The UK Pensions Regulator (the Regulator) has just announced that it has reached a settlement with the intended target of its first Contribution Notice (CN), with the result that the CN has been issued, but for a far lower amount than the Regulator originally sought. This case gives important guidance on the situations in which the Regulator believes it will be justified in issuing a CN, and on the potential liabilities targets may face.

The Moral Hazard Powers

The power to issue a CN is one of the Regulator’s two key “moral hazard” powers, the other being the power to issue a Financial Support Direction (FSD). Under these powers, if the Regulator considers a pension plan is at risk (e.g. because the plan is underfunded or because a transaction could be considered detrimental to the plan, for example because it will introduce additional secured debt into the group), it can serve a CN or FSD on any employer that participates in the plan, or on any entity which is “connected” or “associated” with that employer.

The definition of connected or associated is very wide and includes all companies in the same group as the employer (above and below the employer in the chain) and any person that controls 33 percent or more of the voting power, or is a shadow director of the employer or its parent. CNs (but not FSDs) can also be served on individuals (including directors of group companies or their families). The affected party would be required to pay a sum of money into the plan on the issuance of a CN. On the issuance of an FSD, the party would be required to put support arrangements in place for the plan, such as a guarantee or letter of credit.

The recipient of a CN could be required to make a contribution to the plan of an amount of up to the buy out (or termination/insolvency) deficit in the plan. This will be higher, often significantly, than the IAS19 or FRS17 plan deficit. A CN can be issued where the recipient was party to an act or deliberate failure to act and:

  • The “material detriment” test is met, where the Regulator considers that an act or omission has had a materially detrimental effect on the likelihood of plan members receiving their benefits (although this test only applies to acts occurring after 14 April 2008 and therefore was not applicable in the case considered in this Client Alert) or
  • The main purpose or one of the main purposes of the act or failure was:
  • To prevent the recovery of the whole or part of a debt that was, or might become, due from the employer to the plan or
  • To prevent such a debt becoming due, to compromise or otherwise settle such a debt, or to reduce the amount of such a debt, which would otherwise become due

As well as requiring an act or omission that falls within the definitions outlined above, the Regulator cannot issue a CN unless it would be “reasonable” to do so. In determining this, the Regulator will consider, among other things, the degree of involvement the person had with the act or failure to act and the relationship the person has or had with the employer in the plan.

The Bonas Case

Bonas UK Limited (Bonas) operated a defined benefit pension plan. Its parent company was Michel Van De Wiele NV (VDW), a Belgian entity, and Mr Beauduin was Bonas’ managing director and VDW’s chairman. Throughout its ownership of Bonas, VDW provided financial support to Bonas, but the growing pension plan deficit still became a significant drain on Bonas’ resources.

Bonas’ management and VDW came to the conclusion that the current situation was not sustainable, and VDW decided to investigate the options for putting Bonas into a formal insolvency process. The funding position of the plan continued to deteriorate, and it became clear significant additional contributions would be required from Bonas.

The board of VDW voted to put Bonas into administration, and the Bonas board reached the same decision in late 2006. The restructuring took the form of a pre-pack administration whereby Bonas’ business and assets were transferred to a new company also owned by VDW, and the pension plan and its liabilities were left behind in the insolvent Bonas. The plan entered an assessment period to determine whether it was eligible to enter the Pension Protection Fund (the PPF), which takes on the assets and liabilities of underfunded plans with insolvent employers. One of the Regulator’s stated aims is to protect the PPF.

The Regulator started investigating the matter, and its determinations panel ultimately made the decision in 2010 to issue a contribution notice against VDW for approximately £5 million. This sum was the amount necessary to be paid into the plan to bring it to the level of solvency required so it would not be taken over by the PPF. The Regulator had also originally intended for the CN to be issued against Mr Beauduin, but the panel rejected this on the basis that he had been acting as a director and not in any personal capacity.

The panel held that the pre-pack was deliberately entered into to rescue the business without its pension liabilities, and that this intention was withheld from the trustees of the plan, who were not consulted. VDW had also been made aware of the risk that the Regulator might use its powers and had ignored this risk. The panel’s view was that VDW had chosen not to engage with either the trustees or the Regulator with the purpose of avoiding liability to make any future payments to the plan. In addition, the sum sought in the CN was reasonable as VDW had been warned that making the plan solvent on the PPF basis would have been the likely cost of obtaining clearance from the Regulator for the pre-pack, should clearance have been sought. In addition, the panel took into account VDW’s financial position, its close degree of involvement with the relevant act, its close association with the plan and its control of Bonas (in particular its control of all aspects of the pre-pack sale and the abandonment of the plan).

