Third parties associated with an employer may find themselves liable to contribute to the employer's occupational pension scheme. Where a pension scheme is in deficit, the Pensions Regulator has powers - so-called 'moral hazard' powers - that can require a third party to give financial support or a specific payment to the pension scheme.
For third parties and insolvency practitioners, the implications are wide ranging. This briefing highlights the commercial implications in light of a recent case and explains how moral hazard powers apply to a company in insolvency.
The Pensions Regulator (TPR) has powers to make third parties liable to provide support or funding to an occupational pension scheme in certain circumstances. Briggs J had to consider how a financial support direction (FSD) should be treated if issued against a company in administration. He considered the law to be in a mess and not fit for purpose but felt obliged due to binding case law to hold that:
a) such an FSD is not a provable debt in a company's insolvency (this is the case even though the facts giving rise to the FSD occurred before the insolvency commenced);
b) an arrangement entered into by the insolvency practitioner to comply with the FSD will constitute an expense of the administration (and as such is payable out of the assets in priority to floating charge assets, general unsecured provable claims and the insolvency office-holder's remuneration);
c) for administrations started prior to 5 April 2010, a contribution notice (CN) issued on a company when its administration has been converted into a liquidation, to enforce an FSD issued when the company was in administration, will be a provable debt in the company's liquidation;
d) a CN issued on a company in administration started post-5 April 2010 will rank as an expense of the administration/subsequent liquidation; and
e) the courts have power to prospectively order a change in the priority of expenses.
1. Commercial implications
We consider that the impact of Briggs J's decision is very wide ranging and affects many areas. These are the likely consequences:
a) where there is a risk of a pension deficit and subsequent FSD or CN imposition, the administrators may wish to be appointed by the court conditional upon the court granting an order varying the order of expenses so that they can fund the administration;
b) given the point above, insolvency practitioners are unlikely to be comfortable to take an appointment using the out-of-court appointment method of a company that has a pensions deficit (or is associated with an employer of a scheme that has one) and is potentially the subject of an FSD or CN;
c) administrators in existing (pre-5 April 2010) administrations will need to balance carefully the competing demands of unsecured creditors and the compliance with an FSD and will need to give thought to whether and when to convert an administration into a liquidation;
d) banks that have already lent to companies that may become the potential target of an FSD or CN will come under more pressure to agree a consensual deal rather than pursue an insolvency option, given that an insolvency is likely to reduce the banks' recoveries under the floating charge; this might also give out-of-the-money creditors more leverage in a situation where it would otherwise be necessary to put one of the employer companies into an insolvency process and where there is value in any of the associated companies that would otherwise flow to the lenders;
e) in future, banks lending to companies that are the potential subject of an FSD or CN will need, where possible, to consider structuring the lending by way of fixed charges as FSDs/CNs will rank as an expense of the administration and as such before any return for floating charge holders; and
f) insolvency practitioners may be more reluctant to effect a pre-pack administration of a company that is the possible target of an FSD or CN because the CN will rank as an expense of the administration/liquidation that will cause issues if there are any distributions out of the insolvent company, eg if the assets being sold are subject to floating charges.
Leave to appeal has been granted. Given the implications of the decision and the uncertainty it creates, there must be a real possibility that it will either be overturned by a higher court or parliament will come under pressure to legislate to overturn the outcome of the Briggs J decision - as, for example, parliament did in relation to rates following Exeter City Council v Bairstow.
2. Detailed analysis
Moral hazard powers
The Pensions Act 2004 gave TPR powers, if certain conditions are met, to make third parties who are connected or associated with an employer liable to contribute to a pension scheme where there is a deficit. These powers are generally called the 'moral hazard' powers. They are:
a) an FSD requiring the target to give financial support (eg a guarantee) in a form approved by TPR. If such support is not given, TPR may seek the imposition of a CN; and
b) a CN requiring payment of a specified sum by the target to the pension scheme.
