Supreme Court to rule on pension scheme insolvency ranking next week

Both the High Court and Court of Appeal have previously said that if the Pensions Regulator issues a claim against a company over a pension scheme which is in deficit after the company enters formal insolvency, that action would rank above the claims of other creditors, including certain claims by banks.

"This decision is eagerly anticipated by the stakeholder groups whom it will directly affect: scheme employers and associated companies, banks, scheme trustees and investors.  It has highly-significant implications" said restructuring expert Alastair Lomax of Pinsent Masons, the law firm behind Out-Law.com.

"The insolvency profession will no doubt be hoping that their Lordships will be keen to avoid the law of unintended consequences by finding that moral hazard claims made by the Pensions Regulator both before and after formal insolvency rank as provable, unsecured claims in the target company's insolvency. To do otherwise would afford a greater priority to such claims against non-employers than is afforded to the scheme's claim in its employer's insolvency," he said.

However, such a verdict would not mean that insolvency practitioners "could all relax", he said. "The threat of such claims could still produce a real headache for administrators and liquidators who are faced with the thorny question of how they should be valued, with a knock-on effect for other creditors," he said.

Since 2004, the Pensions Regulator has had wide powers to seek financial contributions or support to meet a pension scheme deficit from companies connected to or associated with the pension scheme employer through financial support directions (FSDs) and contribution notices. These powers prevent the 'moral hazard' that solvent companies in the same corporate group could leave the scheme without adequate funds knowing that the Pension Protection Fund (PPF), which guarantees the pensions of members of DB pension schemes in the event of employer insolvency, would cover the deficit.

Next week's Supreme Court ruling relates to a claim made by the Pensions Regulator on behalf of former employees of Nortel Networks and Lehman Brothers' European division who had been members of defined benefit (DB) pension schemes. When the companies went into administration Nortel's scheme was approximately £2.1 billion in deficit, while Lehmans' was approximately £148 million in deficit. When the companies went into administration the regulator began the process of issuing an FSD against companies within the two groups that did not participate in the pension schemes.

In November 2011, the Court of Appeal confirmed that the regulator's claims for contributions ranked as expenses of the administration because the claims were made after the administrators were appointed in each case. Had the claims been made before the administrators' appointment the claims would have ranked lower in the hierarchy of creditors, as unsecured provable debt.

Restructuring expert Alastair Lomax said that the lower courts had had "some misgivings" about this outcome, with one of the Court of Appeal judges describing the interaction between pensions and insolvency law as a "legislative mess".

"If the Supreme Court follows suit and decides that Pensions Regulator claims arriving post-insolvency – and let's face it, most will do so – should be classed as administration expenses, this could threaten vital funding and rescue strategies for corporates connected with schemes in deficit; at least unless Parliament comes to the rescue with revised legislation," Lomax said.

"An insolvency expenses ruling would reinforce insolvency practitioners' concerns over the viability of appointments to those corporates at most risk, since even the costs of running the insolvency process would be at risk. It would also give further cause for concern to those lenders that are overly reliant on the value of the target's assets that are subject to their floating charge, since these would be available to satisfy Pensions Regulator claims ahead of the lender," he said.

Pensions expert Simon Tyler of Pinsent Masons said that if the Supreme Court decided that the Pensions Regulator's claims ranked as unsecured debt, this would "restore the position that we all expected to be in when the moral hazard legislation was first introduced".

"No one in the pensions industry expected the regulator's claims to be given a higher ranking," he said. "When the original High Court decision gave its claims super-priority, the Pensions Regulator effectively announced that it would act as if that were not the case. It is as if the whole pensions industry has been taken on a long, frustrating, wild-goose chase."

Lomax said that whatever the outcome of the case it was perhaps too much to hope that the Supreme Court's judgment would settle the "related argument over the question of when rent will rank as an administration expense". Earlier this month, landlords pursuing the administrators of Game for millions of pounds in rent that went unpaid while the retailer was insolvent were told that their case could be fast-tracked to the Court of Appeal.

"Nonetheless, the timing is helpful in light of the Game appeal and the outcome in Nortel may help to narrow the issues significantly," Lomax said.