High Court Rules Pensions Act Financial Support Directions and Contribution Notices To

High Court rules Pensions Act Financial Support Directions and Contribution Notices to be payable as expenses in insolvency

1)  Summary

On Friday 10 December Mr Justice Briggs (“Briggs J”) handed down judgment in the two applications for directions made by the two sets of administrators appointed by the UK court in the Nortel and Lehman insolvencies[1]. The cases considered the effect of the financial support direction (FSD) and contribution notice (“CN”) regimes under the Pensions Act 2004 where the company which is the target of an FSD or CN goes into administration or insolvent liquidation prior to the issue of an FSD or CN.

Briggs J had to determine whether the cost of complying with an FSD was (a) an expense of the administration or liquidation, or (b) a provable debt within the administration or liquidation, or (c) a non-provable claim to be paid only out of any surplus available after the payment of all creditors in full.

With “…an acute sense of discomfort...” Briggs J ruled that the cost of complying with an FSD or CN was an expense of the administration or insolvent liquidation.

2)  Background

In coming to his conclusion, Briggs J had to consider the interrelationship between the pensions legislation (primarily the Pensions Act 1995 (the “1995 Act”) and the Pensions Act 2004 (the “2004 Act”)) and the insolvency legislation (being the Insolvency Act 1986 (“IA86”) and the Insolvency Rules 1986 (“IR86”)).

Pensions

Section 75 of the 1995 Act as amended by the 2004 Act provides that on the happening of certain events, including the administration and the insolvent liquidation of the employer, an amount equal to any shortfall in the assets of the occupational pension scheme as against its liabilities is to become a debt due from the employer to the trustees of the scheme and the PPF. This “s.75” debt is an unsecured, provable but non-preferential debt. It is deemed to arise immediately before the insolvency.

The FSD regime, introduced by the 2004 Act, differs. Under the 2004 Act the Pensions Regulator (tPR) has discretionary administrative powers, including the power to issue an FSD if it is of the opinion that the employer in relation to the scheme is a service company or is “insufficiently resourced”.

This means that tPR looks at whether the value of the employer’s assets is less than 50% of the estimated s.75 debt. If it is, then if there is one or more persons associated with or connected to the employer whose assets when taken together would cover the deficit, the tPR can impose an FSD if it is reasonable to do so.

The conditions that have to be satisfied before an FSD can be imposed can be assessed by tPR at any time during the “relevant period”, which is a period of up to two years before the decision of tPR to issue the FSD in question. This means that if a company which at some point during that period was connected or associated with the employer and had assets which would satisfy the deficit, tPR could impose an FSD even if the target company was insolvent when the FSD was issued, or was no longer part of the employer’s Group.

Before issuing an FSD tPR must consider whether it is reasonable to impose the FSD, taking into account certain matters including the relationship between the target company and the employer and the financial circumstances of the target company. If an FSD has been issued but not complied with, tPR can issue a CN.

tPR must go through at least five stages in the FSD and CN procedure. At each stage the target company can make representations to the Tribunal before an FSD or CN is issued. These stages include following receipt of a warning notice that tPR is considering imposing an FSD, following receipt of a determination that an FSD is to be imposed, following receipt of an FSD to decide what is “reasonable”. At every stage tPR must have regard to the interests of the target company as being directly affected by the FSD.

The Insolvency Regime

Under the insolvency legislation a creditor’s claims are quantified and if necessary valued as at a cut-off date which is generally the date upon which the insolvency started. The exception to this rule is where an administration which started prior to 5 April 2010 is immediately followed by a liquidation, in which case claims are calculated from the start of the liquidation[2].

For a creditor to recover anything in an insolvency he must have a “provable debt. Generally speaking, provable debts only arise out of matters which have occurred or begun to occur prior to the start of the insolvency. However, there have been cases where the courts have held that where the relevant statutory provisions have made no distinction between what is payable by a company outside insolvency and what is payable by it in insolvency, certain types of non-provable debt which have arisen after the start of the insolvency proceedings should nonetheless be paid by the insolvent company.

3)  Factual Background

The administration on 15 September 2008 of Lehman Brothers Limited, the company which provided employees for most of the Lehmans European activities, crystallised a s.75 debt of around £148m. Warning notices were issued by tPR to a number of Lehman companies in May 2010, and a determination was issued on 13 September 2010 that an FSD should be issued against six target companies including LBIE.

Upon the collapse of the Nortel Group, the ultimate parent and the main operating company in Canada sought protection under Canadian bankruptcy proceedings. The main US operating company went into a Chapter 11 bankruptcy in the US at the same time. Nortel Networks UK Limited (NNUK), the Group’s main operating company in the UK, went into administration, together with sixteen of its European subsidiaries whose centre of main interests (“COMI”) was found to be in England. NNUK was the principal Nortel employer in relation to the NNUK pension scheme, which had around 42,000 members. The s.75 debt which crystallised upon the collapse of the Group is around £2.1bn.

As with Lehman, tPR issued a warning notice and then a determination. In both cases, the determinations have been stayed following a referral to the Tribunal. At this stage, therefore, no FSDs have been issued against any of the Lehman or Nortel companies.

Messrs Bloom, Hudson, Hill, Harris and Hughes all of Ernst & Young, as administrators of the Nortel companies in administration other than NNUK, and Messrs Lomas, Pearson, Jervis, Schwarzmann and Howell all of PricewaterhouseCoopers as administrators of the English Lehman companies applied to the Court for directions as to how the obligations under an FSD or a CN should be treated where the FSD was issued after the commencement of the administration. The question that fell to be decided by Briggs J was whether the obligation was an expense of the insolvency, a provable claim, or neither.

