Supreme Court judgment provides reassurance to both the pensions and the insolvency industries as to the status of FSDs

On 24 July 2013 the Supreme Court issued its judgment in two appeals relevant to the Lehmans and the Nortel pension schemes. The decision has wider significance for both the pensions and the insolvency industries.

Background

The collapse of Lehman on 15 September 2008 was notorious. The main London based group companies were placed into administration on that day, including the sponsoring employer of the UK pension scheme. This crystallised a £120 million Section 75 (termination) debt to the UK pension scheme. The Regulator commenced investigations; its Determinations Panel issued a decision on 13 September 2010 that a financial support direction ("FSD") should be issued against six group companies on the ground that the UK sponsoring employer had been a service company, and the requirements for an FSD were met. (A service company is a company which enters into service contracts with employees who work for other group members.)

The Nortel telecommunications, computer network and software business collapsed in January 2009, at which time a Section 75 debt crystallised of approximately £2.1 billion. The Determinations Panel issued a determination notice on 25 June 2010 deciding that an FSD should be issued against certain group companies on the ground that the UK sponsoring employer had been "insufficiently resourced", and the requirements for an FSD were satisfied.

In both cases the administrators applied to the court for directions as to how the administrators of a target should treat the target's potential liability under the FSD regime in a case where the FSD is not issued until after the target has gone into administration. In both cases, the FSD process was stayed pending the outcome of the administrators' court application. The cases were heard together.

Previous decisions

Somewhat controversially, the High Court and the Court of Appeal had both reached the conclusion that previous cases prevented them from holding that an FSD issued after the commencement of an insolvent administration or liquidation (an "insolvency event") could constitute a provable debt which would rank alongside other unsecured creditors in the insolvency. They had found to most people's surprise that an FSD issued post insolvency ranked as an expense of the insolvency, which gave it preference over other creditors. So whilst any Section 75 debt payable to a UK pension scheme following employer insolvency – or an FSD imposed prior to an insolvency event - would rank as an unsecured creditor, if the Regulator issued an FSD after an insolvency event, this would effectively move the FSD liability up the queue of potential creditors, increasing the likelihood of recovery.

The decisions of the High Court and the Court of Appeal had been subject to vociferous criticism and loudly voiced concern as to its impact on the rescue culture as large expense claims limit the ability of an insolvency professional to maximise returns for unsecured creditors. As expenses rank ahead of floating charges, concern had been raised that this would curtail borrowing to groups with defined benefit pension schemes.

Question for the Supreme Court

The Supreme Court was asked to confirm how the administrators of a target should treat the target's potential liability under the FSD regime (and any subsequent contribution notice which may enforce the FSD), where the FSD is not issued until after the target has entered administration.

FSDs: an outline

The FSD regime was introduced by the Pensions Act 2004, with the aim of preventing corporate groups from avoiding their pension obligations. The FSD regime seeks to deter groups from adopting a corporate structure which would leave a weak employer sponsoring a defined benefit/final salary pension scheme, so increasing the risk that the scheme would fall into the Pension Protection Fund.

The Pensions Regulator may decide to issue an FSD where the sponsoring employer is either a service company, or is insufficiently resourced. In imposing an FSD, the Regulator has the power to require companies associated or connected with the sponsoring employer to put in place financial support to support the scheme employer, including support to meet any section 75 debt liabilities where the scheme enters wind up.

The decision

The Supreme Court, to the relief of the pensions and insolvency industries, provided a welcome and pragmatic decision.

  • For a debt to be provable in an administration/liquidation, it must fall within Rule 13.12(1) of the Insolvency Rules 19861. The Supreme Court confirmed that liabilities to which a company "is subject" at the date of the insolvency event fall within limb (a) of Rule 13.12(1), whereas liabilities to which the corporate "may become subject" after that date may fall within limb (b). There is no overlap; liabilities will fall within one category or the other.
  • Does an FSD fall within limb (b), that is, is it a "debt or liability to which the company may become subject after [the insolvency event] by reason of any obligation incurred before [the insolvency event]"? The Supreme Court held that it was. Normally, in order for a company to have incurred a relevant "obligation" for this purpose, it must have been taken, or been subjected to, some step or combination of steps which (a) had some legal effect (such as putting it under some legal duty or into some legal relationship), and which (b) resulted in it being vulnerable to the specific liability in question, such that there would be a real prospect of that liability being incurred. If these two requirements are satisfied, it is then relevant to consider (c) whether it would be consistent with the regime under which the liability is imposed to conclude that the step or combination of steps gave rise to an obligation under Rule 13.12(1)(b).
  • Applying these tests to the facts, the Supreme Court held that (a) on the date they went into administration, each of the companies had been a member of the corporate group. Membership of a corporate group is significant from a legal perspective, carrying with it many legal rights and obligations under revenue, company and common law; and (b) by the date each group entered administration, the group concerned included either a service company with a defined benefit pension scheme, or an insufficiently resourced company with a defined benefit pension scheme. Accordingly the targets were precisely the type of entities who were intended to be caught under the FSD regime.
  • The sensible and fair answer is that the potential liability of a target under the FSD regime, issued after the insolvency event, should be treated as a provable debt. There is no sensible logic in putting the pension scheme trustees in any better or worse position, and it would be surprising if an employer's direct obligation to pay a Section 75 debt were to rank lower in insolvency that an indirect obligation imposed by the Regulator on a target. The Supreme Court also rejected the suggestion that FSDs could rank after provable debts (i.e. behind unsecured creditors).
  • The Supreme Court also provided helpful guidance as to what constitutes an expense of the administration, helpfully confirming that the lower courts had misunderstood and misapplied the guidance of earlier cases. An expense of the administration (which then ranks ahead of preferential creditors, floating charges, and unsecured creditors) arises if it is something done in the administration (usually by the administrator or on his behalf), or if it is imposed by statute whose terms render it clear that the liability to pay the disbursement falls on an administrator as part of the administration, either because of the nature of the liability or because of the terms of the statute.

Comment

We welcome the decision of the Supreme Court. The decision provides certainty that the pension scheme ranks as an unsecured creditor in all cases, and that any liability imposed on group companies under an FSD does not undermine the general position. This will be particularly welcome news to banks (as any floating charges will continue to have priority over pension debts in all cases), and for the same reason to groups with defined benefit pension liabilities seeking credit. This certainty will enable insolvency practitioners to proceed with the administration of schemes where an FSD is imposed, safe in the knowledge that an FSD ranks equally alongside other unsecured creditors.

The case will allow the Pensions Regulator to proceed with the implementation and enforcement of the FSDs issued in the Lehmans and Nortel cases. The case is also likely to influence the approach of the Regulator in future, given that the timing for the issue of an FSD will not impact on the amount likely to be recovered.

Footnotes

1 "Debt in relation to the winding up of a company means ... any of the following - (a) any debt or liability to which the company is subject ... at the date on which the company went into liquidation; (b) any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date" ...

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