This briefing outlines the UK pension implications for an employer (Employer) and its parent company (Parent) of:
- a dividend by the Parent to shareholders; and
- an intra group dividend by the Employer to its Parent (eg to fund the Parent to pay its own dividend).
Both the companies and the trustees may need to consider the implications of the payment of such dividends on the security for the pension scheme, in particular whether dividends would mean:
- the existing funding arrangements need revision; or
- the Pensions Regulator’s moral hazard powers could apply.
Dividends can affect the strength of the employer support (covenant) available to a pension scheme. If there is a material adverse change, the trustee may look at its options to agree new ongoing funding arrangements. Dividends will also be relevant when trustees look at the affordability of deficit contributions. A dividend could also trigger the Pensions Regulator looking to see if it should use its ‘moral hazard’ powers to issue a contribution notice or a financial support direction in connection with (or as a result of) the proposed dividend.
There are various actions that the Parent and the Employer could undertake to limit any Trustee concerns regarding the impact of the proposed dividend on the Scheme.
The potential disclosure obligations in relation to a proposed dividend also need to be considered.
Pensions issues on proposed dividends
Companies will often want to pay dividends to shareholders – whether:
- by a parent company out of the group (to ultimate shareholders); or
- within a group, from (say) the employer to the (non-employer) parent company.
A (simple) example is:
Click here to view diagram.
Pension schemes are direct creditors of the relevant Employer (by reason of the statutory funding obligations under the Pensions Act 2004 and the debt on employer provisions in section 75 of the Pensions Act 1995). Schemes are not automatically direct creditors of other companies in the group (absent a direct guarantee or the Pensions Regulator exercising its moral hazard powers) – see our briefing No 220, Pension debts – priority of claims.
Dividends can affect the strength of the support (covenant) available to a pension scheme. Proposed dividends raise three main pensions issues:
- does any change in the strength of the covenant impact on ongoing funding arrangements?
- does any dividend raise potential risks of the Pensions Regulator exercising its moral hazard powers?
- what are the disclosure and notification obligations? How is any conflict of interest dealt with?
Trustee and funding
The effect of a dividend is that the Employer may need to agree new ongoing funding arrangements with the trustee of the Scheme (the Trustee). The Trustee is likely to take a dividend into account when assessing the strength of the Employer as the principal employer of the Scheme, and any additional support that could be expected from the Parent. The effect of:
- a dividend from the Employer to the Parent, is to weaken the strength of the Employer, but this may be counterbalanced (to a degree) by the extra strength given to the Parent (depending on what the Parent plans to do with the proceeds of the dividend and the degree of support that the Trustee sees from the Parent as part of the Employer’s ‘wider group’).
- dividend from the Parent to its shareholders, is to weaken the strength of the Parent. The materiality of that to the Scheme will depend on the size of the dividend and the degree of support that the Trustee sees from the Parent as part of the Employer’s ‘wider group’ (as opposed to the shareholders who may not be).
Depending on size and materiality, the dividend can affect the level of contributions which the Trustee seeks from the Employer (see ‘Funding implications’ below).
See the section on ‘Funding implications’ below.
Potential moral hazard risk
The Pensions Regulator (TPR) could in some circumstances use its moral hazard powers1 to issue a contribution notice (CN) or a financial support direction (FSD) in connection with (or as a result of) the proposed dividend.
In order to issue a CN or an FSD against someone that is not a participating employer of the Scheme:
- that third party must be ‘connected’ or ‘associated’ with a participating employer;
- the relevant conditions for issuing a CN or an FSD must be met; and
- TPR must consider it reasonable to issue such a notice.
The following entities/persons, in particular, are connected or associated and so could be potential targets for TPR’s moral hazard powers:
- parent and other entities in the Parent group; and
- the directors of the Employer.
See the section on ‘Moral Hazard Powers’ below.
Disclosure/Conflicts of Interest
The Employer and the individual directors of the Trustee board have certain duties to disclose information to the Trustee board. See the section on ‘Disclosure’ below.
Limiting the Trustee’s concerns
The Parent and the Employer could undertake the following actions to limit any Trustee concerns regarding the impact of the proposed dividend on the Scheme:
Explain the group’s dividend policy to the Trustee
This action does not seek Trustee consent, but merely clarification that the Trustee board is aware of the position. This may also allow the company to claim that dividends are not material (either for moral hazard purposes or scheme funding). It also reduces the potential for the Trustee seeking changes to the current ongoing funding arrangements.
