The Pensions Regulator has issued a statement setting out its approach to Financial Support Directions in insolvency situations. It follows the Court of Appeal's decision in Bloom v The Pensions Regulator (Nortel) in October 2011 that a liability arising from a Financial Support Direction (FSD), or a contribution notice (CN), issued to a company in administration or liquidation will, except in very limited circumstances, amount to an expense of that administration or liquidation. As such, it will rank very highly in the payment priority order, in particular ranking ahead of Administrators' fees and lenders' floating charges.
The uncertainty of whether an FSD will be issued and the priority ranking it will receive if it is issued may frustrate the administration process wherever a defined benefit pension scheme exists; in particular because Administrators are likely to be reluctant to accept an appointment in circumstances where they may not be able to discharge their fees and expenses. The decision has also made lenders more reluctant to lend to businesses with defined benefit schemes as the liability under an FSD or CN will rank ahead of floating charge realisations and any unsecured debt the lenders might hold.
The statement seeks to provide reassurance to lenders and insolvency practitioners that the Regulator does not intend to "frustrate" the proper workings of the restructuring and rescue culture and the lending market. This is to be commended but the statement falls some way short of providing the level of certainty that lenders and insolvency practitioners might want. In this briefing, we look at the statement in detail and consider what comfort may actually be drawn from it by lenders and insolvency practitioners in the post Nortel/Lehman landscape.
A Financial Support Direction is issued where the employer in relation to the scheme is a "service company" or is "insufficiently resourced" (within the terms of the Pensions Act 2004). It requires the person on whom it is imposed to put forward a proposal to put in place financial support for a defined benefit pension scheme in order to address funding deficiencies. It may be issued to an employer and anyone connected or associated with the employer (but generally not to individuals).
The statement in a 'nut-shell'
These are the key points from the statement:
- Where an FSD is to be issued, the Regulator has no intention of delaying its issue until after an insolvency event purely so that the FSD may be treated as an expense of the administration or liquidation and have priority over unsecured creditors.
- Where an FSD is issued after an insolvency event but is based on facts and matters which occurred before then, a relevant factor in assessing what financial support is reasonable would normally be the priority position had the FSD been issued before the insolvency event. In other words, a key consideration will be the amount that the scheme would have received under an FSD if it were simply a provable debt.
- The Regulator will have regards to other creditors' claims in assessing whether a proposal for financial support for an insolvent company is reasonable. This will include consideration of the return that the unsecured creditors would receive had the FSD been issued before the insolvency event. According to the Regulator, this will result in a level of support which achieves "broad equity between the trustees of the scheme and unsecured creditors of the FSD recipient".
Taking these factors into account, where an insolvent FSD recipient has submitted proposals for financial support, it is "highly unlikely" to be reasonable for the Regulator to insist upon a level of support which would leave the Administrator out of pocket and unsecured creditors without any return as a result of the FSD.
- In most circumstances, the Regulator will not seek to object to a subordination of the FSD liabilities behind the Administrator's reasonable remuneration where the Administrator makes a Court application to vary the priority order or administration expense to further the purpose of the administration.
- Regarding its approach to the appeal to the Supreme Court in the Nortel/Lehman litigation (scheduled to be heard on 14 May 2013), the Regulator states:
"The Supreme Court may decide that FSD liabilities are provable debts. The regulator will argue for that outcome as an alternative to administration expenses".
Though somewhat ambiguous, we understand this to mean that, while the Regulator will argue in the Supreme Court in favour of upholding the Court of Appeal decision that FSD liabilities are an administration expense, in the event the Supreme Court is not minded to uphold that decision the Regulator will argue in the alternative that they be treated as a provable debt i.e. there should be no "black hole" as to the priority status of FSDs following the Supreme Court's decision. (For our briefing on the Court of Appeal decision in Nortel, click here)
- The statement also has a useful reminder that an FSD does not contain an order for any specified amount or form of support to be provided and does not create an immediate obligation to pay money. The Pensions Act 2004 is flexible as to the form and amount of support that can be proposed by the company on whom the FSD has been imposed and approved by the Regulator. The only case to date where financial support has been offered by a company in insolvency proceedings and approved by the Regulator was in the form of shares in the company which emerged from the bankruptcy proceedings as a going concern. The value of the shares was significantly less than the scheme's section 75 deficit. We assume this was in relation to the FSD imposed on Sea Containers Ltd in 2008.
The statement will not give any real comfort to banks and other lenders that have already offered loans secured by floating charges or are proposing to do so. It does not appear to deal with the position of secured creditors at all, only unsecured creditors.
Nor will the statement provide any real certainty for lenders as unsecured creditors. While the statement that the Regulator will aim for broad equity between unsecured creditors and the trustees of the scheme is welcome, this is no guarantee of how the Regulator will act in individual cases and the Regulator does not have an unblemished record when it comes to sticking to its statements. It is worth remembering that, in Sea Containers, the Regulator said "it was not part of its function to put scheme trustees in a position of super priority", yet that is exactly what it seeks to do before the Supreme Court in Nortel.
Also, the expectation of equitable treatment seems to be limited to how liability under an FSD will rank as among other unsecured creditors, not on the issue of which entities may be made subject to an FSD. It continues to be completely open to the Regulator to issue FSDs on every company in a group and then recover from each of those companies on the equivalent of an unsecured basis (providing the Regulator is able to satisfy the reasonableness requirement for imposing the FSD). This element of uncertainty therefore remains for lenders.
We continue to think that a properly drafted intercreditor agreement with the trustees is a necessity for lenders who want to fix the way in which they and the trustees share any recoveries from insolvent companies. Such intercreditor agreements have the potential to avoid, contractually, the uncertainty created by the existence of a pension scheme and the possibility of a FSD or CN.
Administrators may be able to draw comfort from the Regulator's statement that in "most circumstances" the Regulator will not seek to object to a Court application from an Administrator to vary the priority order of administration expenses. However, this is only useful to the extent that the Regulator considers the Administrator's expenses to be "reasonable" - a subjective criteria – and the implication is that if the Regulator does not consider the expenses to be reasonable, it may oppose the application. We are aware of this actually happening in practice. The default position provides substantial leverage for the Regulator to seek to impose its will on the conduct of an administration. It is open to the Regulator, for instance, to argue that it is not appropriate for an Administrator to seek to challenge a FSD or CN and that its fees in doing so are not "reasonable". The Regulator's statement in relation to reordering priorities also fails to recognise the practical issues which may arise out of such an application. For example, where there is an urgent need for an Administrator to be appointed to protect creditors, a pre-appointment reordering application would add an extra administrative hurdle and costs, and it is unclear whether it would be necessary to join potentially affected third parties to the application.