On 24 July 2013, the Supreme Court handed down its long-awaited judgment in the Nortel/Lehman case: Re Nortel Companies  UKSC 52. The Court looked at the position where a contribution notice (CN) or financial support direction (FSD) was issued by the Pensions Regulator (TPR) on a company that is already in insolvency proceedings in England (eg administration). How does the relevant obligation rank in the order of priority of payment?
The Supreme Court held that liabilities arising under the 'FSD regime' usually rank as a provable debt (at least where the relevant situation relied on by the Regulator pre-dates the start of the insolvency process).
The judgment overturns the decision reached by both the Court of Appeal (CA) and Briggs J in the High Court that such a debt ranks as an expense of the insolvency and so ahead of unsecured creditors, creditors with floating charges and various other expenses including, importantly, the insolvency officeholder’s own remuneration.
The Supreme Court ruling will be welcomed by creditors and insolvency practitioners alike, for whom the implications of the lower courts’ arguably surprising decisions were serious and wide-ranging.
- TPR has, under the Pensions Act 2004, so-called ‘moral hazard’ powers to make third parties liable to provide support or funding to a defined benefit occupational pension scheme in certain circumstances.
- Various companies in the Lehman Brothers and Nortel groups entered into administration in England in September 2008 and January 2009 respectively.
- In June and September 2010 TPR’s Determination Panel determined that it would be reasonable to issue an FSD against companies in the Nortel and Lehman groups.
- The administrators of the relevant Nortel and Lehman companies applied to court for directions as to where, in the statutory order of priority of payment, liabilities arising in respect of compliance with an FSD/CN should rank in circumstances where the FSD/CN was issued when the target company was already in insolvency proceedings.
The High Court and CA held that:
- based on previous cases on provable debts, an FSD issued after insolvency starts is not a provable debt in a company’s insolvency (even where the facts giving rise to the FSD occurred before the insolvency commenced);
- the liability arising in respect of compliance with an FSD made on a company in administration ranks as an administration expense. So it would have ‘super priority’ over all other unsecured claims of creditors (and those secured by a floating charge) and also (subject to the potential for the court to rank them ahead) the administrators’ remuneration;
- for administrations commenced prior to 5 April 2010 only (such as those in Nortel/Lehman themselves), a CN issued on a company to enforce the obligations of an FSD issued while the company was in administration, will, on the company entering liquidation, not be an expense but instead rank as a provable debt in the company’s liquidation; and
- for administrations commenced after 5 April 2010 (and due to a change in the relevant legislation which took effect then), an FSD/CN issued on a company in an administration will rank as an expense of the administration or subsequent liquidation.
Provable debt, expense or black hole: the arguments before the Supreme Court
Pensions legislation is silent as to how FSDs and CNs should be treated if they are issued in an insolvency (although it does specifically state that the underlying s75 debt on the employer which crystallises the pension deficit is not a preferential debt and, as it is taken to have arisen just before the employer’s insolvency, ranks as a provable debt, not an expense). Accordingly, it is necessary to look to the insolvency legislation to find the answer.
Four possibilities on how liabilities in relation to the 'FSD regime' could rank in a company’s insolvency were argued before the Supreme Court:
- Option 1: that the lower courts were right and that an FSD/CN is an expense of the administration or liquidation (that is given ‘super priority’ over all other creditors and the insolvency officeholder’s own remuneration).
- Option 2: as a provable debt (that would rank alongside other unsecured, non-preferential creditors).
- Option 3: as a non-provable claim payable (if at all) only out of any surplus available after all other creditors have been paid in full (the so called ‘black hole’ as it is assumed that payment in these circumstances is highly unlikely).
- Option 4: as a non-provable claim (ie black hole) but with the court under its residual discretion directing the administrators to treat the FSD claim more favourably. This was a new option advanced in the Supreme Court. The argument advanced in the lower courts that the court should direct an officeholder to comply with an FSD/CN under the principle of ex parte James was no longer put forward.
