In December 2010 we reported that the High Court had delivered a shock judgment in linked cases involving two large insolvent groups, Nortel and Lehmans. Both groups had defined benefit pension schemes significantly in deficit. The High Court determined, with reluctance, that claims made by the Pensions Regulator against companies after they enter administration (or a liquidation not immediately preceded by administration) ranked for payment ahead of other creditors. The Court of Appeal has upheld that decision. In many cases this ranking could effectively wipe out recoveries for creditors other than the Regulator.
This case is of major significance for corporate groups with defined benefit pension schemes in deficit, and for creditors of those corporate groups.
Claims by the Pensions Regulator Under the Pensions Act 2004 the Pensions Regulator has wide powers to seek financial support for a pension scheme deficit from entities in the sponsoring employer's corporate group. These powers (financial support directions and contribution notices) are the antidote to the so-called 'moral hazard' risk associated with the creation of the Pension Protection Fund (PPF). They aim to prevent corporate groups abandoning pension schemes in deficit and passing on liability for members' benefits to the PPF.
Background Certain companies in the Lehmans and Nortel groups participated in defined benefit pension schemes with large deficits. In Nortel’s case, this amounted to approximately £2.1 billion. In Lehmans’ case, the amount was approximately £148 million.
Following their collapse into administration, the Regulator took steps to issue a financial support direction against insolvent companies that did not participate in the pension schemes. The administrators asked the High Court how the Regulator's claims on behalf of the pension schemes ranked alongside claims from other creditors.
The outcome in the High Court The court decided that the Pensions Regulator's claims for the pension schemes enjoy "super priority" status as (first-ranking) administration expenses. This decision flowed from the fact that the claims were made after the administrators' appointment and did not exist before that time. Had the financial support directions been made before the administrators' appointment the claims would have ranked a lot lower down, just above claims from shareholders. The judge acknowledged his great discomfort in reaching this decision because he was bound by legislation and previous cases. He recognised that the outcome was potentially unfair to the other creditors. He effectively invited legislative change so that claims by the Regulator would rank equally with other unsecured debts. He described the current position as a “legislative mess”.
The outcome in the Court of Appeal The Court of Appeal agreed with the High Court reasoning, "despite the oddities, anomalies and inconveniences to which it gives rise". This is strangely understated language given that the court recognised that these "inconveniencies" could amount to a "serious impediment to the rescue culture which underlies the administration regime".
Implications In welcoming the High Court decision, the Pensions Regulator noted that it would not change its approach to issuing financial support directions or contribution notices. This may be of some comfort to other stakeholders concerned that the Regulator might simply focus on companies already in formal insolvency so as to secure a better outcome for the scheme than would be the case pre-insolvency. Nonetheless, the outcome is troubling for corporate groups and their creditors seeking to assess risk and outcomes in the event of an insolvency.
Pensions trustees - Pensions trustees are likely to have greater bargaining power when a group of companies is in a distressed state. The judgment may encourage them to take a more aggressive negotiating stance, since contribution claims can now rank highly in an insolvency to the detriment of other stakeholders.
Employers – Companies in a corporate group with a defined benefit scheme may well find it more difficult to refinance, and certainly will find it more difficult to restructure, if they become financially distressed.
What’s next? It remains to be seen whether the administrators will obtain leave to appeal this decision to the Supreme Court. In view of the wide-ranging consequences, with all its "oddities, anomalies and inconveniences", it may fall to Parliament to fix the problem with amendments to the legislation.