Both CNs and FSDs depend on TPR considering that to issue one would be reasonable. For further background, see our briefing notes. The briefing notes can be found at www.freshfields.com/publications. Alternatively, please let us know if you would like to receive a copy of any of the briefings.
What if the target enters insolvency proceedings?
It is clear that if a monetary order is made as part of a CN before the target enters administration or liquidation, the relevant obligation is treated in the same way as any other unsecured debt.
But what happens if the FSD or CN is issued after the target has entered insolvency proceedings? This was the issue that Briggs J grappled with in the recent case Re Nortel GMBH; Bloom v The Pensions Regulator. Judgment was given on 10 December 2010.
Briggs J wrestled with the issues in his judgment of some 208 paragraphs. The judgment sets out the arguments advanced clearly. Unfortunately, Briggs J reaches a conclusion that he himself considers an impediment to the rescue culture in insolvencies, unfair on the creditors of the target company and probably inadvertent.
What are the options?
Briggs J considered three main options (a, b and d below) for an FSD or CN issued after a company is in an insolvency process (ie after the cut-off date for proving debts - usually the start of an administration or liquidation):
a) that the cost of complying with an FSD or CN was an expense of the administration or liquidation;
b) that the cost of compliance was a provable debt within the administration or liquidation;
c) that the court should direct compliance by the relevant office-holder under the principle in ex parte James5 (Briggs J dismissed this option briefly); and
d) that an FSD or a CN created a non-provable claim against the target company, payable (if at all) only out of any surplus available after full payment of all unsecured creditors.
a) Expense of administration or liquidation
This was the option argued for by TPR. The effect would be that any payments or obligations under the FSD or CN would rank as an expense and so be payable out of the assets of the target company in priority to the provable claims. The order of payment is set out in rules 2.67 (administration) and 4.218 (liquidation) of the Insolvency Rules 1986 (as amended). This would mean that the claims would rank ahead of some other expenses (eg the insolvency practitioners' remuneration).
Briggs J recognised that this would be an odd result. A CN or FSD in place before the start of the insolvency would rank alongside other unsecured creditors. Why should it get priority just because the order was made after the cut-off date? In addition, it does seem highly inconsistent with parliament's intention that the underlying section 75 debt on the employer is not a preferential debt.
b) Provable debt
Briggs J would clearly have preferred this as the outcome, being `obviously fairer' to the other creditors. However, he considered that he was forced by binding case law to hold that:
an FSD contained too much discretion of a judicial nature for it to be a provable debt; and if the FSD claim was not a provable debt, then it must be an insolvency expense - following the House of Lords in Re Toshoku.
d) Non-provable claim (and not an expense) - 'black hole'
Briggs J considered that the Pensions Act 2004 did not expressly exclude companies in insolvency proceedings being the target of an FSD or CN. Section 43(6)(a) refers to an issue against an employer and, according to Briggs J, this means it is clear that an FSD or CN can be issued against an insolvent employer. Given Briggs J's conclusion on the interpretation of Re Toshoku (see above), he dismissed the black hole option.
The judgment sets out the options argued clearly, but its conclusions create real issues for practitioners. We comment on the judges' reasoning below.
Briggs J is too cautious on the provable debt argument
a) The decisions of the Court of Appeal on provable debts are difficult to follow. Briggs J comments about his acute sense of discomfort on this and that it is `incomprehensible' as to why a court costs award should not be provable, but that one by an arbitrator is.
b) Briggs J felt he was bound by existing case law and that any change should be left to parliament, while hoping that a higher court may be able to find its way through.
c) This is a very cautious approach. Most of the case law looks at debts provable in a bankruptcy, not a corporate insolvency. As Briggs J notes, the two are different (a corporate insolvency is usually terminal, while in the bankruptcy the individual still lives). The only exception here is Day v Haine and even there the employment claim was held to be provable.
d) Norris J had held in another Nortel case that post-insolvency employee claims are provable. Briggs J refers to this but is unconvinced that the Court of Appeal cases can be distinguished. Briggs J does not refer to another decision of Norris J (in a capital reduction case) that potential claims by TPR are not to be considered provable - see Re Liberty International.
