Biggart Baillie Solicitors

Pensions / Insolvency Update

Wednesday, January 12, 2011

by Derek Ellery and Steven Jansch and Iain Talman and Colin Greig and June Crombie

Pensions Regulator’s financial support direction  is an expense of administration

Bloom and Others v The Pensions Regulator & Others

Summary

On 10th December the High Court in England ruled that a financial support direction (FSD) or contribution notice (CN) issued by the Pensions Regulator after a company had been placed in administration or liquidation would rank as an expense in the administration or liquidation. 

As such the amounts due will have a “super priority” ahead of unsecured creditors, a position the judge recognised as unsatisfactory. In addition it is at odds with Parliament’s decision to make the debt on the employer under Section 75 of the Pensions Act 2004 rank as an unsecured creditor, despite calls at that time for this debt to be promoted to a higher position in the ranking of debts than is provided for in the Act.

Where the FSD or CN is not issued until after the insolvency commences then the Regulator will not rank in the insolvent estate as a provable debt. The Court was therefore left with the choice of determining that the sums due rank as an expense, or that they fall into a black hole whereby they are not recoverable unless all other debts are satisfied in full. The Judge concluded that given the nature of the ‘moral hazard’ provisions, it could not have been Parliament’s intention to create a situation where insolvency would make the sums due under CNs unlikely to be recovered; he therefore decided they must rank as an expense. The Judge did, however, criticise the way the pensions and insolvency legislation clash.

The decision will considerably strengthen the position of the Pensions Regulator when seeking to make recovery from group companies which are insolvent.

An administrator, when faced with a possible FSD or CN which might exhaust all the available funds of the company, can make an application to vary the priority of expenses as amongst themselves such that the FSD or CN expense ranks behind all other expenses. Pension scheme trustees can be expected to actively look after the interests of the scheme in these situations.

The Regulator also argued that administrators should take some comfort from the fact the Regulator must only issue a CN where the company cannot provide some reasonable financial support. What would be considered ‘reasonable’ in any case will depend on the financial circumstances of the company from whom the financial support is to be sought, but clearly this would be far short of seeking to recover the entire deficit of the Section 75 debt from the company.

The Decision

The full case report can be seen by clicking here

The High Court was asked for directions by the administrators of twenty companies in two groups, all of which raised the same questions as to the effect of the Financial Support Direction ("FSD") regime created by the Pensions Act 2004 upon companies in administration or insolvent liquidation. The answers depended entirely upon issues as to the interpretation of a number of interrelated statutory provisions both in the pensions legislation and the insolvency legislation and, in particular, an understanding of the way in which Parliament intended that those two regimes should interact.

In bare outline, the common questions were as follows.

The FSD regime enables the Pensions Regulator in specified circumstances to impose, by the issue of an FSD to associated companies of a corporate employer, an obligation to provide reasonable financial support to the under-funded occupational pension scheme of the employer, and to deal with non-compliance with that obligation by imposing, by Contribution Notice ("CN"), a specific monetary liability payable by the associated company to the trustees of the employer's pension scheme.

The critical issue was whether the cost of a company complying with an FSD, or the monetary obligation imposed by a CN, ranks in the administration or liquidation of that company as (i) a provable debt, (ii) an expense of the insolvency, or (iii) neither of those so that it is recoverable only in the very unlikely event that there is a surplus otherwise available for distribution to members after all creditors have been paid in full.

The FSD regime together with the Scheme Specific Funding regime, introduced by the Pensions Act 2004 ("the 2004 Act"), represented a further stage in a series of statutory interventions designed to protect employees from the adverse consequences of under-funded occupational pension schemes. One of the principal employee protection measures introduced by the 2004 Act was the Pension Protection Fund ("the PPF"), financed by levies upon occupational pension schemes. It operates by assuming the assets and liabilities of a deficient scheme, using the industry-wide levies for the purposes of meeting the shortfall between the deficient scheme's assets and the prescribed level of compensation.

Those responsible for framing the 2004 Act perceived a risk (generally known as a “moral hazard”) that the creation of the PPF might incline employers to arrange their affairs in such a way as to throw the burden of pension scheme deficiencies upon the PPF. The FSD regime was designed as the antidote to this moral hazard.

The High Court was presented with a range of arguments as to the effect of the FSD regime  where the subject of an FSD goes into administration or liquidation prior to the issue of the FSD.  The three principal arguments were, as follows:

• that the cost of complying with an FSD or a CN was an expense of the administration or liquidation,
• that the cost of compliance was a provable debt in the administration or liquidation, or
• that an FSD or a CN created a non-provable claim against the company, payable (if at all) only out of any surplus available after payment in full of all unsecured creditors.

It was common ground among the parties to the litigation that the choice between the three alternatives was, ultimately, a question of statutory interpretation. In its simplest form, the question was which of those alternative levels of priority did Parliament intend to confer upon the financial consequences of the FSD regime?

The priority issues

The primary case of the Pensions Regulator was that liabilities arising from the FSD regime are payable as a liquidation or administration expense. This proposition was based on the following:-

• Nothing in the FSD regime excludes companies in an insolvency process from being made targets for the purposes of an FSD or a CN. The criteria for liability were insolvency neutral. Therefore Parliament intended that liabilities arising from an FSD and a CN should be paid by such companies.
• A financial liability triggered by an FSD or a CN issued after the insolvency cut-off date is not a provable debt.
• Therefore, since Parliament nonetheless intended that they should be paid, they must rank as expenses, otherwise they would fall into a “black hole”.

The Administrators challenged that analysis in the following way.

