some cases to the debts that arise on employers under section 75 of the Pensions Act 1995.
In a multi-employer scheme, if one employer ceases to employ any active members, a s75 debt can arise on that employer. The period of grace provisions allow the employer to serve a notice so that the debt is suspended, giving the employer a period (at least a year, but potentially up to three years if the trustees agree) in which to employ an active member.
If the employer does employ an active member within the grace period, the potential s75 debt trigger is cancelled. There are various conditions for this, including service of a notice on the trustees within two months of the cessation date and there being no intention for the scheme to become a frozen scheme.
If the employer fails to employ an active member within the grace period (or enters an insolvency process), the grace period is cancelled and the original s75 debt revived.
This briefing sets out when a period of grace notice can be used, the necessary requirements for an effective period of grace notice and the effect of a grace period.
Section 75 and ECEs
When an employer in a multi-employer defined benefit occupational pension scheme ceases to employ active members of the scheme (e.g. the last active member employed by that employer leaves employment or retires or dies), an “employment-cessation event” (ECE) will usually occur – 2005 Employer Debt Regulations.1
The effect of this is usually to trigger a debt (a “section 75 debt”) under section 75 of the Pensions Act 1995. This is a debt obligation on the leaving employer to pay a share of the total funding shortfall (calculated on a buy-out basis) in the scheme. This can result in significant payments becoming due – see our Briefing no 214: “Multi-employer pension schemes and s75 debts – the elephant trap”.
An employment-cessation event only occurs at this stage if there is at least one other employer who continues to employ active members in the scheme. So if the scheme freezes (i.e. all active members cease to be active members at the same time) no employment-cessation event occurs at that time. But the last employers remain deemed to be employers for relevant statutory purposes (e.g. statutory funding obligations under Part 3, Pensions Act 2004) and remain potentially liable for a s75 debt if another trigger later occurs (e.g. the scheme starts to wind-up).
Period of grace - overview
In order to offer some flexibility to employers when an ECE occurs, regulations introduced from 6 April 2008 a “period of grace” for:
- an employer who ceases to employ active members2 in a scheme, but
- who intends to employ at least one person as an active member within a limited period (originally 12 months, but now extended to up to three years following the amendments to the regulations taking effect in 2012).
The period of grace is designed to protect employers from unintentionally triggering a section 75 debt when ceasing to employ active members. It may also be useful in respect of employers/workers in seasonal industries.
Under the period of grace provisions, the employer is able to:
- suspend the section 75 debt by serving a notice (a period of grace notice) on the trustee(s) of the scheme; and
- cancel the ECE (and s75 debt) if the employer employs an active member during the period.
When such a notice is served, the regulations provide that the employer will be “treated for a period of grace as if he employed a person who is an active member of the scheme,” subject to certain conditions.
If the employer fails to employ an active member within the grace period (or enters an insolvency process or changes its intention to employ an active member), the grace period is cancelled and the original s75 debt revived (based on the original ECE and cessation date).
Circumstances where a period of grace will be available
A period of grace can be available if a situation arises where:
- an employment-cessation event occurs. This occurs where there is a multi employer scheme and “the employer has ceased to employ at least one person who is an active member of the scheme and at least one other employer who is not a defined contribution employer continues to employ at least one active member of the scheme”. The date of the ECE is the cessation date; and
- the employer gives the trustees a period of grace notice within the relevant time.
- The notice must be given to the trustees before or on the cessation date or before the date which is two months after the cessation date.
- A period of grace notice is a written notice that the “employer intends during the grace period to employ at least one member who will be an active member of the scheme”; and
- the employer intends to employ at least one person who will be an active member; and
- the scheme is not a frozen scheme and there is no intention for it to become one during the grace period – see below.
Requirements for serving a valid period of grace notice
The employer must notify the trustee(s) or manager(s) of the scheme of its intention to “employ at least one person who will be an active member of the scheme.”
This notice must be in writing and given by the employer to the trustee(s) or manager(s) either before, on or within two months after the cessation date.
If an employment-cessation event has occurred (and so a section 75 debt has been triggered) but this is not discovered until more than two months has elapsed, the grace period provision will not be available. The Trustee has no power to agree an extension of this initial two month time limit.
If the two month time limit was missed, the employer would need to pay the s75 debt or seek to agree an apportionment arrangement with the trustee (if possible). See our Briefing no 216, “Dealing with a s75 debt – apportionment and withdrawal arrangements”.
For this reason, where it is contemplated that a grace period may be needed, without the date of triggering the section 75 date being known, a form of grace notice may be provided to the trustees in advance to preserve the position.
There is no requirement for the trustees to consent to the period of grace. The trustees merely have to be given the notice. But trustee consent is needed:
- if the grace period is to last for longer than one year; or
- if trustee agreement is needed because the scheme needs to be amended to allow a new entrant.
There is no requirement to notify the Pensions Regulator.
Frozen and closed schemes
If all the employers have already ceased to have active members in the Scheme, this will mean that the Scheme will be a “frozen scheme” and the period of grace will not be available. In practice if a scheme freezes there is usually no need for a grace period as an employment-cessation event (the relevant s75 trigger) cannot occur.
In addition, a period of grace notice can only relate to a scheme where the employer “is not aware of any intention for [the Scheme] to become a frozen scheme during the period of grace”.