4)  FSDs and CNs as Provable Debt?

As a starting point Briggs J noted that neither the insolvency nor pensions legislation expressly covered the treatment of FSD or CN obligations which arose after a company had gone into an insolvency process. The issue was therefore trying to determine how Parliament had intended those obligations to be treated in the relevant insolvency process.

At the heart of the arguments from all sides was the main statutory provision governing the definition of what constitutes a provable debt, Rule 13.12 IR86. The version of Rule 13.12 IR 86 which was in force as at the date of both the Lehman and Nortel administrations provides:

13.12 “Debt”, “liability” (winding-up)

(1) “Debt”, in relation to the winding up of a company, means (subject to the next paragraph) any of the following:

(a) any debt or liability to which the company is subject at the date on which it goes into liquidation;

(b) any debt or liability to which the company may become subject after that date by reason of any obligation incurred before that date; and

…

(5) This Rule shall apply where a company is in administration and shall be read as if references to winding-up were a reference to administration.”

tPR and others argued that the target companies each incurred an obligation prior to the commencement of the relevant administrations because the FSD regime was intended to make companies provide the relevant support to the pension scheme, so that an FSD would only be imposed on companies which failed to comply with this obligation. The obligation therefore existed prior to the start of the Nortel and Lehman administrations.

The administrators countered that argument by stating that (i) the obligation to provide support was not a legal one until the FSD was imposed, and (ii) as the imposition of an FSD was at the discretion of tPR, there was therefore no liability until that discretion had been exercised.

Briggs J concluded that without a qualifying legal obligation under Rule 13.12(b), there could be no contingent liability under Rule 13.12(a) sufficient to constitute a provable debt. Pending the issue of an FSD, the only obligations, contractual or statutory, owed to the employee beneficiaries were owed by the employer. In any event, Briggs J held that the complex and sophisticated discretionary process created by the FSD regime left tPR with the discretion to issue an FSD or a CN against a target. Hence an FSD or CN issued after the start of an administration could not be a provable claim.

Briggs J then went on to consider whether (a) the issue of a CN in any subsequent liquidation would give rise to a provable debt, and (b) the FSD would be a provable claim in any subsequent liquidation (where the administration had started before 5 April 2010). He held that in both cases the answer was yes. For an FSD issued during the administration but before the liquidation, the obligation would exist as at the date of the liquidation and so be a provable claim. The same was true of a CN.

5)  FSDs and CNs as administration or liquidation expenses?

Briggs J then considered whether the obligation under an FSD would be an expense of the administration. His starting position was that nothing in the FSD or CN regime excluded insolvent companies and so Parliament must have intended the regime to apply to both solvent and insolvent companies. The obligation was “insolvency neutral”.

Having gone through a detailed analysis of the Toshuku principle, Briggs J concluded that the Toshoku principle established as a general rule that where by statute Parliament had imposed a financial liability which was not a provable debt on a company in an insolvency process then, unless it constituted an expense payable under any other sub-paragraph in the twin expenses regimes for liquidation and administration, that liability would as a general rule constitute a necessary disbursement of the liquidator or administrator. Briggs J concluded by saying that no case had refuted the “commonsense view” of Lord Hoffman in Toshoku that there would be little point in statute imposing liabilities on a company in liquidation or administration if they were not payable as either provable claims or as expenses.

The obligation under an FSD issued after the start of an administration was therefore a “necessary disbursement” and it was payable as an expense in the proceedings.

6)  Conclusion

It is clear throughout the judgment that Briggs J came to his conclusion reluctantly. He acknowledged the negative impact the expenses ruling could have on the rescue culture.

Briggs J did go on to say that the fact that FSDs or CNs could amount to expenses could be mitigated by the court making a prospective order under Rule 2.67(3) IR86 to the effect that the FSD or CN liability should only be met after all other administration liabilities (including the fees of the administrators) had been met. The ruling will nevertheless create much uncertainty. Unless or until an order is made as to priority of payment, a prospective administrator may be reluctant to act unless he can satisfy himself that there will be sufficient assets in a company to meet prospective FSD or CN liabilities.

It is also possible that prospective administrators in prepacks where there are pension schemes in deficit will look for comfort from banks or other financial creditors that their fees will be met, even if there are insufficient assets in a prepack administration to meet those fees.

7)  Next Steps

The importance of the status of FSDs and CNs, both to the Nortel and Lehman administrations and more generally, means that today’s judgment is most unlikely to be the final word on the question. Briggs J has given leave for an appeal to the Court of Appeal. He said that there were so many issues involved that it was inappropriate for his judgment to go directly to the Supreme Court. Time will tell whether the legislature will use this further appeal to amend pensions and insolvency legislation to make FSD or CN claims provable, thus removing the uncertainties created by the absence of express insolvency provisions in the present FSD and CN procedures.

[1] Hogan Lovells act for the PPF and the Trustees of the Nortel Networks UK Pension scheme in this case.

[2] The amendments to the Insolvency Rules which came into effect on 5 April 2010 now provide that for administrations commenced after 5 April 2010 and which are followed by a liquidation, the cut-off date will be the date of the commencement of the administration and not the liquidation (the IR amendment).