The Court of Appeal’s decision in the matters of Nortel GMBH and Lehman Brothers International (Europe) (both in administration) and other companies has been overturned by the Supreme Court. Liabilities imposed on insolvent companies by the Pensions Regulator (“tPR”) will not be treated as an expense of the insolvency, which would be payable by the office holder in advance of making payment of his own remuneration or to floating charge holders. The liability will rank as an unsecured debt rateably with all other unsecured creditors.

The Court of Appeal had confirmed the decision of the High Court. The Courts found that liability under a Financial Support Direction (or any Contribution Notice resulting from failure to comply with the Financial Support Direction), issued by tPR against a company in administration or liquidation in relation to liabilities to a defined benefit pension scheme 1, would be an expense 2of that insolvency process.

Once a company is in an insolvency process its assets are realised and paid in a statutory order of priority: to fixed charge creditors; for payment of expenses of the process including office holders’ remuneration (with sub-categories of priority); to preferential creditors; to floating charge creditors; to unsecured creditors; for non-provable liabilities; to shareholders. The Court of Appeal’s decision meant that the liability imposed by tPR would rank ahead of office holders’ remuneration and floating charge holders.

This left Insolvency Practitioners nervous or unwilling to take appointments over companies in groups connected to a scheme and lenders reluctant to lend to such companies. Unsecured creditors would find the realisations in the insolvency depleted before those realisations came to be shared rateably amongst creditors. The decision was, therefore, a blow to the rescue culture.

Moral Hazard Powers

The liability in question arises out of the provisions of the Pensions Act 2004. The Act gave the Pensions Regulator (tPR) certain “moral hazard” powers including the power to impose a Financial Support Direction (FSD) upon a company connected and associated 3 with an employer of a defined benefit pension scheme 4. This requires the “target” of the FSD to provide support to the Scheme, which may be a guarantee, an interest in assets, or any other kind of support that tPR considers satisfactory. This power was given to tPR, in particular, to assist the members of an underfunded pension scheme where the employer is “insufficiently resourced5”. This state of affairs occurs where the employer has no or few assets but is within a group of companies that have substantial assets (a “rich man/ poor man” situation) or where the employer is a service company.

If the recipient of an FSD fails to provide support to the pension scheme, then tPR can issue a notice requiring payment of a sum up to the full amount of the pension scheme liability. This notice is a Contribution Notice. A Contribution Notice can also be used where there has been an event that is materially detrimental to the scheme.

The Trustees of a pension scheme would ordinarily have no direct recourse to the group companies’ assets to enforce payment of any Section 75 debt arising 6, not being a creditor of those companies. Therefore targets of these powers can find themselves subject to a huge liability that they had not anticipated.

In the case of Lehman Brothers the employer’s liability to the scheme was £125 million. In Nortel it was £2.1 billion. An FSD has not yet been issued by tPR in relation to most of the parties to the appeal but notices had been issued warning the targets of tPR’s intention to do so. The process was stayed pending the outcome of this appeal.

Priority in Insolvency Processes

In an administration or liquidation assets are realised and distributed to creditors in an order prescribed by the Insolvency Rules 1986. Expenses of the insolvency process have priority over other creditors save for those with fixed charges. Certain expenses of the insolvency also have priority over the office holder’s remuneration. Unsecured debts, provable in the insolvency process, rank rateably amongst themselves after charge holders, preferential creditors (employees) and expenses of the process have been paid. A provable unsecured debt is one which a company is subject to at the date of liquidation or may become subject to pursuant to an obligation arising before that date 7. Therefore a contingent debt is an unsecured debt.

The payment obligation imposed by an FSD or Contribution Notice is not stated, in the Pensions Act 2004 or in insolvency legislation, to be a debt provable in an insolvency process. No guidance can be found in legislation whereas the Pensions Act 1995 states that the liability owing from an employer to the Trustees would not be regarded as a preferential debt. It is deemed to have arisen immediately before the insolvency event such that it is provable in an insolvency as an unsecured debt.

