In related Nortel and Lehman Brothers cases, the UK Supreme Court ruled in July that Financial Support Directions ("FSDs") and Contribution Notices ("CNs") under the Pensions Act 2004 rank as provable debts if issued against insolvent targets.

Overturning the decisions of Mr Justice Briggs and the Court of Appeal, the Supreme Court has ruled that such FSD or CN liabilities are not administration or liquidation expenses. It has also confirmed that they do not rank behind other provable debts (the option which had become known as the 'black hole').

This decision balances the competing interests of both pensioners in under-funded pension schemes and other creditors of an insolvent target company, and provides clarity for both insolvency office holders / lenders and pension scheme trustees.

Brief Context

The UK Pensions Regulator has a statutory power to issue FSDs and CNs against group companies which it considers ought to provide financial support to under-funded defined benefit pension schemes. The aim of those provisions is to ensure that, if a corporate group is run in a manner which leaves the employer company unable to fund its pension scheme properly, other group companies can be directed to support the scheme in appropriate cases.

This regime protects both pension scheme members and the UK Pension Protection Fund ("PPF"), which might otherwise have to assume certain liabilities of an under-funded scheme if it cannot be supported by the employer company.

In the Nortel and Lehman Brothers cases, the Pensions Regulator pursued FSDs against various group companies. That process only began after the relevant target companies had themselves entered administration, even though the case related to the way in which each group was run pre-insolvency.

In essence, the Supreme Court was faced with three competing arguments:

  1. the FSD or CN liability is a provable debt in the target company's administration (or liquidation, as the case may be);
  2. the liability ranks as an expense in the relevant administration or liquidation, thereby falling to be paid ahead of unsecured creditor claims; or
  3. the liability is neither an expense nor a provable debt, and only falls to be met if there is a surplus once all other expenses and unsecured creditor claims have been paid (an outcome which Lord Neuberger recognised meant that the FSD or CN "would probably be worthless").

In both courts below, the judges (in part constrained by earlier case law) had concluded that FSD/CN liabilities ranked as expenses.

The Supreme Court Decision

The Supreme Court unanimously ruled that if an FSD or CN is issued to a company which is already in administration, the resultant liability ranks as a provable debt in that insolvency process.

In the leading speech, the President of the Supreme Court, Lord Neuberger, began with a number of key points:

"… the sensible and fair answer would appear to be that the potential liability of a target, under a FSD issued after an insolvency event … should be treated as a provable debt. There seems no particular sense in the rights of the pension scheme trustees … having any greater or any lesser priority than the rights of any other unsecured creditor." "It also seems unlikely that it can have been intended that liability under the FSD regime could rank behind provable debts. One would have expected that FSDs and CNs would normally be issued in respect of insolvent companies … ; accordingly, [such an approach] would mean that, save in very unusual cases, nothing would be paid in respect of most FSDs issued after an insolvency event."

The critical legal issue turned upon Rule 13.12 of the Insolvency Rules 1986. In essence, that Rule provides that a provable debt in an administration must be either:

  1. a liability to which the company is subject at the date on which the company went into administration; or
  2. a liability to which the company may become subject after that date "by reason of any obligation incurred before that date".

Lord Neuberger agreed with both courts below that limb (a) was not applicable in circumstances where no FSD had been issued as at the date of administration.

As regards limb (b), each of the courts below had concluded that where an FSD is issued after a company has entered administration, there was no "obligation incurred" before the administration date.

The Supreme Court took a different view on this critical point, which effectively decided the appeal. Lord Neuberger and Lord Sumption (the only other Law Lord to deliver a speech) both held that by their conduct, the relevant target companies had incurred a sufficient contingent obligation prior to the administration date such that the resultant FSD liability would be provable. The target companies had operated as part of a group to which the FSD statutory regime applied alongside the relevant employer company whose financial position satisfied the relevant FSD tests.

As Lord Neuberger put it:

"… by the date they went into administration, the group concerned included either a service company with a pension scheme, or an insufficiently resourced company with a pension scheme, and that had been the position for more than two years. Accordingly, the Target companies were precisely the type of entities who were intended to be rendered liable under the FSD regime … In other words, the Target companies were not in the sunlight, free of the FSD regime, but were well inside the penumbra of the regime, even though they were not in the full shadow of the receipt of a FSD, let alone in the darkness of the receipt of a CN."

In reaching this conclusion, the Supreme Court overruled a number of previous cases, including Court of Appeal authorities, which had appeared to adopt a different approach to the assessment of an 'obligation incurred'.

Implications

From a pensions perspective, this result is a welcome recognition of the importance of the FSD/CN regime. There had been grave concern that, had FSDs and CNs been consigned to the 'black hole' in priority terms, a key tool for the protection of pensioners would have been redundant in cases where it is most needed and most commonly used. From the outset, the 'pension parties' in this case had argued that the liabilities must either be expenses or provable debts, so as to ensure the effectiveness in insolvency of these important statutory provisions.

Likewise, it seems likely that this result will be welcomed by the finance and insolvency community. Previous concerns had been expressed at the Court of Appeal's conclusion that FSDs and CNs rank as administration expenses, ahead of (for example) creditors with floating charges. The Supreme Court has now removed that perceived threat, striking a balance which gives effect to FSDs and CNs in an insolvency context whilst also recognising the interests of other creditors of the target company.