Certain events - such as a re-organisation - can trigger an obligation for an employer to contribute to its defined-benefit pension scheme (a so-called section 75 debt). There are many pitfalls in handling this situation, including some complicated decisions over whether it needs to be declared to or approved by the Pensions Regulator. This briefing outlines the issues and how to handle them.
Events such as company re-organisations can trigger an obligation for an employer to contribute to its defined-benefit (DR) pension scheme. This is known as a section 75 debt, because it arises under section 75 of the Pensions Act 1995. Our briefing Section 75 of the Pensions Act 1995 - an overview explains more fully. This briefing deals specifically with the obligation to report certain section 75 debts to the Pensions Regulator (TPR).
1. The Pensions Regulator's 'moral hazard' powers
TPR is given powers under the Pensions Act 2004 that aim to discourage employers from abusing corporate structures to avoid their liabilities (including liability under section 75) to a DB scheme. These powers are broad and allow TPR to make employers and third parties that are 'connected' or 'associated' with the employer liable for the deficit in an employer's pension scheme.
The definitions of 'connected' and 'associated' are broad and can include other companies in the group, an employer's director or a shareholder with one-third or more of the company's shares.
TPR can issue a contribution notice (cN) requiring a person to make a contribution into the scheme if they were party to an act (or failure to act):
a) that has had a materially detrimental effect on the likelihood of scheme members receiving their accrued benefits; or
b) whose 'main purpose' was to:
- prevent the recovery of the whole or part of a section 75 debt; or
- prevent the section 75 debt from becoming due or to compromise, settle or reduce the section 75 debt.
TPR can also require an employer or connected or associated third party to put financial support in place for the scheme.
On the face of it, most attempts to manage or reduce an employer's section 75 debt may be at risk of a CN either because they may be considered materially detrimental to members' benefits or because their main purpose may be to prevent recovery of the debt or prevent the debt becoming due.
However, the Pensions Act 2004 contains a formal clearance procedure whereby an employer (or persons connected or associated with the employer) can seek confirmation from TPR that a proposed transaction will not fall foul of the moral hazard provisions.
For more information, see our briefings Extracting pension scheme funding from third parties: overview and Who is 'connected' or 'associated'?
2. Is clearance needed when dealing with a section 75 debt?
TPR's guidance indicates that clearance should be considered for 'type A events'. Broadly, a type A event occurs in circumstances that would be 'materially detrimental to the ability of the scheme to meet its pension liabilities'. This may be because of an employer's legal obligations (eg an obligation to pay a section 75 debt) to a scheme and/or because its financial strength is so badly weakened. See our briefing Pensions and transactions - applying to TPR for clearance.
Examples of a type A event listed in TPR's clearance guidance include: 'an agreement entered into by the trustees to compromise the employer's s75 debt and reduce the amount that will be paid to the scheme' and `any such attempt to compromise will always be a type A event, irrespective of the level of the scheme's deficit before or after the compromise...'
3. Scheme apportionment arrangements
However, TPR states that the use of a scheme apportionment arrangement (SAA; see our briefing Dealing with a section 75 debt - apportionment and withdrawal arrangements) will be a type A event, unless:
a) it increases the section 75 debt that is immediately payable by an employer, which can afford the increased section 75 debt;
b) the cost and complexity of other alternatives (including calculating the unmodified section 75 debt or an approved withdrawal arrangement (AwA)) are far greater or disproportionate and the apportionment results in a section 75 debt that is the scheme actuary's best estimate of the unmodified section 75 debt and is immediately payable by the departing employer; or
c) the section 75 debt arises in circumstances in which there is no net reduction of employer covenant - for example, on the consolidation of several employers within the employer group in certain circumstances, provided that all employer assets and their pension liabilities transfer.
If the SAA does not have any of the above features it will, in TPR's opinion, be a type A event irrespective of the level of the scheme's deficit.
4. Withdrawal arrangements
TPR also states that a regulated apportionment arrangement (RAA) may be a type A event.
It also says that an AWA may be a type A event, particularly if the guarantee does not sufficiently mitigate the effect of a financially strong employer leaving the scheme (apparently, even if the guarantee is sufficient to meet the exiting employer's liabilities to the scheme). Similarly, other forms of withdrawal arrangement (WA) can be type A events, especially if the guarantee does not sufficiently mitigate the fact that a section 75 debt is not being paid in full.
Employers that use the general or de minimis easement to manage the section 75 debt (see our briefing Dealing with a section 75 debt - apportionment and withdrawal arrangements) will also need to consider whether to apply for clearance.
5. Notifiable events
Some events trigger an obligation to notify TPR. The Employer Debt Regulations expressly state that if an SAA is entered into after an employment cessation event, it will be a scheme-related notifiable event. This triggers an obligation on the trustees to notify TPR of the event. Failure to notify can lead to a maximum civil penalty of £50,000 and can influence TPR's decisions on whether to use its moral hazard powers.
Regulation 2(2) of the Notifiable Events Regulations 2005 also requires the employer or trustees (depending on who makes the decision) to notify TPR of any decision `which will, or is intended to, result in any debt which is or may become due to the scheme not being paid in full. `Debt' can include a contingent debt so is likely to apply to a section 75 one that is triggered on an employment-cessation event.
The breadth of these provisions suggests that most attempts to compromise a section 75 debt will be notifiable.
However, an SAA entered into before the employment-cessation event does not appear to be a notifiable event because, if the necessary circumstances are satisfied, the debt will be the amount payable under an SAA. If the intention is that the SAA amount (which is the section 75 debt) will be paid in full, this means that the decision to enter into the SAA will not result in any 'debt' that is 'not being paid in full' and therefore neither the trustee nor the employer should be required to notify TPR.
This view is consistent with and supported by the fact that an SAA entered into after an employment-cessation event is expressly stated to be notifiable.
Similarly, a WA will also not be a notifiable event because the debt becomes the amount that is payable under the WA.
Notification is less of an issue for RAAs and AWAs because TPR will need to approve these arrangements in any case.
There is probably an obligation to notify TPR when using either the general or de minimis easements. The requirement that the exiting employer transfer all its assets and employees will probably mean that it will `cease to carry on business in the United Kingdom', which must be notified to TPR under the Notifiable Events Regulations.