Pensions trustees’ ‘loan to own’ strategy: a trend to come?

Summary

Eastman Kodak Corporation (Kodak US), the US parent of the Kodak group, filed for chapter 11 protection in the US on 19 January 2012. It successfully emerged from bankruptcy on 3 September 2013 as a new restructured technology company focused on imaging for businesses. Many other Kodak companies throughout the world were able to avoid following in their parent’s footsteps and were maintained as going concern businesses while the US bankruptcy process was ongoing.

As a result of a restructuring deal agreed between the English Kodak entity, Kodak Limited (Kodak UK), Kodak US and the UK Kodak Pension Plan (KPP) (and approved by the US bankruptcy court), the KPP has acquired the global Kodak Personalised Imaging and Document Imaging businesses. The consideration for the purchase consisted of both cash and a settlement of KPP’s claims against Kodak US and Kodak UK. As part of the deal, Kodak UK is now free of all liabilities to the KPP.

Impact of the parent guarantee and interplay with the Chapter 11 process

Kodak UK maintained a final salary pension plan for its employees, the KPP, which had developed a significant funding deficit. As is increasingly common in pension structures, Kodak UK’s parent, Kodak US, had agreed to provide certain funding support regarding Kodak UK’s liabilities to the KPP. When Kodak US entered into bankruptcy proceedings, the KPP filed a claim in the US process and was the largest unsecured creditor in those proceedings with potential claims against Kodak US and Kodak UK in excess of $2.8bn.

Agreeing the KPP restructuring deal was therefore a key component to Kodak US successfully emerging from bankruptcy and the deal required the approval of the US bankruptcy court. The UK Pensions Regulator was involved in negotiations between the trustees of the KPP and Kodak US from an early stage. Clearance from the Pensions Regulator of the deal (ie confirmation that it would not use its ‘moral hazard’ powers against the Kodak group) and confirmation from the Pension Protection Fund (PPF) that it would not object to the Pensions Regulator’s clearance were conditions precedent to completion of the transaction. Unusually, the Pensions Regulator effectively gave advance clearance at the signing stage of the acquisition of the Kodak businesses on 26 April 2013 when details of the business acquisitions (and the underlying transaction documents) were not yet fully settled.

The advance clearance was important for the Chapter 11 process and meant that at the time the Chapter 11 disclosure statement in respect of the US emergence plan was filed in court by Kodak US (June 2013), the KPP deal had already been approved and signed on a conditional basis.

The Pensions Regulator reserved the right to object if the transaction changed materially between signing in April and completion in early September. Ultimately, the Pensions Regulator did not object to any changes and the transaction successfully closed on 3 September, as planned.

Settlement of Kodak’s pension liabilities in exchange for two businesses

The KPP was able to purchase two large Kodak businesses with reduced cash paydown by using debts owed by the Kodak group as consideration, thus mirroring ‘loan to own’ strategies and rationale from the private equity world.

It is unusual for pension trustees to give up all claims against the employer group and settle its pension claims by way of consideration for a business. In this case, the KPP bought the businesses to hold them under a separate vehicle. The KPP created a new company, Kodak Alaris, in which to hold the business under a licence.

In the past, it has been more usual for trustees to accept cash and shares in the restructured employer group. It is however not unprecedented for pension trustees to invest in assets in which the wider group has a stake – in 2012, the UK Coal Pension Scheme invested its own funds to acquire a majority interest in the property division of the UK Coal group.

Restructured KPP – reduced benefits but higher than PPF

As a result of the restructuring, members of the KPP will be given the chance to transfer to a new pension scheme, which is not expected to enter the PPF. Under the new scheme, scheme benefits for members will be lower than the unsustainable levels under the old KPP, however such benefits would still exceed the benefits members could expect if the KPP were to enter the PPF. The new scheme will be entitled to receive dividends from the two businesses acquired from Kodak and a share of the KPP’s existing assets.

Any members who do not wish to transfer to the new scheme will remain in the KPP, which, it is anticipated, will enter the PPF in due course. It has now been confirmed that more than three quarters of members of the KPP have agreed to transfer to the new pension scheme.

Does the Kodak settlement herald a new trend of pension plan trustees acquiring business assets from the plan’s sponsor to settle large pension debts?

It remains to be seen whether other pension funds see sufficient value/income generation potential in the businesses related to their employer groups to seek to acquire them at a heavily discounted price by using the debts owed by the employer group to them as part consideration.

For smaller schemes with little investment potential, this is unlikely. It is possible that the Pensions Regulator was willing to agree to an innovative, unusual solution for Kodak at least in part due to the sheer size of the deficit and the strain this would have placed on the PPF had the KPP failed. We expect that – perhaps counter-intuitively – the Pensions Regulator will continue to take a more conservative approach with smaller schemes in financial difficulty.

However, recently larger pension scheme trustees do seem to have been acting as one would expect any interested commercial players to act and are willing to take a more active role in restructuring the employer group.