Financial support directions and insolvency: the Regulator's statement
In October 2011 the Court of Appeal confirmed that where the Pensions Regulator (Regulator) exercises its financial support direction (FSD) power against a company in insolvency, the liability which arises ranks as an expense in the insolvency process which means it has "super priority" ahead of many other creditors (including creditors with floating charge security). Whilst this decision is being appealed to the Supreme Court, the Regulator issued a statement on 26 July 2012 to set out its approach to FSDs in insolvency situations. This speedbrief considers that statement.
FSDs: a quick reminder
An FSD requires the recipient to put in place Regulator-approved financial support for the scheme in respect of the obligations of an employer who is either a service company or is insufficiently resourced. The Regulator may only impose an FSD where it considers it reasonable to do so.
Why has the Regulator issued its statement?
In 2010 (in separate decisions) the Regulator's Determinations Panel decided to impose FSDs against various companies in the Nortel and Lehmans groups. Both determinations have been appealed. In addition, the administrators of the Nortel and Lehmans companies applied to the Companies Court for directions as to the effect of an FSD on a company in administration/liquidation. The Court of Appeal confirmed the 2010 High Court decision and held:
- 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;
- a third alternative, that the FSD might be neither provable as a debt nor an expense (the "black hole" option), was not applicable.
This decision grants the pension scheme "super priority" behind holders of fixed charges but ahead of other creditors (including unsecured creditors, floating charge holders and even the administrator's own fees) where the FSD is imposed after (but not before) the insolvency process affecting the FSD recipient begins. The Supreme Court will consider this issue in May 2013. The statement recognises the possibility that the Supreme Court may decide that FSDs create provable debts, even when issued after the recipient enters formal insolvency.
Both the High Court and the Court of Appeal commented that they felt bound to reach the conclusion they did based on the principles of insolvency legislation and case law. However, each court acknowledged the difficulties with the outcome. Particular issues expressed include:
- the conclusion reached could potentially impede the rescue culture and affect the ability of corporate groups with defined benefit schemes to borrow money;
- UK insolvency law might become less attractive to international groups if the UK pension liabilities took a higher priority in the process; and
- lenders might feel constrained against lending if security might become impaired at precisely the time they needed to rely on it.
What does the Regulator's statement say?
The statement is intended to help the pensions and insolvency industries understand the Regulator's approach to FSDs in insolvency situations and to allay some of the anxieties created by Nortel/Lehmans. In particular, the Regulator's intention is to ensure that the FSD powers do not frustrate legitimate insolvency and restructuring practice or impact negatively on the lending market.
Amount of support under an FSD
The statement confirms:
- the FSD does not contain an order for any specified amount or form of support to be provided. In addition, it does not create an immediate obligation to pay money (even if a contingent liability does arise) and the FSD legislation is flexible as the form and amount of support to be provided;
the factors the Regulator takes into account when considering whether the form and the amount is reasonable include:
- where the FSD is issued after insolvency but arises in relation to events which occurred pre-insolvency, the position under insolvency law had the FSD been issued before the insolvency event;
- the recipient's financial circumstances;
- the interests of directly affected parties, including the recipient's creditors;
- the creditors' claims including the return which unsecured creditors would have received had the FSD been issued prior to the insolvency event. This will result in a level of support which achieves broad equity between the scheme's trustees and unsecured creditors of the FSD recipient.
Regulator's decision to issue an FSD
The statement notes that an FSD investigation can be a lengthy process. However, the Regulator comments that where an FSD is appropriate, it has no intention of deliberately delaying its issue until after an insolvency event in order for the FSD to have super priority.
The Regulator suggests that administrators and other interested parties (for example lenders) should approach it to discuss any likely regulatory action against the insolvent companies. In particular, Regulator clearance should be considered where appropriate.
The statement comments:
- the order of insolvency priority ranking does not override the Regulator's duty to act reasonably when considering whether the amount and form of financial support proposed is reasonable;
- the administrator may apply to court for a prospective order to vary the order of priority, and with sufficient information (in consultation with the trustees and the PPF) it would not seek to object to the re-ordering of the priority of FSD liabilities to sit behind the administrator's reasonable remuneration;
- it will also consider any proposals to re-order other categories of administration expense above FSD liabilities;
- the Regulator's procedure where an FSD is issued during an administration would be the same whether the FSD liabilities rank as an expense of the administration or a provable debt;
- the fact that FSD liabilities rank as an administration expense does not make it any more likely that the distribution of assets from the estate will be delayed.
Neither pensions nor insolvency legislation specifically addresses the question of priority for FSDs in relation to an insolvent company. The courts, therefore, have had to weave a way through the unintended consequences of the legislative mess. Despite the fact that the appeal to the Supreme Court is not being heard until May 2013 (judgement likely sometime later), it is useful to have confirmation from the Regulator that it will take a pragmatic approach to FSDs in the context of insolvent companies. In particular, the restructuring industry may take some comfort from the comments that the Regulator does not want to prevent effective restructuring or frustrate the rescue culture.
At the same time, it is worth bearing in mind that it is not until the Supreme Court has given judgement that the Upper Tribunal will re-hear the Nortel and Lehmans FSD cases. It is likely to be several more years until the Nortel and Lehmans FSD litigation as a whole will be completed.