Finding that the FSD claim was an expense is illogical
a) Briggs J gave too great a weight to the comments in Re Toshoku that any statutory claim that is not a provable debt must be an expense. Lord Hoffmann made this comment in the context of a statute that specifically imposed a liability on a company in liquidation. It is not necessary to extend the expenses claim to all statutory claims including those that arise in an insolvency. The Pensions Act 2004 does not expressly state that a CN or FSD is enforceable against an insolvent company; hence, the statute is distinguishable.
b) Without a clear statutory provision, it is illogical to impose an expense priority on a claim that relates to facts and circumstances that pre-exist the cut-off date.
c) Briggs J declined to follow other case law that refused to make other claims expenses - eg Lawrence Collins J in Re Allders Department Stores. He did not cite some other employment cases - eg the Court of Appeal in Re Huddersfield Fine Worsteds (on employment claims as not an adoption expense) or Pumfrey J in Re Leeds United (damages for wrongful dismissal not an expense). This case law demonstrates that employment claims (and hence pensions claims?) can be distinguished from the Toshoku principles.
The consequences are messy
a) Elevating an FSD (or CN) to the status of an expense raises significant practical difficulties for administrators. Briggs J cites the comments of Alan Bloom (one of the Nortel administrators) as to the general effect upon the rescue culture of a conclusion that the FSD regime imposed financial obligations by way of expense as follows:
'i) Pending any decision by the Regulator as to quantum (either when considering whether to approve proposed arrangements or upon the issue of a CN) the administrators would be faced by a contingent liability with super-priority of an indeterminate but potentially crippling amount.
ii) That would in practice disable him from any informed judgment as to the choice between the alternative statutory objectives of administration, which would, in turn, disable him from the beneficial management of the company's business and affairs.
iii) An administrator would not know whether any dividend would be payable to unsecured creditors, nor even whether he would be able to discharge administration expenses in full.
iv) The uncertainty as to quantum, in the case of a substantial section 75 debt owed to the employer, might make it impossible for the administrator of the target to properly determine that its business should continue to be traded.
v) Potential administrators might be put off from accepting office in relation to associated companies of an under-funded employer in a group with a pension scheme in substantial deficit, because of the propensity for FSD obligations to impinge upon his ability to pay either himself, or his employees, remuneration.
vi) The recent strengthening of the rescue culture by the EU Insolvency Regulation in relation to associated group companies with centres of main interests in the United Kingdom would be undermined if, in cases like Nortel, it was perceived that companies under an English insolvency process were uniquely, or particularly, prone to attrition by the financial consequences of the FSD regime.'
Briggs J noted the concerns and commented that some relief could perhaps be given by a prospective court order modifying the priorities. But this seems unduly complex and it still leaves the unsecured (and floating charge) creditors subordinated.
a) TPR could recognise the effect of the expense priority by cutting back on any FSD or CN claim. But Briggs J noted that this may well be difficult. The obligation on TPR in the Pensions Act 2004 for TPR to 'have regard' to affected parties was not the same as balancing their interests. TPR's main objectives (set out in the Pensions Act 2004) are to protect members' benefits and reduce claims on the Pension Protection Fund.
b) In a pre-5 April 2010 insolvency, if an FSD is issued, the relevant enforcement CN could be reduced to being provable debt if the company enters liquidation before it is issued. However, this seems an odd process and will leave the insolvency practitioner having to balance carefully the rights of creditors in the insolvency.
Briggs J gave leave to appeal his decision to the Court of Appeal. He refused an application for leave to petition the Supreme Court for a 'leapfrog' appeal bypassing the Court of Appeal.
It is to be hoped that the Court of Appeal or Supreme Court (failing which, parliament) can find a more logical way through this mess.