Relief for lenders and administrators as UK Supreme Court reverses “super-priority” status of pensions liabilities in insolvency ranking.

After four years of litigation, common sense has prevailed in the Supreme Court on the issue of “super-priority” of the Pensions Regulator’s moral hazard powers on insolvent companies. The judgment handed down on 24 July 2013 overturns the Court of Appeal’s decision and confirms that liabilities imposed by the Pensions Regulator on companies in administration are not an expense of the administration but should in fact be treated as a provable debt and therefore rank equally with other unsecured creditors. The Court explicitly stated that “there seems no particular sense in the rights of the pension scheme trustees … having any greater or lesser priority than the rights of any other unsecured creditor.”

Background

The Supreme Court’s long-awaited decision concerns the occupational pension plans of Nortel and Lehman Brothers. At the time of entering into administration, Nortel and Lehman Brothers had pension plan deficits of £2.1bn and £120m respectively. The Pensions Regulator subsequently determined that Financial Support Directions (FSDs) should be issued to various companies within each group (but not to companies that actually participated in the plans).

As discussed in more detail in the Client Alert we published in October 2011, the High Court and the Court of Appeal found that, notwithstanding that a pensions deficit ordinarily ranks pari passu with a company’s other unsecured creditors as expressly set out in the relevant legislation, the liabilities imposed by an FSD that was issued to a company after it had commenced the insolvency process should be classified as an expense of the administration. In other words, liabilities imposed by the Pensions Regulator on non-employer group companies which had already appointed administrators were deemed to have “super-priority” over preferential creditors, floating charge holders and other unsecured creditors, meaning FSDs would rank higher in the insolvency of non-employers than any claims of the pension plan itself would rank against the employer company.

The Court of Appeal had, at the time, conceded that this outcome was incongruous and commentators had expressed concern that banks would become less willing to lend to businesses with occupational pension plans, and that administrators would not accept such appointments as their own expenses would also rank below the FSD. The Pensions Regulator offered assurance that it would not abuse its position by deliberately delaying exercising its moral hazard powers in order to take advantage of this anomalous outcome. Nevertheless, there remained a lot of disquiet among lenders and insolvency practitioners regarding the perceived “super-priority” of FSDs. Fortunately, the Supreme Court has this week restored the balance between insolvency legislation and the ranking of pensions liabilities by arriving at the “sensible and fair answer” that the potential liability under an FSD issued to an insolvent company should rank as a provable debt, i.e. pari passu with other unsecured creditors, and behind administrator’s expenses, preferential creditors and floating charge holders.

Test for Provable Debt

The decision turned on whether the liabilities imposed by an FSD issued after a company has entered insolvency arose “by reason of an obligation incurred before that date” as set out in Rule 13.12 of the Insolvency Rules. The lower courts had felt unable to reach the conclusion that this was the case. However, the Supreme Court established the threefold test for “an obligation incurred before that date” as:

  • a company must have taken or been subjected to a step, which,
  • had some legal effect which resulted in the company being vulnerable to the specific liability in question such that there was a real prospect of that liability being incurred; and
  • consideration should then be given to whether it would be consistent with the regime under which the liability is imposed to determine that the step in question does in fact give rise to such an obligation.

Upon applying this test to the circumstances of Nortel and Lehman, the Supreme Court reasoned that the first element set out above was satisfied by the fact that, on the date each group entered into administration, the target companies were all members of the respective groups of companies. As to the second element, by virtue of the fact that these groups of companies included companies with pension plans, the target companies were rendered “precisely the type of entities … intended to be liable under the FSD regime”. The Supreme Court went on to state that given that at the time each group entered into administration it was in serious financial difficulties, the target companies were “well inside the penumbra of the [FSD] regime”. The Supreme Court finally ascertained that the third requirement was satisfied because to determine otherwise would lead to the “somewhat arbitrary” result that the characterisation and treatment of a liability under the FSD regime should turn simply on the timing of the issue of the FSD. Therefore as the FSD would rank as a provable debt if issued before the administration, it was equitable that it should have the same ranking if issued after the administration, if based on a state of affairs which existed before the insolvency event.

Having established that these pension liabilities were provable debts, the Supreme Court went on to confirm that, even if such a conclusion had not been reached, this would not automatically give rise to a finding that they would instead be expenses of the administration (as the lower courts had felt bound to conclude). This was on the basis that the FSD would be deemed a debt payable “during the period of” the administration, but not “part of” the administration or a payment which was a “natural incident connected with” the administration. The Court added that it would be “remarkable” if a liability pursuant to an FSD issued after an insolvency event had priority over other unsecured creditors, when it would not have such priority if, on precisely the same facts, it was issued prior to the insolvency event. In other words, had the Supreme Court been unable to find that an FSD liability was a provable debt, unlike the lower courts which found it to be an expense of the administration, thereby granting it “super-priority” status, the Supreme Court indicated that it would instead have found it to be a non-provable liability, i.e., it would disappear down the insolvency “black hole”.

What this means for pensions liabilities in insolvency situations going forward

Provable unsecured debts rank equally such that where there are insufficient funds to meet them all, as is predominantly the case in an insolvency scenario, the remaining funds are apportioned equally among them. The Supreme Court’s decision means that liabilities imposed by an FSD, regardless of whether it is issued before or after an insolvency event, now simply will be afforded a proportionate bite at the cherry, as opposed to swallowing up the whole cherry before any other creditors, save for fixed charge holders, get a look in.

This judgment should provide significant comfort in the face of the last four years of uncertainty concerning this particular aspect of the insolvency regime. Any fears that preferential creditors and floating charge holders would be usurped by pension liabilities should now be allayed and similarly administrators can take comfort in the fact that their expenses are no longer at risk of being diluted by FSDs or other liabilities imposed by the Pensions Regulator after a company has entered insolvency. In addition, other companies with defined benefit pension plans will no longer have the concern that the perceived “super-priority” of pensions liabilities would impede their ability to get finance, and, in particular, floating charge holders in restructuring situations may be more likely to agree to a pre-pack as they now have assurance that they will recover their debts ahead of any action taken by the Pensions Regulator. The Pensions Regulator itself issued a statement affirming that the outcome is “welcome news for many thousands of pension scheme members and will provide clarity to insolvency practitioners on how to treat a pension scheme liability.”