Option 1: provable debt
Rule 13.12 of the Insolvency Rules 1986 defines what constitutes a ‘debt’ for the purpose of proving in an insolvency. The Supreme Court held that there were in summary two types of debt set out in this rule: liabilities to which the company is already subject at the start of the insolvency (set out in rule 13.12(1)(a)) and those to which it may become subject after the insolvency by reason of any obligation incurred before (rule 13.12(1)(b)).
The Court found that an FSD/CN claim issued after the insolvency is not capable of falling within rule 13.12(1)(a) and the issue was whether it falls within rule 13.12(1)(b). While the Court stated that it would be dangerous to try and suggest a universally applicable formula for a company to have incurred an obligation under rule 13.12(1)(b), three conditions must normally be met [paragraph 77]:
- it must have taken, or been subjected to, some step or combination of steps which have a legal effect. Here, this was met because on the administration date the companies had been a member of the respective Lehman/Nortel group for the relevant look-back period under the Pensions Act 2004 (two years). Membership of a group of companies was ‘undoubtedly’ a significant relationship in terms of law and therefore fulfilled the first condition;
- the steps must have resulted in the company being vulnerable to the liability in question, such that there is a real prospect of that liability being incurred. The Court held that if, on the administration date, the groups included either a service company (Lehman) or an insufficiently resourced employer company (Nortel) then the target companies were precisely the type of entities who were intended to be rendered liable under the FSD regime. The target companies ‘were not in the sunlight, free of the FSD regime, but were well inside the penumbra of the regime, even though they were not in the full shadow of the receipt of a FSD, let alone in the darkness of the receipt of a CN’;
- it must be consistent with the regime under which the liability is imposed to conclude that the step or combination of steps gives rise to a liability under the rule. Here the court considered that the FSD/CN regime should give rise to a liability but that this should be similar to a (provable) s75 debt.
In reaching its decision, the Supreme Court overruled the earlier decisions (made mostly in the context of personal bankruptcy) which had constrained the lower courts. These earlier decisions had held that where an order for costs was made (in litigation) against a bankrupt person after the insolvency process began this did not arise from an obligation which had arisen before the bankruptcy, even where the litigation had been started before the insolvency. The lower courts considered the same reasoning to apply to the FSD regime. The Supreme Court was clear that (in line with its ruling on the FSD regime) an order for costs made against a company in insolvency will be a provable debt where proceedings were begun before the insolvency.
Option 2: insolvency expense
If the FSD/CN liabilities rank as a provable debt, all sides accepted that the liablities would not be expenses. In light of this, the Court did not strictly have to analyse whether they would have been an insolvency expense. However, Lord Neuberger held that even if the FSD/CN was not considered to be a provable debt, it would not fall within the scope of a ‘necessary disbursement’ under the expenses regime as set out in rule 2.67(1)(f) (administration) or rule 4.218(3)(m) (liquidation) for these reasons:
- the liability did not result from any act or decision taken by the insolvency officeholder (unlike, for example, the decision to remain in premises which are subject to commercial rates); and
- the mere fact that an event occurs during the administration which under statute gives rise to a debt is not, of itself, sufficient to render payment of the debt an insolvency expense.
The Supreme Court held that the lower courts had misinterpreted the 2002 House of Lords decision in Re Toshoku. Lord Neuberger held that Toshoku did not hold that where a statutory claim is not a provable debt it must be an expense under the ‘necessary disbursement’ heading (if it does not fit neatly within any other head of expenses). The Supreme Court held that where a statutory liability is one that can be imposed both before and after insolvency and where the statute is silent on ranking, the liability can only be an expense (assuming that it is not a provable debt) if the nature of the liability is such that it must be reasonably have been intended by parliament that it should rank ahead of provable debts.
The Supreme Court distinguished Toshoku as relating to a tax liability that was specifically imposed on a liquidator (not the company) and as it specifically applied to a company which had gone into liquidation. However, the Court held that even in such a case it would be appropriate for a court to consider whether parliament intended the liabilities to rank as an expense.
