The Pensions Regulator intends to issue its first financial support direction (FSD) against the Bermudan-based Sea Containers Limited (SCL), which is currently restructuring under the US Chapter 11 bankruptcy process.
On 18 June 2007, after an oral hearing, the Regulator’s Determinations Panel issued notices against SCL in relation to the two pension schemes of its UK subsidiary Sea Containers Services Limited (SCS). The Determinations Panel considers it is reasonable in the circumstances to issue an FSD against SCL. Its reasons were published on 27 June 2007. Unless the determination is appealed within 28 days, an FSD will be issued against SCL.
This briefing note considers the Determinations Panel’s reasons.
FSDs: a quick reminder
The Regulator may issue an FSD to an entity connected or associated with an employer which is either a service company or is insufficiently resourced and which participates in an underfunded final salary pension scheme. An FSD compels the recipient to put in place financial support (approved by the Regulator) for the employer’s obligations, for example, a parent company guarantee where the recipient has sufficient resource in its own right to “plug the gap in the funding”. The support must remain in place until the scheme winds-up. The Regulator will only impose an FSD where it considers it reasonable to do so.
Sea Containers: the background
SCL is registered in Bermuda. SCS is registered in England and is a wholly owned subsidiary of SCL. It is the service company for the Sea Containers group and employs many of the group’s key central management. This structure has allowed SCL to enjoy the tax and other advantages of being registered in Bermuda while having a European trading base.
The relationship between SCL and SCS is set out in the 1989 Services Agreement. This agreement made it clear that SCS would provide SCL with such services and for such period as SCL reasonably required. SCL would pay for the services. The unchallenged evidence was that SCL intended to stand behind its obligations (including pension obligations) to SCS.
SCS sponsors two pension schemes - the 1983 Scheme and the 1990 Scheme. While SCL only participated in the 1983 Scheme, its officers were trustees of the 1990 scheme. Both schemes have large deficits on the buy-out basis.
In June 2006 SCL gave notice to the 1983 Scheme trustees terminating participation in the 1983 Scheme. The 1983 Scheme trustees took this to mean that SCL was no longer going to stand behind SCS and they contacted the Regulator.
In July 2006 the Regulator wrote to SCL to provide it with financial information to help it carry out its regulatory functions. SCL provided some information on its restructuring proposals. In September 2006 the Regulator wrote to SCL stating that it might issue an FSD. In October 2006 SCL and SCS filed for Chapter 11 bankruptcy in the US. In October 2006 and April 2007 the Regulator sent warning notices to SCL threatening to issue an FSD. In June 2007 the Regulator’s Determinations Panel held a two day oral hearing to determine whether or not to issue an FSD against SCL.
What were the issues to be decided by the Determinations Panel?
The main issue for the Determinations Panel was whether or not it would be reasonable to issue an FSD on the facts of the case. This is because SCL conceded that SCS fulfilled the definition of a service company, as well as being connected and associated with SCS for the purposes of the legislation.
When is it reasonable to issue an FSD?
Legislation sets out the factors the Regulator must consider in order to decide whether or not it is reasonable to issue an FSD as follows:
- The relationship the person has or had with the employer. For example, is the person a company that is the parent company of the employer?
- The benefits the person has received directly or indirectly from the employer. For example, has the person received assets or dividends from the company, or shared common security or cashflow arrangements or gained tax advantages?
- Any connection or involvement the person has or had with the scheme. For example, was the person a trustee of the scheme or an employer in relation to it?
- The financial circumstances of the person.
In addition, the Regulator may consider other factors, for example the status of the scheme. It is also required to take into account the interests of the generality of the members of the scheme as well as the interests of anyone who appears to be directly affected by the exercise of the power.
What were the Determinations Panel’s reasons?
The Determinations Panel concluded that overall it was reasonable to issue an FSD. It dealt with SCL’s arguments as follows:
- Benefit derived from SCS: There was unchallenged evidence that SCS was wholly owned and controlled by SCL. The benefits which SCL is required to receive from SCS are wide-ranging. Examples of benefits which suffice are that SCL did not usually or actually pay for the services provided by SCS within a prescribed period, and that SCS’s function and position in the group structure was designed to benefit the group.