However, it must be remembered that this offers no express clearance or exemption from moral hazard powers.
Agree the dividend with the Trustee
The dividend policy of the Employer/Parent could be agreed with the Trustee, at the time or in advance (eg as part of the scheme funding negotiations). This should allow the company to claim that dividends within that policy are not material (either for moral hazard purposes or scheme funding).
Mitigate any reduction in the Employer covenant
In relation to a material dividend from the employer to the parent, mitigation could be offered – eg a parent company guarantee may result in no overall covenant reduction (and could improve the scheme’s PPF levy situation), but would also formally tie the Parent to the Employer and Scheme. Furthermore, a parent company guarantee would not then be available for future negotiations if needed.
Seek clearance from TPR
Formal clearance from TPR will provide comfort to the parties on TPR’s moral hazard powers (but only to the extent of the facts as disclosed). TPR or the Trustee may also want extra funding in return and the clearance may not cover all future events.
As part of the scheme specific funding arrangements (under the Pensions Act 2004), the Trustee will need to consider the strength of the employer covenant supporting the plans when assessing scheme specific funding. Trustees increasingly look for a formal covenant review and the proposed dividend will be relevant to this assessment.
Dividend from the Employer
An intra-group dividend from the Employer to the Parent would have the effect of reducing the net assets of the Employer. The Scheme would usually be (eg if an insolvency occurred) an unsecured creditor of the Employer. Depending on the financial impact, the Trustee may consider a dividend to be a material change when looking at covenant issues. This will have an effect on the negotiation of future funding.
The impact of this may in some cases be reduced, given that the Parent is part of the Employer’s ‘wider group’ and so may (depending on the circumstances) be an entity that the Trustee may look to for support in any event.
Dividend from the Parent
As stated above, schemes are not automatically direct creditors of other companies in the group (absent a direct guarantee or the Pensions Regulator exercising its moral hazard powers)2. But schemes may have an interest in the strength of the Parent for various reasons:
- the Employer may be a creditor of the Parent (eg if it has lent funds to the Parent). So the strength of the Employer depends (in part) on the ability of the Parent to repay that debt;
- the Parent may have given security or support direct to the Scheme; or
- the Scheme may consider that TPR could exercise its moral hazard powers (see below) and force the Parent to contribute or give security to the Scheme; and
- the Parent will form part of the ‘wider group’3 on which the Employer or the Scheme may be able to rely (to a degree) in practice even absent a formal legal obligation.
What can the Trustee do?
The Trustee’s powers, when faced with a dividend (or notice of a potential dividend), to raise employer contributions, depend on the terms of the scheme and the funding arrangements already agreed.
- some schemes give the Trustee a unilateral power to fix contributions – in such cases, where the dividend has a potentially material impact, the Trustee may consider exercising that power and raising contributions.
- In other schemes, the rules provide for contributions to be fixed by the employer or by agreement – here the Trustee does not have a unilateral power to increase contributions, but it may be able to seek agreement with the Employer on a revision to the funding arrangements in light of the dividend. The scheme specific funding provisions under the Pensions Act 2004 include provision for a scheme’s recovery plan to be reviewed ‘and if necessary revised’ where the trustees ‘consider that there are reasons that may justify a variation to it’4. If the Trustee and the Employer do not agree, then the Pensions Regulator may have power to impose a new schedule of contributions (s231, Pensions Act 2004).
TPR’s views on dividends
TPR’s guidance on ‘Monitoring employer support’ suggests that trustees and employers should consider increasing scheme security by using contingent assets, including:
‘negative pledges, whereby an employer makes a commitment not to do something such as grant new security without the agreement of trustees or not to increase dividends’.
TPR’s statements on funding indicate that it expects the funding of the pension scheme to be taken into account by companies, when looking at dividend policy. It discourages increases in dividend payments at a time when recovery plan periods may be looking to be extended. Its general guidance is for trustees to look for contributions based on the amount that companies can reasonably afford5.
TPR Statement (April 2012)
Pension scheme funding in the current environment (April 2012)
- Where deficits have increased, some employers will be in a position to accommodate deficit repair contribution increases in their business plans. Others will have significant competing demands making cash contribution increases difficult. Servicing of other debts and facilitation of appropriate capital expenditure are necessary features of successful businesses as part of ensuring ongoing employer support.