Option 3: non-provable claim (and not an expense) – ‘black hole’
The Supreme Court was clear that if it had decided that the FSD/CN liability was not a provable debt, it would not have held that the FSD/CN liability was, by default, an administration expense. In this case it would have simply fallen down the black hole.
Option 4: court’s residual descretion
Again, in light of the provable debt decision, this point was technically moot. However, the Court held that a court does not have the power to order an administrator to treat an FSD liability as a provable debt – even where it would otherwise fall down the black hole.
Commercial implications of the CA decision – avoided
In reaching its decision the Supreme Court was clearly guided by what it considered the ‘sensible and fair answer’ that liabilities under an FSD/CN should be treated as a provable debt. By ruling in favour of the provable debt option, the Supreme Court avoided the ‘oddities, anomalies and inconveniences’ of the CA decision, for example:
- An FSD/CN issued just before a company enters administration or liquidation would be a provable debt, and so rank alongside all other non-preferential unsecured creditors. But an FSD or CN issued just after a company enters an insolvency process would count as an expense and be given ‘super priority’. The Supreme Court acknowledged that ‘It appears somewhat arbitrary that the characterisation and treatment of the liability under the FSD regime should turn on when the FSD or CN happens to have been issued…’.
- If a CN were issued to enforce an earlier FSD that was issued before the company entered administration or liquidation, the CN would be a provable debt and not an expense.
- While a s75 debt is a provable debt in the insolvency of an employer, an FSD/CN liability aimed at reducing the s75 debt would be payable with much higher priority, namely as an expense. Again, the Supreme Court grasps this anomaly by the head and acknowledges that ‘It would be strange if the employer company’s statutory obligation to make good a shortfall in its employees’ pension scheme ranked lower in its insolvency than the more indirect statutory obligation of a target to make that deficiency good ranked in the target’s insolvency.’
In adopting a ‘compromise’ outcome that falls between the two extremes of insolvency expense and black hole, the Supreme Court has reached a pragmatic and commercial solution. The Court was clearly driven by the policy rationale that all possible liabilities, within reason, ought to rank as a provable debt and thereby achieve equal justice to all creditors.
The consequences of the Supreme Court decision for each stakeholder:
- Insolvency practitioners should take care when complying with or settling an FSD liability to ensure that the parties agree that such settlement/compliance does not give rise to an administration expense but remains a provable debt.
- Banks may breathe a sigh of relief – to the extent that the fixed charge security does not cover the amounts owed, the floating charge realisations are now no longer diluted – or indeed entirely wiped out – by a large FSD/CN claim.
- TPR issued a press release shortly after the Supreme Court decision was released stating that it welcomed the decision and was ‘pleased that the Supreme Court has decided that an FSD issued against an insolvent target is effective’. Although it sought (in a press release issued shortly after the CA judgment and subsequent formal statement in July 2012 on FSDs and insolvency) to provide reassurance that it was not TPR’s intention to hamper the legitimate work of the administration and restructuring process, it was inevitable that concern and uncertainty had remained. Now TPR no longer has to face the conflict between maximising recovery by members (and schemes) and seeking to be ‘reasonable’ and not interfere with commercial restructurings.
The judgment also fixes the anomaly that a s75 debt ranks as a provable debt, whilst an FSD/CN liability aimed at reducing the s75 debt would be payable with much higher priority, namely as an expense. Employment specialists will also take note of the Supreme Court’s endorsement of the decision in Day v Haine holding that a protective award issued by an employment tribunal following the start of an administration is a provable debt.
So, can the insolvency world now sleep easy? Well, no – there is still one issue that practitioners and interested parties have been grappling with for as long as the one in Lehman/Nortel, namely the issue of how rent is dealt with in administration. It is to be hoped that the very commercial decision taken by the Supreme Court sets a strong example and that we can expect the Goldacredecision to be ultimately remedied on appeal to either the CA or the Supreme Court. Then the insolvency world really can sleep easy (until the next thunderstorm appears.