Categorisation of FSD’s by the Court of Appeal

The question for the Court was whether an obligation imposed by tPR, using its moral hazard powers, would also be provable and, therefore, an unsecured claim, whether it would rank as an expense or whether it would fall into a black hole giving it no priority at all.

The types of payments becoming due, in the course of an administration, that are treated as expenses has been clarified and some would say extended through case law, from Toshoku 8 in 2002 to Goldacre (Offices) Ltd –v- Nortel Networks UK Ltd 9 in 2009.

Before the Court of Appeal the Nortel administrators argued that the liability imposed by tPR would be provable as a debt. The Lehman administrators argued that it fell into a black hole.

The High Court and the Court of Appeal considered whether the debt could be considered to be in existence at the time of the insolvency, rendering it a contingent and therefore provable debt ranking along side other unsecured creditors 10. Both Courts found that it was not. It was considered that there was insufficient certainty that tPR would use its discretionary powers such that, up until its powers were invoked, only the employer company could have been liable to the scheme.

The Court was bound by other Court of Appeal decisions such as In Re Bluck, Ex p Bluck (1887) and Glenister –v- Rowe (2000) which concerned the categorisation of cost liabilities arising after a bankruptcy but arising out of proceedings issued before the bankruptcy. In these cases it was decided that the costs liability was not a bankruptcy debt since the obligation to pay costs was not in existence or contingent at the time of the bankruptcy.

Accordingly, the Court of Appeal decided that the liability under an FSD or Contribution Notice imposed after an insolvency event was not provable in the insolvency and was then left with a choice of either deciding that the liability had super-priority and therefore greater priority than the scheme debt held as against the employer or was neither a debt nor an expense and therefore had lower priority than the scheme debt held. The Court of Appeal considered the latter conclusion to be unsatisfactory.

The Court of Appeal considered that the position as decided in Toshoku was to be applied to the circumstances before them. In Toshoku the Court found that tax liabilities imposed by statute were an expense of an insolvency process where the relevant statute specifically intended and provided that the obligation would be imposed upon a company in insolvency. In Nortel and Lehman it was acknowledged that the Pensions Act 2004 did no such thing and left it to insolvency law to determine the priority. However, it was considered to be highly likely that the regime would be used in the case of an insolvent employer and a real risk that other potential targets in the group would also be insolvent at the time that tPR came to use its powers. For that reason the obligations of a company under liability imposed by tPR whilst in an insolvency process would be an expense of that process.

The Supreme Court Decision

The Supreme Court was not bound by the Court of Appeal decisions and overruled the decisions In Re Bluck and Glenister –v- Rowe. It found that the fact that a company was within a group of companies where the test for an FSD was satisfied at a time prior to the insolvency meant that it was at risk of becoming subject to an FSD or resulting Contribution Notice prior to the insolvency and as such the obligation under those powers arose prior to the insolvency.

Having decided the case in this way it was not necessary for the Supreme Court to consider whether the liability would rank as an expense. However it did address this point and disagreed with the Court of Appeal’s interpretation of Toshoku. It considered that “necessary disbursements” that would fall to be paid as an expense were those that carried a legal or, in exceptional cases, a moral obligation upon the office holder to pay them. They would arise in the course of the administration out of something done by the administrator, being a natural incident connected with the administration. Alternatively, statute may provide for it to be payable by the administrator.

Conclusion

Liability under FSD’s or Contribution Notices are unsecured debts in insolvency processes being a contingent liability.

This decision may be considered to be a blow to pension schemes. However, query how many Trustees ever considered that any liability to the scheme might have the priority in insolvency that the Court of Appeal decided it might have. In truth the Supreme Court has confirmed that the position is as it has been considered to be since the Pensions Act 2004 came into force.

The Court of Appeal’s decision, if confirmed, could have left groups of companies with pension schemes unable to raise finance and unsupported by existing financiers. This would have meant the slow decline and ultimate death of many companies and perhaps a further nail in the coffin for defined benefit pension schemes.

This decision is likely to be cited in the future where Courts are asked to categorise other types of debt. It is also likely to be cited where the effect of Toshoku is being debated and may mark a change in the types of liability that the Courts will consider should be paid by office holders ahead of other creditors.