Doing a Deal? Pay Attention To Pensions

For any company planning a merger or acquisition, regulations covering defined benefit schemes are an important consideration advises Ian Bulman.

The number of defined benefit pension schemes in the UK has diminished rapidly over the last few years. But there are still several thousand schemes funded by sponsoring employers at uncomfortably high rates.

Extraordinary rates of funding are required because so many pension schemes have assets that simply fall short of their liabilities.

The deficit for defined benefit pension schemes run by FTSE100 companies is believed to be around £60 billion (source: ABC Money, April 2006). Which begs the question: how large is the deficit as a whole? The answer is likely to be a scary one.

Large deficits can be deal breakers in corporate mergers and acquisitions, and the regulations introduced in July 2003 and The Pensions Act 2004 don’t (at first glance) appear very helpful to companies going through such transactions.

The regulations are designed to ensure that members who retire from schemes receive a pension that fulfils what they were promised, and also to make sure that companies don’t shirk the responsibilities of the schemes they established.

Regulations to protect member’s rights include the following key points, amongst others:

• a deficit recovery plan must be agreed between the company and the trustees and submitted to The Pensions Regulator (TPR)

• requirements for pension scheme trustees, their advisers and companies to report to TPR

• the need to recognise and mitigate the risk of a moral hazard, where an employer manipulates affairs to shift their fund deficits to the Pension Protection Fund (PPF).

With regard to moral hazard, it’s clear that the regulations aim to make corporate manoeuvring around under-funded schemes a thing of the past.

For example, if a company withdraws from a multi-employer scheme, its share of the overall fund deficit must be calculated and actions taken to pay the shortfall.

And, because of the reporting requirements, an agreement to withdraw from any pension scheme must be obtained from TPR. So, for instance, if a company group is acquired during a merger, this may have serious implications for everyone concerned in the transaction.

Beyond the three key points mentioned, the regulations are far reaching. So much so that TPR has issued in-depth guidance on withdrawals from multi-employer schemes, and clearance from TPR prior to a merger or acquisition is likely to be required.

Failure to notify TPR can have significant consequences. It has powers to unravel a transaction where the rights of scheme members have been put at risk, or where TPR believes an employer is deliberately attempting to avoid their pension obligations.

For example, if there is a deliberate attempt to avoid a statutory debt, TPR can impose a contribution notice or, in the case of an under-funded scheme, it can stipulate financial support, both of which require a company to provide additional funding to the scheme.

The effect of Financial Reporting Standard 17 (FRS 17), which sets out the treatment of pensions benefits in a company’s statutory accounts, also needs to be considered.

FRS 17 generally involves a valuation of a pension scheme’s assets and liabilities with reference to the current market. This can have a direct effect upon your balance sheet and consequent reduction in dividend payments, so you can appreciate the need to take expert advice.

Good, timely advice can help everyone achieve a reasonable outcome. We know that TPR will, where circumstances allow, accept some compromise to resolve a matter, because their principal aim is to prevent problems developing.

Companies will also need to consider whether a transaction is affected by the recently revised Transfer of Undertakings (Protection of Employment) Regulations 2006. These can impose legal obligations on a new employer when a business is taken over as part of a merger or transfer.

Contractual rights and promises also need to be thought about, including compliance with other relevant pension legislation, which can entail numerous questions.

But it’s not all doom and gloom. Taking good counsel is key, and it’s generally the case that once a problem is recognised, it is surmountable. The trick is to recognise a potential problem early in the negotiation process of a transaction.

Where those concerned are clear on their responsibilities and take sound advice, pension schemes needn’t be deal breakers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.