- The pension scheme should, however, be equitably treated among the competing demands on an employer (eg to balance the business dynamics for capital investment and dividends payments with obligations to service debt). Where cash is being used within the business at the expense of what otherwise would have been affordable pension contributions, it is important that it is being used to improve the employer’s covenant – rather than benefits accruing disproportionately to other stakeholders.
- Most employers can afford appropriate dividend payments without prejudice to the funding of the pension scheme. However, if there is substantial risk to the likelihood of the pension scheme delivering the benefit entitlements promised within it, then dividend payments need to be re-assessed in light of the obligations to the pension scheme, and other creditors.
- Where the employer’s covenant has weakened and it cannot afford to continue contributions at previously agreed levels, or is unable to pay more in respect of a larger deficit, trustees may need to agree to a longer recovery plan. A material extension to the recovery plan end date will require sound justification.
Moral Hazard Powers
The moral hazard powers of TPR include powers to make third parties liable for pension deficits/funding etc in certain circumstances. Such third parties must be connected or associated with an employer, the relevant conditions for issues or issue of an FSD or CN must be met and TPR must consider issue of such a notice to be reasonable.
A dividend has two potential impacts on the risk of a CN or FSD:
- the dividend could itself be a trigger for a CN as being an act that supports a CN; or
- in the case of a dividend payable to the Parent, the fact of the dividend having been paid, reinforces the connection of the Parent with the Employer. It is an example of the Parent having drawn a benefit from the Employer and so could make it more reasonable to make a CN or FSD against the Parent. See for example the reasons given by the determinations panel of TPR in the Box Clever determination in 20116.
TPR has the power to issue a CN where either:
- a person has been a party to an act/omission since April 2004, the main purpose of which or one of the main purposes of which was to avoid or reduce the s75 pension liability7; or
- an act/failure to act since April 2008 has detrimentally affected in a material way the likelihood of accrued scheme benefits being received.
In both cases TPR must consider it reasonable to issue a CN having regard to factors set out in the legislation.
A CN can be issued on a person who is (or has been) connected or associated with the employer8– eg an individual (eg a director of the Employer) or a company (eg Parent) – who was a ‘party to’ (or ‘knowingly assisted’) in the relevant act or omission. The warning notice needs to be issued within six years of the relevant act or omission.
The primary test for an FSD is financial – is the employer a service company or ‘insufficiently resourced’? An FSD cannot be made against an individual (where the employer is a company).
Who is potentially liable?
An FSD in a group situation can only be issued against other group companies. It cannot be issued against individuals. CNs can be issued against connected companies (eg Parent) but also against individuals who are associated or connected with an Employer (eg directors or employees of the Employer9). They need to be ‘party to’ (including those who ‘knowingly assist’) the relevant act or omission that triggers the CN.
There is a statutory defence (s38B, Pensions Act 2004) available to the ‘materially detrimental’ CN test – where a target (eg a director):
- gave due consideration to how the scheme might detrimentally be affected; and
- took all reasonable steps to minimise any detriment; and
- reasonably concluded that the act or failure ‘would not detrimentally affect in a material way the likelihood of accrued scheme benefits being received’.
Disclosure/Conflicts of Interest
There may be two potential disclosures which arise in relation to a proposed dividend:
- disclosure by the Employer (or Parent) to the Trustee; and
- disclosure by individual members of the Trustee board (who may hold senior positions in the Parent) to the Trustee board.
One issue for the Employer is when to discuss the proposed dividend with the Trustee.
Partly this depends on whether there is any formal disclosure protocol that has already been agreed. There is a statutory obligation on an employer to disclose material events to trustees within one month of them happening. In addition, an employer is required to disclose material information if requested by the Trustee (Reg 6, Scheme Administration Regulations 1996).
There is no obligation to inform the Pensions Regulator about a dividend – dividends are not within the notifiable event obligations10.
The position where a member of the Trustee board is aware of a proposed dividend (eg by virtue of his position within the Employer or Parent) depends on the materiality of the proposal and on the disclosure/conflicts provisions of the Scheme (or the articles of association of the trustee company).
The conflicts policy that has been adopted by the Trustee (following the Companies Act 2006 and TPR guidance on conflicts at about the same time) needs to be considered.