The Court of Appeal has confirmed that where the Pensions Regulator (Regulator) exercises its anti-avoidance powers against a company during insolvency, the liability ranks as an expense in the insolvency process.  The 14 October 2011 judgment, in a case involving the Nortel and Lehman Brothers groups, upheld the High Court's landmark decision of last year.

This means that, in theory, the cost of complying with financial support directions (FSDs) and potentially also with contribution notices (CNs) ranks in an insolvency in priority to unsecured creditors, floating charge holders and the administrator's own fees.  In practice this may make FSDs and CNs such "nuclear weapons" that the Regulator will be less willing to use them in insolvency situations.

The law is acknowledged to be in a mess and urgently needs clarification by Parliament rather than the courts.

Background

By way of brief reminder, the Regulator has powers under the Pensions Act 2004 to issue FSDs and CNs.  These are commonly referred to as its anti-avoidance powers.  FSDs and CNs may be issued, broadly, in circumstances where the Regulator believes an employer is attempting to avoid its obligations under a defined benefit occupational pension scheme.

Following their collapse, the Regulator started down the road of exercising its anti-avoidance powers against companies in the Nortel and Lehman Brothers groups.   The process was suspended because an important question arose as to the effect of FSDs and CNs imposed on a company during an insolvency process.

Pensions legislation does not say what priority FSDs and CNs have in relation to an insolvent company (though it does not give them priority over other creditors when a company is solvent).  So, the question fell to be decided in accordance with the rules of priority on insolvency, which do not directly address this issue either.

The High Court case

In December 2010, the High Court held that:

  • an FSD issued by the Regulator before the company enters an insolvency process is a "provable debt" which means it will rank equally with unsecured creditors in the company's insolvency; but
  • an FSD issued after an insolvency process begins will rank as an expense, which is prioritised ahead of other unsecured creditors.

This would, in effect, grant the pension scheme "super priority" behind holders of fixed charges but ahead of other creditors (including  unsecured creditors,  floating charge holders and the administrator's own fees) where the FSD is imposed after (but not before) the insolvency process begins.

The High Court felt bound to reach this conclusion based on the principles of insolvency legislation and case law but acknowledged that it was an anomalous outcome.

Our speedbrief of December 2010, describes the High Court case in more detail.

The Court of Appeal case

On 14 October 2011, the Court of Appeal unanimously upheld the High Court's decision.  It felt compelled to do so "despite the oddities, anomalies and inconveniences" to which this gives rise.

It said that a reading of the legislation that makes the anti-avoidance liabilities a provable debt (which would rank equally with other unsecured creditors) rather than an expense (which has super priority) was unfortunately not possible.  The only other alternative would be for these liabilities to "go into a black hole", meaning that they would not be recoverable at all; this, the court felt, could not have been the intention of Parliament, which left only the expenses option.

The question of when the liability in relation to the FSD actually arises (whether at warning notice stage, issue or some point in between) was not addressed.

Comment

The courts have struggled to interpret sensibly legislation described by Briggs J in the High Court as a "mess".   Both the High Court and the Court of Appeal felt bound by case law to reach a decision with which they clearly felt some discomfort.  In the circumstances, their conclusion (based on a choice between super priority and the black hole) seems understandable.

The Court of Appeal decision will reinforce the effectiveness of the Regulator's powers, at least for the time being.  Fears have been expressed (including by the court itself) that this could potentially impede the rescue culture and affect the ability of corporate groups with defined benefit schemes to borrow money. Lenders and other creditors may hesitate to get involved with companies where the pension scheme could unexpectedly "leapfrog" them in an insolvency. Administrators may also be less inclined to act where there is a risk they will be unable to recover their fees.

The Regulator has attempted to downplay these fears and emphasised its duty to act reasonably when considering use of its anti-avoidance powers. This must be right.  Whilst the FSD might now appear something of a nuclear weapon, the Regulator may be open to charges of acting unreasonably (and hence without legal effect) if it makes FSDs that impose personal liabilities on insolvency practitioners, or relegate the interests of other creditors who would normally rank ahead of or equal to the pension scheme.

This is unlikely to be the final word on the subject.  The parties are due to hear within the next fortnight whether leave to appeal to the Supreme Court will be granted.  We will not find out whether FSDs will in fact be imposed in relation to Nortel and Lehman Brothers companies until this litigation concludes.  Given the unsatisfactory nature of the law and the potentially anomalous consequences, early clarifying legislation from the Government would appear a better solution than a further court hearing, which is unlikely to be able to reconcile the underlying tensions in the existing legislation.