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The opdu Report - Issue 22, May 2007 Advisory Service Forum Stuart O’Brien considers where this recent case leaves employers and trustees on the knotty issue of section 75 apportionments The recent case of L & Others v M Ltd (L v. M) has provided some guidance for schemes and advisers on the rarely litigated (but highly complex) section 75 of the Pensions Act 1995 and the equally convoluted regulations governing entry to the PPF. The case also sheds some light on the ability of a pension scheme’s employer and its trustees to alter the scheme’s rules in such a way that when an employer exits the scheme it crystallises a much smaller cessation debt under section 75 of the Pensions Act 1995 than it would have done had the amendment not been made. The ability to do this is highly relevant for corporate deals and internal reorganisations involving a defined benefit scheme with more than one employer.
In order to help understand L v. M it is necessary to have a working knowledge of the employer debt legislation contained in section 75 of the Pensions Act 1995. Most readers will be well aware that when a pension scheme winds-up, the scheme’s employers are liable to fully fund the scheme up to an annuity buy-out basis under section 75 (i.e. so that on winding-up all members’ benefits can be bought out in full with an insurance company). Crucially, however, section 75 also bites if, in relation to a multi-employer pension scheme, any of the scheme’s participating employers cease to participate in the scheme at any time before the scheme winds-up (and when other employers continue to participate in the scheme). Since September 2005 the exiting employer becomes liable for its own share of the scheme’s deficit on the annuity buy-out basis at the point at which it ceases to participate (referred to below as the ”Section 75 Debt”). Although the legislation sets out a default mechanism for calculating the Section 75 Debt, it also gives schemes an alternative option. Under this alternative, pension scheme rules may provide for debts to be calculated and allocated differently between participating employers. It is this provision for calculation of the debt in a manner differing from the statutory default which has become known as ”Section 75 Apportionment.”
In the L v. M case, the company in question (”M Ltd”) was the sole participating employer in a defined benefit scheme (the ”Scheme”) whose funding shortfall was approximately £38 million on an annuity buy-out basis. Having run at a loss for some years, a restructuring plan was devised to prevent M Ltd going into insolvency. This involved, amongst other things, a ”Pension Proposal” as follows:
Whilst the above may seem contrived, such an apportionment is allowed by section 75 of the Pensions Act 1995 and the regulations made under it. Indeed, the Pensions Regulator and the PPF were both aware of the Pension Proposal. The intention throughout was for M Ltd to continue in business ensuring a better result for its employees and the Scheme members. The PPF would also take a stake in the restructured business of M Ltd. The only wrinkle was whether the contemplated Section 75 Apportionment might, in law, have actually prevented the Scheme from being eligible for the PPF. The reason why it might is because in order to be eligible for entry into the PPF, a scheme must pass the various tests set out in the PPF Entry Regulations . The regulations, among other things, generally prevent section 75 debts being ”compromised”. Specifically, the regulations prevent schemes from entering the PPF where at any time trustees have entered into ”a legally enforceable agreement the effect of which is to reduce the amount of any debt due” under section 75. So what did this mean for the proposed Section 75 Apportionment rule to be inserted into the Scheme rules in the L v. M case? The decision in L v. M The case essentially hinged on two different interpretations of what a ”legally enforceable agreement the effect of which is to reduce the amount of any debt due” might be. The ”broad view” (deliberately argued on behalf of the trustees to test PPF entry) is that a wide range of agreements might be caught, even those which compromise contingent debts which may (or may not) become payable in the future. If this view was held to be correct it would have meant that the Section 75 Apportionment proposed in L v. M would have prevented the scheme from being eligible for PPF entry. The ”narrow view” is that only agreements made in respect of a Section 75 Debt which has been both crystallised and calculated by the actuary are caught. This follows the line of reasoning given in the earlier case of Phoenix Venture Holdings Limited. In the end Mr Justice Warren decided that the Pension Proposal did not constitute an agreement, the effect of which ”is to reduce the amount of any debt due to the scheme” because that phrase indicated ”a temporal requirement that the debt is due at the time of the agreement” (which was not so on the facts of L v. M). His view was that it was not enough that ”the agreement has the effect of reducing a debt which will, or even may, become due as a result of a triggering event in the future”. The Pension Proposal could therefore go ahead without prejudicing the scheme’s eligibility for PPF entry. What was not clear from his decision, however, was whether in coming to this conclusion he completely agreed with the ”narrow view” set out above. Instead he seemed to favour a third interpretation of the regulations falling somewhere between the broad and the narrow interpretations set out above (perhaps even more confusingly this has been referred to as the ”broad narrow view"). Under this third interpretation he suggested that an agreement entered into after a Section 75 Debt has been triggered but before it has been calculated might fall foul of the Regulations. The implication is that to be certain of staying within the parameters set by Mr Justice Warren in L v. M. the safest So where does the case leave employers and trustees? The L v. M decision may be regarded as being limited to its (quite complicated) facts. However, it is helpful in that it provides some judicial authority for schemes to enter into Section 75 Apportionments without prejudicing the scheme’s eligibility for PPF entry. Additionally, the decision offers an insight into how apportionment rules should be drafted. Specifically, given the wording of section 75 and the Debt Regulations, such rules should refer to the apportionment of the difference between the value of the scheme’s assets and liabilities (and not to the apportionment of a debt). Employers may well consider the use of a Section 75 Apportionment in a corporate transaction (eg if they are selling off a part of their business and as a result one of the companies within the group ceases to participate in the group’s pension scheme). They are also likely to be useful where company groups undergo internal restructuring (e.g. the business of two or more companies within the group is rationalised into one entity). In both of the above scenarios a Section 75 Apportionment can be extremely helpful. Indeed, it may be the only realistic way of achieving the sale or restructuring. However, a huge amount of care needs to be taken before trustees agree to a Section 75 Apportionment. So what should trustees think about if the employer approaches them about entering into a Section 75 Apportionment? Trustees will certainly want to take comprehensive advice if an employer suggests amending a scheme’s rules (or exercising an existing rule in the scheme) to effect a Section 75 Apportionment. The circumstances of every Section 75 Apportionment will be different. However, below is a non-exhaustive list of some of the key questions which trustees should consider:
Conclusions The L v. M decision provides judicial authority for Section 75 Apportionments. However, the decision was by no means a carte blanche and trustees will want to take comprehensive advice before agreeing to any Section 75 Apportionment. The considerations will be different for every scheme and will depend heavily on the circumstances. Whilst trustees may feel relaxed about apportionments in circumstances such as internal restructurings (where the combined covenant strength of the scheme’s employers before and after the apportionment are the same) they will need to be a lot more cautious if their recourse to employer assets is weakened (e.g. on the sale of part of the employer’s business). Trustees and employers should also bear in mind that Section 75 Apportionments are not a panacea for all ills and there may be circumstances where a Regulator Approved Withdrawal Arrangement (or even, although perhaps rarely, a Bradstock style compromise) may be a more appropriate way of dealing with a Section 75 Debt problem. Finally, it should be noted that notwithstanding the decision in L v. M, there is still a lot of uncertainty on the question of Section 75 Apportionments. It is understood that the Pensions Regulator has not yet formulated a definitive policy on whether they should be giving clearance for Section 75 Apportionments where there is no specific ”Type A event” for the purposes of their clearance guidance. Furthermore, the Debt Regulations are likely to be revised this year. It is expected that there will be clarifications to definitions used and policy intention, but it is quite possible that the wording in the regulations dealing with Section 75 Apportionments will also be altered. Watch this space! * The Occupational Pension Schemes (Employer Debt) Regulations 2005 Stuart O’Brien
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