- Chapter 11 bankruptcy: the Determinations Panel considered that the FSD and contribution notice provisions can continue to apply during insolvency proceedings. The Determinations Panel considered expert evidence that the Chapter 11 issue was a material consideration and as such had heard from US attorneys. However, it concluded that the issue of an FSD would not put SCL in an impossible position in relation to the Chapter 11 proceedings. It noted that if there was failure to comply with the FSD, the Regulator would need to decide whether it was reasonable to issue a contribution notice. Different considerations then could lead to a different result.
- Precipitate action by the Regulator: there was no evidence to suggest that the Regulator had acted with inappropriate haste. SCL had been given a substantial period of time to formulate any proposals and to explain its position to the Regulator. It had not applied for clearance or even indicated that it was going to make such an application. The Determinations Panel also rejected the argument that the issuing of a warning notice had destroyed SCL’s bargaining position with the trustees. Finally, SCL’s creditors had been invited to argue that they would be directly affected by any FSD made but they had not sought to do so.
- Super priority: the Determinations Panel rejected the argument that the issue of an FSD put the schemes’ trustees in a position of super priority as compared with other creditors. It considered that the trustees would continue to rank equally with the other unsecured creditors. Instead an FSD would facilitate the trustees making a proper claim against an entity which it might not otherwise have been able to make. The fact that an inevitable consequence of issuing an FSD was that the amount available for other unsecured creditors would be reduced was not a reason not to issue the direction.
- Consistency: the Determinations Panel rejected the argument that the Regulator should have waited until SCL had applied for clearance before considering an FSD. It considered SCL’s assumption that the Regulator’s approach to clearance and its approach to the potential issue of an FSD were one and the same was wrong. The evidence was that these matters were dealt with separately within the Regulator.
What is going to happen next?
SCL has until 16 July (that is 28 days from the date of the Determination Notices) to appeal the issue of the FSD. Any appeal would be considered by the Pensions Regulator Tribunal. It is not clear whether or not SCL will appeal. However, the latest press release on its website, dated 18 June after the Determination Notices were issued, states that it would consider whether an appeal is appropriate once it has had the chance to study the Determinations Panel’s reasons.
It is nearly two and a half years since the Regulator came into existence and had the ability to impose both FSDs and contribution notices. Until now the Regulator has not issued a single FSD or contribution notice. Instead employers who considered themselves to be in the firing line have instead applied for clearance. The Regulator will not use its powers provided the parties remain within the terms of the clearance given. It is interesting to note that the Regulator has rarely refused to grant clearance. Presumably this is because the parties have been able to renegotiate the deal in order to secure clearance. With that background in mind, it is not clear from the Determinations Panel’s reasons why SCL did not apply for clearance or tie in any clearance application with the timing of US process. The reasons merely comment that SCL had had plenty of time to formulate proposals to put to the trustees as well as indicate that it was going to apply for clearance.
It is interesting that the first FSD is going to be issued against a company based overseas where the Regulator may have enforcement issues. The SCL press release dated 18 June seems to suggest that SCL would comply with any FSD imposed after any appeal process (if used) has been exhausted. However, even if SCL was minded to comply, it is not clear whether or not the FSD would be enforced by the US court as part of the Chapter 11 proceedings. The expert evidence in support of an FSD being issued was to the effect that it almost certainly would be recognised in the US.
An FSD may only be imposed if it is reasonable to do so. There is now some interesting guidance on this including the wide concept of “benefit” and the relevance of the insolvency processes (an area where there may be more detailed argument in future cases given the Determinations Panel’s acknowledgement that its powers ought not to be exercised in a way that was inconsistent with the pari passu treatment of creditors).
For those that might be subject to an FSD, the determination highlights the importance of keeping the trustees and the Regulator engaged as far as possible in plans to address funding issues. Without that involvement, as the determination reasoning makes clear, there is a much greater risk of the Regulator using its powers to avoid members being prejudiced.
The clearance regime was established to give comfort that the antiavoidance powers would not be exercised in a particular case. It is curious, therefore, that the Determinations Panel states that clearance applications and FSDs are dealt with by separate parts of the Regulator.
This briefing note is based on the Reasons of the Determinations Panel of The Pensions Regulator in relation to the Determination Notices issued on 15 June 2007 re: The Sea Containers 1983 Pension Scheme and The Sea Containers 1990 Pension Scheme issued on 27 June 2007, sections 43 to 51 and 100 of the Pensions Act 2004 and the Clearance statements: Guidance from the Pensions Regulator