The story of the restructuring of carpet-maker, Brintons has featured in the press recently, with emphasis on the role of Carlyle, one of the world's biggest private equity firms. The facts are similar to the Silentnight pre-pack which we featured in a previous bulletin. In each case, the Pensions Regulator is said to be considering using its anti-avoidance powers under the Pensions Act 2004 to compel senior debt holders to pay towards the deficit of the defined benefit pension scheme operated by the company.
It is difficult to see what the senior debt holders have done that should invoke the wrath of the Pensions Regulator. In each case, the debt holder has simply sought to exercise its rights as the senior debt holder to restructure the business. The effect of this is to crystallise and demonstrate the true value of the pension trustees' claim against the sponsoring company. The alternative, that companies should maintain unaffordable pension arrangements and use what little profit is available to fund them over a lengthy period in the hope that improved market conditions will eventually wipe out the deficit, has been rejected in the past by the Pensions Regulator and the Pension Protection Fund (PPF) as being simply too risky.
The Pensions Regulator will face substantial hurdles in using its anti-avoidance powers against Carlyle, particularly in establishing that Carlyle is "connected" or "associated" with Brintons (the Pensions Act 2004 makes this a pre-requisite for a Pensions Regulator sanction). PE houses contemplating similar transactions should take particular care with the way in which they structure each step of the transaction to ensure that they avoid being connected or associated.
The facts are underreported but appear to have significant similarities to Silentnight:
- Carlyle acquired Brinton's senior debt. As debt holder, it had certain rights (e.g. to call in the debt or seek the appointment of an administrator) but no control over Brintons in the legal sense.
- It appears that proposals were put forward to creditors for the restructuring of Brinton's finances. In exchange for further investment, it was proposed that unsecured creditors (including the pension scheme trustees) would agree to their claims being reduced.
- The proposals were rejected, presumably because the trustees (and the PPF) thought the return to the scheme would be better if the company entered administration.
- Brintons was then put into administration. In a "pre-pack" process, Carlyle bought the Brinton's business (i.e. the assets and goodwill) for an undisclosed sum.
- The pension scheme will now enter a "PPF assessment period", during which the PPF will assess whether the scheme qualifies for compensation from the PPF.
(For our briefing on Silentnight, click here.)
Where a company needs further investment in order to survive, it is not uncommon for potential equity investors to look upon a defined benefit pension scheme as a barrier to investment. Depending on the relative sizes of the scheme, the company and the required investment, insolvency priority rules (and the treatment of the pension scheme as an unsecured creditor) can make a new equity investment unviable. Where not all creditor claims would be capable of being met (and so in effect, the equity value is nil), it is not unusual for a company to seek a compromise with all or some of its creditors, including the pension scheme, in order that the company can continue to trade, potentially facilitating new investment.
It is difficult to see what is inappropriate about Carlyle buying senior debt and (allegedly) exercising its rights and precipitating a restructuring. The financial issues facing the company are likely to have existed before Carlyle's involvement and it is not Carlyle's fault that Brintons cannot satisfy the claims of unsecured creditors. Moreover, the position of pension scheme trustees as unsecured creditors is well documented and was a conscious decision of the legislators who wrote the Pensions Act.
The alternative is that Brintons would struggle on with a pension scheme that stifled investment, ate cash and was of no relevance to its current business (assuming the scheme is closed to future accrual). From the trustees' point of view, the recovery plan would need to be so lengthy that there could be no real expectation that it would be met; any business plan supporting it would be at best an optimistic guess. The very existence of the scheme, and its negative effect on potential new investment, would make it less likely that the company could generate the cash to fund the scheme. We have been involved in similar situations where the Pensions Regulator itself has decreed that the long term recovery plan is too risky and has effectively pushed for a restructuring.
Issues for PE houses
If a private equity investor had bought Brintons' shares, there would be the possibility of the Pensions Regulator using its anti-avoidance powers to require the PE house to make good some of the pension scheme's deficit. The press comment focuses on whether buying senior debt is a means of avoiding any such potential liability. The Pensions Regulator is said to be investigating whether there is a possibility of using its powers against debt holders. Whether the Pensions Regulator can seek to sanction Carlyle will depend on whether it can establish that Carlyle is "connected" or "associated" with Brintons.
While "connected or associated" is usually established through a shareholding, it is possible for one company to be connected or associated with another where the directors are "accustomed to acting in accordance with the wishes" of the other company. In addition, association can also be found through shadow directorships, common directorships, concert parties and employment relationships.
On an ongoing basis, it seems clear that a lender is not connected or associated with a borrower due to the independent duties of the directors of the borrower. Equally, in a pre-pack administration, the independent duties of the administrator should prevent the borrower being associated or connected with the senior lenders. But it will be very interesting to see whether the Pensions Regulator can find enough evidence that the overall process of purchasing senior debt, "forcing" administration and subsequently acquiring the business out of the administration in a pre-pack, is such as to establish the necessary degree of "control".
For PE houses contemplating similar transactions, it will be essential that they fully and carefully evaluate the "connected or associated" test in light of the aggregate steps that they intend to take, or may take in relation to a target company in order to seek to ensure that the test will not be met. It remains to be seen whether the Pensions Regulator will take any action of the sort that might provide clarity to PE houses as to the risks they may face in similar situations.
A further area of interest is whether the Regulator could impose a financial support direction on Brintons itself in order to skip the priority order and claim a greater proportion of the assets of the administration. In Bloom and others v Pensions Regulator (Nortel, Re)  EWHC 3010 (Ch) (10 December 2010) (currently being appealed), the High Court found, with some reluctance, that liability under a financial support direction and contribution notice issued on the back of a financial support direction ranks as an expense of the administration, and so has super-priority over other creditors. If monies are paid out to other creditors by the administrator, such payout could be subject to challenge. Whether this is a serious possibility would depend on the corporate structure of the Brintons group, the consideration in the pre-pack administration and the Regulator's position as to the reasonableness of such super priority claims, which is unclear given statements made by the Regulator to the court in Bloom.