CASE SNAPSHOT

In the matter of the Nortel Companies, the UK Supreme Court found that pension liabilities attributed to a company that arose prior to the occurrence of an insolvency event were not entitled to priority treatment, even if the first demand for payment was only made after the insolvency event occurred.

FACTUAL BACKGROUND

The Pension Act

The UK Pensions Act of 2004 (the “UK Pensions Act”) established, among other things, a regime to protect employees from underfunded occupational pension schemes in the event of their employer’s insolvency. As part of this law, the Pension Protection Fund (the “PPF”) was established as a statutory body that maintains a fund for members of eligible pension plans financed through levies on pension plans (similar to private insurance premiums) to compensate beneficiaries if their pension plan is inadequately funded.

This UK Pensions Act regime is in addition to the existing protections available under section 75 of the Pensions Act 1995 (the “1995 Act”), which provides that upon the occurrence of an insolvency event, an amount equal to any shortfall in the assets of an occupational pension scheme (a “scheme”) that exists immediately prior to the insolvency event, is a “section 75 debt” due from the trustees of the scheme. Although an insolvency event was initially limited to an employer going into an insolvent liquidation, it was extended by the UK Pensions Act to administrations. Section 75(8) of the 1995 Act provides that a section 75 debt is treated as a provable debt (i.e., a general unsecured claim) arising immediately prior to the insolvency.

The UK Pensions Act recognized that when it established the PPF, it also   needed to include protections to prevent companies from passing along pension obligations to the PPF by, for example, having a group of companies use a single service company to employ the workers for the larger group of companies,   while limiting the pension obligations to the service company and effectively trying to ring-fence the pension liabilities of a group in the service company. To combat any attempts to avoid rightful liability, the Pensions Regulator was established. Among its powers, the Pensions Regulator may (i) issue a financial support direction (an “FSD”) to some or all of the other group companies (known as “targets”), which is an obligation to provide reasonable financial support to   an under-funded scheme or the service company or insufficiently resourced employer; and (ii) impose a contribution notice (a “CN”) imposing a specific monetary liability payable by the target to the pension trustees if the FSD is not complied with.

Insolvency and Administrations

A number of procedures are available in the UK that can be utilized when a company becomes insolvent, including liquidation and administration. Liquidation (commonly called “winding-up”) can be used by both a solvent and insolvent company, although an insolvent liquidation is more common. Administrations are governed by the Insolvency Act 1986 (the “1986 Act”). The 1986 Act initially did not allow for distributions to creditors while the administration was on going. If the administration was not successful in rescuing the company, it was expected that a winding-up would follow and the available assets would then be distributed to creditors. Following the Enterprise Act 2002, it is now possible for assets to be distributed to creditors by administrators, and thus a separate winding-up can be avoided.

In both an administration and liquidation (and similar to what is provided under the U.S. Bankruptcy Code), the unsecured debts (referred to as provable debts) of a company are payable pari passu to the relevant creditors, who must provide proof of their claim. Rule 12.3 of the Insolvency Rules states that “all claims by creditors are provable as debts against the company…whether they are present or future, certain or contingent, ascertained or sounding only in damages.” Rule 13.12 further provides that a “Debt” is “any debt or liability to which the company is subject…at the date on which the company went into liquidation.”  The cut-off date to determine the creditors entitled to a distribution is the date the administration began, regardless of whether the administration is followed by a liquidation. If the insolvency event is a liquidation (and no administration preceded the liquidation), the relevant date is the date the liquidation began.

Additionally (and, again, similar to U.S. bankruptcy law), there is an order of priority for distributions, with expenses of the administration or liquidation being paid out prior to unsecured debts.

Nortel and Lehman

Lehman

Contemporaneously with U.S. Lehman entities filing for chapter 11 in 2008, the main London-based Lehman group companies were placed into administration on 15 September 2008. The principal Lehman employer company in the UK   was Lehman Brothers Limited (LBL), who provided employees on secondment for most of the group’s European activities. At the time of the administration, LBL crystallised a section 75 debt of approximate £120 million in relation to the Lehman Brothers Pension Scheme. Following the administration, the Pensions Regulator began investigating LBL and certain other Lehman Companies and, on the basis that LBL was a service company, determined that FSDs should be made to six target Lehman companies.

Nortel

In January 2009, Nortel companies in Canada, the United States and England each sought protection under the respective insolvency laws, with the   English entities being placed into administration. Nortel’s principal operating company in the UK was Nortel Networks UK Limited (NNUK), which was also the principal employer in the Nortel Networks UK Pension Plan. NNUK had a number of subsidiaries with operations in various European countries. At the time of its administration, NNUK’s section 75 debt crystallised in an amount of approximately £2.1 billion. Following the commencement of the administration,  the Pensions Regulator began its investigation of NNUK and ultimately determined that FSDs should be issued to a number of Nortel companies.

COURT  ANALYSIS

The Lower Courts

For both Lehman and Nortel, the lower courts held, based on existing case law, that a target company’s potential liability under an FSD when the FSD is not issued until after the target has gone into administration was an expense of the insolvency proceeding and, therefore, took priority over unsecured creditors.

The Supreme Court

Upon review, the UKSC unanimously held that the liability arising under an FSD made after an insolvency event was not an expense entitled to priority treatment, but instead was a provable debt that would be treated pari passu with other unsecured creditors.

This decision was based largely on the UKSC’s reading of Rules 12.3 and 13.12  of the Insolvency Rules 1986, that the liability arising from an FSD made after an insolvency date still constituted a “debt” of the insolvent company. One of the limbs of the definition of debt provides that a “debt” includes “any debt or liability to which the company may become subject after [the insolvency date] by reason of any obligation incurred before [the insolvency date]” (Rule 13.12(1)). The UKSC noted that prior to the insolvency date, the insolvent entity was a member of a particular group of companies and held that this was sufficient to find that the obligation was incurred prior to the insolvency event, as required under Rule 13.12(1)(b).

Additionally, the UKSC held that for a company to have incurred an obligation, it must normally have taken (or be subject to) some step or combination of steps that (i) had some legal effect, and (ii) resulted in it being vulnerable to the specific liability in question, such that there was a real prospect of liability being incurred. The UKSC held that this was satisfied (i) by virtue of the target being part of the relevant group of companies, and (ii) because the group of companies met the key criteria for the imposition of an FSD. Finally, consideration should be given to the fact that it would be consistent with the type of liability being imposed to conclude that it would be a “debt” under the Insolvency Rules. Upon review of the facts, the UKSC was satisfied that the FSDs against Nortel and Lehman were properly viewed as a “debt” that should be treated on par with the other unsecured debts of each.

PRACTICAL   CONSIDERATIONS

Prior to these cases, the law was clear that if a CN was issued to a target company prior to an insolvency event, it would be treated as a general unsecured claim, and if a CN was issued any time after an insolvency event, it would still be considered a general unsecured claim if it was based on an FSD issued before  the insolvency event. The question the Supreme Court was faced with was if an FSD based on events that occurred prior to an insolvency event is issued after  the insolvency event, is it then treated as an expense of the administration, and therefore entitled to higher priority treatment? In its judgment, the UKSC ruled that the sensible and fair answer was for such claims to be treated as general unsecured claims.