Note that it is not clear from the drafting of the Regulations who needs to have such an intention (e.g. does it refer only to the intention of the employer itself, or is it all of the employers in the scheme? Or the principal employer only?)
The grace period provisions will be more difficult where a multi-employer scheme is closed to new entrants (but still has active members – so is a closed scheme rather than a frozen scheme).
- One solution would be if the employer can arrange to employ someone who is already an active member of the scheme, such as an employee of another group company.
- The alternative may be to arrange for the scheme to re-open to a new entrant, but care needs to be taken in such a case:
- an amendment to the scheme may be needed if the scheme has been formally closed. Often such an amendment will need the agreement of the trustee.
- the exemption from the prohibitions on age discrimination for a scheme or section closed to new joiners may cease to apply. The impact of this would need to be considered.
Chart on availability of grace periods
Establishing if a grace period is available:
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Length of grace period
The grace period runs for the longer of:
- up to 12 months starting from the employment-cessation event; and
- a longer period (up to 36 months) if the trustees agree – this was a change introduced in 2012.
The grace period ends if the employer starts to employ an active member of the Scheme. This means that a new grace period must be started if that member ceases to be an active member even before the end date for what would have been the old grace period.
The grace period can only last for longer than one year, if:
- the trustees nominate a longer period in writing; and
- the nomination is made before the end of the current grace period.
This means that any initial extension beyond the 12 month default grace period would need to be agreed prior to the end of the 12 month period. The Regulations also allow further extensions to be agreed (subject to the overall limit of 36 months post the employment-cessation event), provided again that the extension is nominated in writing before the end of the previously applicable end date for the grace period.
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Effect of Grace Period
During the grace period the (ex) employer is treated as remaining an employer for section 75 purposes and during that period no s75 debt is triggered on the employer ceasing to employ active members.
However, the grace period will be ineffective (and a s75 debt will arise as at the original cessation date) if the employer:
- does not employ an active member in the scheme before the end of the grace period; or
- enters an insolvency process (e.g. liquidation, administration); or
- changes its intention during the grace period to employ an active member. In this instance, the employer must notify the trustee(s) that it no longer intends to employ any active members.
In these three scenarios, the grace period will end. The section 75 debt will be calculated as if the grace period had never applied and will arise as at the date of the original employment-cessation event.
Therefore, it is not possible for employers to use a grace period to alter the time at which the section 75 debt is calculated if no active member is ultimately employed during the grace period.
There is no provision for interest to be paid on section 75 debts, so the effect of the grace period ending (with the s75 debt reviving) is not to increase the amount payable. The leaving employer will usually be deemed to remain an employer for statutory purposes (e.g. moral hazard powers, employer-related investment) until the section 75 debt is actually paid.
Once the employer employs an active member of the scheme, either before or after notice is given, the period of grace comes to an end and the employer is treated as though the original employment-cessation event had not occurred. As the employer remains an employer in the scheme, it has a contingent section 75 debt in the future if a later trigger occurs (eg a further employment-cessation event or an insolvency event of the employer).
Outcomes of grace periods
During grace period:
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Moral hazard powers
Section 38 of the Pensions Act 2004 provides that the Pensions Regulator (TPR) may issue a contribution notice on an employer of a defined benefit pension scheme if TPR is of the opinion that the employer was a party to act in relation to which one of the main purposes is to prevent the recovery of the whole or part of the section 75 debt due from the employer, or the act has the effect of preventing such a debt becoming due or otherwise settling or reducing the amount of such debt.
Where the grace period provisions are used but do not, in the end, apply to defer the section 75 debt (because the employer is unable to employ at least one active member within the grace period), the original section 75 debt will be calculated as at the employment cessation event date. It seems, therefore, that in this scenario and in relation to the use of the grace period alone, there would be little scope for TPR to argue to that it is able to exercise its moral hazard powers. This is because the use of the grace period does not ultimately reduce or prevent the section 75 debt from arising.
Similarly, where the grace period provisions are successfully used to defer a section 75 debt, the regulations provide that no section 75 debt is deemed to have arisen. There therefore seems to be no scope for TPR’s moral hazard provisions to apply simply because a grace period notice is given.
Summary of factors to be taken into account when considering whether to issue a period of grace notice
As explained above, the grace period is intended to alleviate the accidental triggering of an employer’s section 75 debt. This helps reduce the risk for employers with only few active members if they were all to leave and the employer then having to pay the debt when new employees are still expected to join in the near future.
Therefore, if an employer’s intention is to defer triggering the section 75 debt, the period of grace acts as a useful mechanism to do so. It is not however, a mechanism by which an employer can circumvent or eradicate the section 75 debt. Employers will therefore need to be careful to use the period of grace provisions in the appropriate manner.
Timing is also a very important issue for employers when considering when to issue a period of grace notice. There are no restrictions on when an employer can issue the notice before an employment-cessation event occurs. But when an employment cessation event does occur, the employer will only have two months from the date of the employment-cessation event to issue the notice.
The grace period provisions will be more difficult where a multi-employer scheme is closed to new entrants. They could still apply if (say) the employer can employ someone who is already an active member, such as an employee of another group company.
If the employer expects to become insolvent, or is likely to have difficulty in employing an active member within the grace period, the grace period will potentially only be useful in delaying the debt, given that the debt will be treated as having arisen as at the date of the original cessation event if an insolvency event occurs in relation to the employer or if no active member is ultimately employed during the grace period.