The panel rejected VDW’s argument that only Bonas had a legal obligation to make payments to the plan. VDW contended that as Bonas was insolvent, no further payments were possible, so any debt to the plan would not have been recoverable anyway. Therefore VDW’s actions did not “prevent” a recovery of the debt. The panel also rejected a further argument by the Regulator that the pre-pack sale was at an undervalue, as the Regulator had not raised this argument prior to the panel hearing.

The Strike-Out Application

VDW appealed and applied to the Upper Tribunal of the Tax and Chancery Chamber for an order to strike out the CN. The Regulator counter-claimed that the amount of the CN should increase to the size of the buy-out deficit — approximately £20m. The strike out application failed, with the Judge holding that there were complex issues to be considered which should be heard at a full appeal hearing.

The Judge, at a hearing in January 2011, concluded that there were three key acts involved that needed to be assessed in determining liability and the appropriate amount of the CN.

Act 1 — Failure to Engage with the Trustees and the Regulator

The Judge held that in considering the impact of this act on the plan, the key point was whether, if such engagement had taken place, the plan would have recovered more than it did in the ultimate insolvency of Bonas. That would involve assuming VDW would have agreed to pay an additional sum to the plan when it was not legally obliged to do so. It was difficult to see whether this conclusion could in fact be reached.

Act 2 – Minimising the Sum Paid For the Business in the Pre-Pack

At the time of the hearing, there was no independent evidence as to whether the amount paid for the business was in fact less than it should have been (unsurprisingly, the administrator’s view was that the consideration paid was reasonable). The Judge commented that even if it was less, given the market value of the business was low (not more than £100,000), in his view the Regulator could only seek a CN for the amount of the difference between the true value and the value actually received. This would be in the tens of thousands rather than millions of pounds.

Act 3 – Retaining the Business in the Group While Avoiding Ongoing Pension Liabilities

As a result of the pre-pack, the pension plan would not receive any more ongoing contributions. It is not clear whether that fact actually brings the act within the CN regime, as one reading of the legislation is that there would need to be some form of avoidance of the buy-out debt as opposed to just a cessation of contributions for the regime to apply. In addition, the Judge considered that the Regulator would need to show that if the pre-pack had not occurred in the way it did, Bonas would have continued to pay ongoing contributions to the plan. However, it was clear Bonas did not have the funds to do so. In the Judge’s view it was “highly questionable” that a CN could be issued against VDW on the grounds that it could have chosen to put Bonas in funds to pay the contributions but did not do so, because VDW had no legal obligation to provide such support.

The Judge therefore seemed to be suggesting that even if the full hearing concluded that a CN could be issued, the correct amount of the CN would be far lower than the Regulator was seeking, if anything at all. It was important that the amount of any CN should be proportionate to the detriment caused by the act in question, rather than imposing a penalty.

The Settlement

The Regulator announced on 9 June 2011 that the matter had settled and that it would not therefore proceed to a full hearing of the Upper Tribunal. As a result of the settlement, VDW will be issued with a CN for £60,000 — a significant reduction from the amount originally sought. The CN has been issued on the basis that VDW minimised the amount paid for the business in the pre-pack administration.

Despite the reduction in the amount of the CN, the Regulator also commented that the Judge’s observations in the strike-out application hearing regarding the amount that can be demanded under a CN must be viewed in the context that they were obiter statements (i.e. not directly relevant to the issues that Judge was deciding) and further were specific to the facts of the Bonas case. The Regulator has stated that it does not consider that a CN must be limited to compensation for the detriment caused to the pension plan by the relevant act, although this will be something the Regulator considers when assessing reasonableness. In the Regulator’s view, the Judge did not mean the use of a CN to be restricted in this way, and the Regulator will not consider itself so restricted in its approach to CN cases, including other pre-pack cases.

This settlement unfortunately means that we will not have the benefit of the full appeal hearing and detailed consideration of the various issues raised in the strike-out application. However, the case is interesting as it is the first of its kind, and it provides some useful guidance as to factors companies should consider when looking at options to deal with their underfunded UK defined benefit pension plan. Whether the Regulator will in future successfully issue a CN for the full buy-out deficit against a connected or associated party remains to be seen.