• Although they shrank from suggesting that the FSD regime was wholly inapplicable to a company in administration or liquidation, they submitted that the regime was primarily aimed at solvent corporate targets. The statutory language made no express reference to targets in an insolvency process, and  Parliament cannot have intended that the priority to be afforded to an FSD or CN liability in the target's insolvency should be higher than the ordinary provable debt priority afforded to the section 75 debt in the insolvency of the employer. To give super-priority to such potentially large and uncertain liabilities would be fatal to the rescue culture.
• However they acknowledged, and indeed asserted, that liabilities arising from FSDs or CNs issued after the insolvency cut-off date could not be provable debts.
• They submitted that the principles established in the case of Tokushu as to when a statutory liability ranked as an expense were not so inflexible as to require every non-provable statutory liability to be recoverable as an expense. Rather, they submitted, the true principle to be derived from Toshoku was that a statutory liability was an expense if, but only if, Parliament intended that it was not merely a liability of a company in an insolvency process, but a liability which the office-holder was obliged to discharge.
• Since, for a variety of reasons, Parliament could not have intended FSD liabilities to have the super-priority of being expenses, it must have been content for them to be payable only after all provable debts had been paid in full.

It was observed to be no small irony that the primary arguments of both camps depended upon an assertion that financial liabilities arising from post insolvency cut-off date FSDs and CNs are not provable debts.

The Court therefore had to approach the construction of the FSD regime on the necessary (albeit hypothetical) assumption that Parliament must have been aware when imposing it that, if it intended to impose financial liabilities on a target company in an insolvency process, but left the question as to the priority of that obligation in the insolvency to be decided by the technical provisions of the Insolvency Act and the Insolvency Rules, then:

• if the FSD was issued before the onset of the insolvency process, all financial consequences, both of the FSD and any subsequent CN would create debts provable in the insolvency of the target to which they were issued,
• if the FSD was issued after the onset of the insolvency process, the financial consequences of that FSD and any subsequent CN would not rank as provable debts in that insolvency process, therefore, as a general rule,
• such liabilities would rank as necessary disbursements, and therefore expenses in that insolvency process, with a super-priority as against the claims of any unsecured creditors, and indeed floating charge holders, but that,
• if an FSD were issued to a company in one type of insolvency process (say, an administration) which was then followed immediately by another (say, liquidation), then a CN subsequently issued would rank as a provable debt rather than as an expense in the second process.

The Court described that assumption about Parliament's knowledge of the law as hypothetical because, in reality, the FSD regime was almost certainly drafted by pensions experts rather than insolvency experts, and the complete failure of the 2004 Act to make any reference to the effect of the regime upon insolvent companies suggests that issues as to priority of consequential financial obligations of a target company in an insolvency process may never have crossed the draftsman's mind.

The Court concluded that the FSD regime does indeed have a potentially adverse impact on the rescue culture but, because it can to a large extent be kept under control by the making of prospective priority orders in appropriate cases, the adverse effect was by no means sufficient to force the Court to a conclusion that Parliament must have intended that the financial obligations imposed by the FSD regime should be neither an expense nor a provable debt, so that they fall down a black hole. Parliament cannot possibly have intended to legislate in vain.

The Court considered that there were powerful considerations pointing to a conclusion that Parliament did not intend that the financial consequences of the FSD regime should be to afford the Pensions Regulations (and in effect pension trustees) a super-priority in the administration or liquidation of a target. The starting point is that, as between the pension trustees and the employer, and after consultation and careful thought, it was decided that the ordinary provable debt priority given to the section 75 debt by the Pensions Act 1995 (and its predecessor) should not be upgraded in 2004. It was demonstrated beyond doubt that the retention of the section 75 debt's ordinary priority as a provable debt was both deliberate and carefully thought through, despite submissions at the time from the majority of the Government's consultees that it should be promoted.

The Administrators submitted that it was even more extraordinary that Parliament should have intended to confer a higher priority for FSD obligations imposed on a target, than the priority given to the section 75 debt in the insolvency of the employer. A further peculiarity inherent in a conclusion that the FSD regime, if applied to targets in an insolvency process, will give rise to the super-priority inherent in expense liabilities is that it would produce an entirely different result to that which would flow from the issue of an FSD to the same target at any time (however short) before the commencement of its insolvency process.

That judge agreed that to conclude the FSD regime creates provable debts rather than an expense, would, undoubtedly, produce a less unsatisfactory resolution of the policy clash. However, the Pensions Act 2004, left the priority of the financial consequences of the FSD regime upon an insolvent target to be resolved by reference to the insolvency legislation, and this meant that if the FSD is issued after the cut-off date, the solution which Counsel called the ‘gut-feel fair solution’ is not achieved. The judge was clear that he would very much have preferred to be able to reach the conclusion that it did just that, as to his mind this was obviously fairer as between scheme members and unsecured creditors, and preferable as a means of resolving the underlying policy clash

The judge was therefore driven to the conclusion, that this is a case in which Parliament has legislated to create financial obligations applicable to and payable by a company in an insolvency process which may be triggered (after the cut-off date) in such a way that, rather than creating provable debts, they create administration or liquidation expenses, as the case may be. That conclusion was seen as likely to be an impediment to the achievement of the objectives of the rescue culture, but the ability of the Court to make a prospective priority order may keep that potential for damage to a minimum, in cases where the uncertainties might otherwise be fatal.

The outcome is, in the Courts’ view, likely to prove unfair to the creditors of an insolvent target and the Judge clearly indicated if a higher court cannot see a way to conclude that the correct legal reasoning was in fact that the claim is a provable debt, then he hoped that Parliament may move to legislate to remove this anomaly.

For more information please contact Derek Ellery, Steven Jansch, Iain Talman, Colin Greig or June Crombie