Under the Pensions Act 2004 the Pensions Regulator (tPR) has the power to impose a financial support direction (FSD) requiring a company “connected or associated” with the sponsoring employer of a UK pension fund to provide financial support to the pension fund. To date tPR has used the power in insolvencies.
In 2010 tPR issued FSDs against several Nortel and Lehman Brothers companies (the Targets) requiring them to provide financial support for the underfunded pension schemes in their group. In each case the FSDs were issued against the Targets after they went into administration. The Administrators of the Targets sought directions as to where liability under a FSD ranked in the order of priority for the payment of creditors. There were three options:
- as an expense of the administration ranking ahead of all other creditors other than fixed charge creditors;
- as an unsecured provable debt ranking behind preferential creditors and floating charge creditors;
- as a non-provable claim payable only after all other creditor claims were paid in full.
The Supreme Court decided a FSD was a provable debt and that it could not rank as an expense of the administration. As a consequence it reversed the decision of Briggs J in the High Court which had been upheld by the Court of Appeal.
The provable debt issue
This turned on the construction of Rule 13.12(1) of the Insolvency Rules because the Pensions Act 2004 is silent on where a FSD ranks in the insolvency of a target. Rule 13.12(1) defines a debt in relation to a company in winding up as:
- any debt or liability to which the company is subject … at the date on which the company went into liquidation;
- any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date.”
A FSD liability arising after the date of the insolvency could not fall under (a) as this was concerned only with liabilities to which a company “is subject” at the date of the insolvency . The FSD liability could only fall within (b) if the Targets were under a FSD “obligation” before the date of the insolvency. The Targets were under such an obligation before the date of the insolvency for the following reasons:
- For a company to be under an “obligation” it must have taken, or been subjected to, some step or combination of steps which (a) had some legal effect and (b) resulted in it being vulnerable to the liability. If (a) and (b) are satisfied the imposition of the liability must be consistent with the regime in question.
- The requirements in (a) and (b) were met as the Targets were members of the group of companies during a two-year look-back period as required under the Pensions Act 2004. They were also the type of entities who were intended to be rendered liable under the FSD regime. The group in each case was in very serious financial difficulties at the date of the administrations so the Targets were not free of the FSD regime but well within its shadow.
The administration expense issue
This turned on the construction of Rule 12(2) and Rule 2.67(1)(f) of the Insolvency Rules. To be an administration expense the FSD must be within the term “charges and other expenses incurred in the course of the … administration” or “necessary disbursements by the administrators in the course of the administration”.
A FSD liability did not fall within these provisions for two reasons. First, it did not result from any act or decision taken by or on behalf of the administrators or any act or decision during the administration. Instead, it arose out of events that occurred before the insolvency event. Second, an event which occurs during the administration which gives rise to a debt on the company under a statute is not enough to render payment of the debt an expense of the administration. It is a debt payable “during” the period of the administration but not “part of” the administration or one of the “natural incidents connected with” the administration.
- The High Court and Court of Appeal concluded that a FSD was not a provable debt which then forced them to reach the conclusion that it was an administration expense, otherwise the FSD regime would have been rendered useless in an insolvency as any liability under it would have ranked only as a non-provable claim. The Supreme Court was able to find that the FSD was a provable debt but the decision that a target is under an “obligation” or committed the potential FSD liability because it is part of a group with an underfunded pension scheme seems to be at the outer limit of what these terms could include.
- The Supreme Court recognised many of the illogical results that arose from treating a FSD as an administration expense:
- an insolvent employer’s liability under section 75 Pensions Act 1995 for debt to its pension fund is expressly stated to be a provable debt. It would be strange if the obligation of a target on whom a FSD is imposed to provide support to a pension fund to which it had no other liability should rank higher in priority as an administration expense on the target's insolvency
- a contribution notice (CN) based on an FSD issued to a company before insolvency is a provable debt as is a CN issued to a company after insolvency but based on an FSD issued before the insolvency. However, a CN based on an FSD issued after the insolvency would have ranked higher as an administration expense
- treating a CN based on a FSD as an administration expense where the FSD was issued after the insolvency event would give tPR an arbitrary power. If tPR was minded to issue a FSD against a company in financial difficulty he would be well advised to wait until after it became insolvent to ensure any CN based on the FSD jumped from provable debt to administration expense in the priority order.
The Supreme Court concluded that it was unlikely that these consequences could have been intended.
- The reversal of the earlier decisions in this case will ensure that floating charges are not jeopardised by FSDs taking priority over them. Since that concern is now removed it may encourage lenders to invest in companies with significant defined benefit pension schemes.
- The decision weakens the FSD regime since administration expense status gave tPR and the pension fund excellent prospects of recovering the pension deficit in full. In future tPR will need to give greater consideration to the prospects of recovery before issuing an FSD against targets especially after they have become insolvent.
- For pension fund trustees the decision is a reminder of the need to constantly review employer covenant strength and to take security to protect scheme members in the event of employer insolvency