The Government recently published draft regulations to introduce a new way to avoid triggering a "section 75 debt" on an employer that ceases to employ any active members of a multi-employer scheme.
The Regulations would allow such an employer to enter into a "deferred debt arrangement" under which no immediate debt would be triggered on it ceasing to employ any active members, with the employer instead remaining liable to fund the scheme on an ongoing basis. The proposed changes have been particularly welcomed by participants in schemes for non-associated employers, where existing methods for addressing section 75 debts are often not workable.
A deferred debt arrangement does not remove the possibility of the employer being liable for a section 75 debt in future, so existing ways of addressing section 75 debts are likely to remain the preferred option where a company is being sold out of a group and the buyer wants to be sure it is taking the company free of any pension liability.
Under current legislation, an employer will be liable for a "section 75 debt" if it ceases to employ any active members in a multi-employer scheme in deficit while another employer continues to do so. The debt is calculated as a share of the deficit on a buy-out basis and may include a share of "orphan" liabilities that cannot be attributed to any existing employer. Such debts can be very substantial.
Existing legislation already contains mechanisms (e.g. a "flexible apportionment arrangement") whereby an employer can avoid liability to pay a full section 75 debt on ceasing to employ active members. However, a flexible apportionment arrangement is only possible where a remaining employer is willing to assume responsibility for the departing employer's pension scheme liability, meaning that it is not a viable option where the employers in the scheme are not associated with one another. The new "deferred debt arrangement" is being introduced in addition to the existing legal mechanisms for addressing section 75 debts.
The draft regulations have a coming into force date of 1 October 2017. The deadline for responding to the consultation is 18 May 2017.
New Deferred Debt Arrangement
The proposed new deferred debt arrangement (DDA) would allow an employer to continue as a scheme employer with ongoing funding liabilities, but with no section 75 debt triggered, where it ceases to employ active members while other employers continue to do so. The key requirements for entering into a DDA are:
- The scheme trustees agree; and
- The "funding test" is met. Broadly this means that the trustees must be satisfied that the employers will be reasonably likely to be able to fund the scheme so that after the DDA it will have sufficient assets to cover its "technical provisions" (i.e. the amount calculated by the actuary as being needed to fund the scheme's liabilities).
There are a number of events which will bring a DDA to an end, including:
- The employer starting to employ at least one active member of the scheme again (in which case the employer will be treated as if no debt trigger event had ever occurred);
- An agreement between the employer and trustees that the section 75 debt will be calculated and paid from a particular date;
- The scheme ceasing to have active members;
- The employer "restructuring"; and
- The trustees serving a notice on the employer stating that the DDA has come to an end. The trustees can serve such a notice if they are reasonably satisfied that the employer has failed to comply with its obligations under scheme funding legislation or that the employer's covenant is likely to weaken in the next 12 months.
In the event of the scheme ceasing to have active members, the employer "restructuring" or the trustees serving a notice bringing the DDA to an end, a debt trigger event will be treated as occurring at that point in relation to the employer subject to the DDA. The term "restructuring" is not defined - a significant ambiguity which will presumably be addressed in the final form regulations.
The issue of section 75 debts being triggered on an employer ceasing to employ active members has been felt particularly acutely in sectors where it is common for employers to participate in a defined benefit scheme for non-associated employers, e.g. the charities sector and those who have participated in the industry-wide scheme for plumbers. For employers participating in schemes for non-associated employers, who may until now have had no way of dealing with such debts, the proposed changes are likely to be seen as an important and welcome development. However, a DDA offers only a temporary reprieve from liability for a section 75 debt, as the potential remains for a section 75 debt to be triggered in future for reasons completely beyond the employer's control.
The DDA is unlikely to be widely used in the context of corporate transactions where an employer company is being sold out of a corporate group, as unlike a flexible apportionment arrangement, a DDA does not allow a buyer to take a company free of any pension liability.
Section 75 debts can sometimes be triggered inadvertently, e.g. on an employer's last active member leaving service. A DDA could be a useful way of managing such a situation in the short-term, but will result in the employer losing control of when the debt is ultimately triggered. A former employer in a "frozen" scheme (i.e. one that has ceased to have active members) normally has the option of crystallising a section 75 debt in relation to itself by giving notice to the trustees. However, an employer that is a party to a DDA cannot do this without trustee consent.