The news that the planned £250m takeover of Uniq was in danger of collapse as a result of concerns over the £102m hole in Uniq’s pension fund, serves only to back up the view that pension scheme liabilities are definitely curbing M&A activity. Last year saw the collapse of high profile deals involving WH Smith and Marks & Spencer and recent research suggested that nearly half of FTSE350 Chief Financial Officers believe that deals are being adversely impacted.
The problem however is not restricted to the UK’s largest firms and there is growing evidence that it is extending to companies in the SME sector, affecting a wider spectrum of corporate activity. With the publication of the ‘moral hazard’ provisions of the Pensions Act 2004 the situation is likely to deteriorate further in the short term. Those advisers involved in corporate transactions and business restructures need to be aware of the potentially far-reaching implications of these provisions.
The moral hazard provisions aim to ensure that if there is a pension liability in a scheme in respect of a particular employer then, in the event that that particular employer is unable to meet its liability, other group or associated employers may be held responsible for it. The rationale for this legislation is to protect the pension protection fund (PPF) from employers who deliberately try to avoid a pension liability which will then ultimately fall on the PPF. Whilst the Governments’ intention is that these changes should not impact on normal corporate activity it seems inconceivable how they could not. Any deal process will now need to consider the potential impact of the main provisions of the Act and ensure they are fully complied with to avoid the possibility of future surprises.
The Act gives the new Pensions Regulator (the Regulator) additional powers of enforcement, the main ones of which are contribution notices, financial support directions and restoration orders all of which could impact on corporate activity.
Contribution notices can be issued where the Regulator believes there has been a deliberate attempt to prevent the recovery of a debt, prevent a debt becoming due or reduce a debt. The notice can be issued against an employer or anyone connected or associated with the employer which could include directors and their advisers although it does specifically exclude insolvency practitioners.
Contribution notices are not intended to stop bona fide business activities carried out without any intention of avoiding a debt. The key point is whether a purpose of the transaction (or action taken in the course of a transaction) is to avoid or reduce a debt. However, where a debt exists, the ultimate intention of a business transaction may be unclear and the participants are unlikely to act until the situation is clear cut. The Government has recognised this and proposed that in future companies will be able to get advance clearance from the Regulator that undertaking a particular transaction or restructure will not result in the imposition of a contribution notice. Whilst this move is welcome and indeed sensible, many corporate transactions have short and often finite timescales and the pre-clearance solution will be likely to be effective only if the Regulator can work within very tight timescales.
The new Regulator will be in a difficult position, particularly initially, as this will be a completely new system. They will need to develop formulaic processes and build up experience of the issues involved as well as deal with a variety of interests in any transaction, none of which are likely to have consistent objectives. It will be very difficult for them to meet short transaction timescales and so their early involvement in any exercise will be of crucial importance.
Contribution notices have no geographical restriction so overseas parents or associated companies are not immune. Clearly we would envisage enforcement will be more difficult in some countries than in others. There is also a 6 year time limit for the issue of a notice.
Financial support directions can be issued where the Regulator believes an employer has insufficient resources to meet its pensions’ liabilities. Directions can be issued against other companies in a group and will effectively make them assume the liabilities of the scheme even if they don’t participate in it. Directions apply for all service within the scheme and there is no limit to their amount. Clearly this means that buying a business with a final salary pension scheme will result in all companies within the purchasing group potentially being ‘on the hook’ for that scheme’s liability and the purchaser must be aware of the implications. The legislation must have the effect of making the pension scheme a much more integral part of the due diligence process on sale and purchase.
Restoration orders would be made within 2 years of an insolvency where there has been a transaction which has undervalued scheme assets, for example, where an enhanced TV was paid just prior to insolvency without re-imbursement of the funds used. In these circumstances the action will effectively be ‘unpicked’ with the Regulator seeking to return the scheme to the same financial position which existed pre the event.
It is important to note that a contribution notice may also be issued should the provisions of a financial support direction or restoration order not be complied with.
In order for the Regulator to be able to use their new powers effectively they need to be made aware of circumstances in which pension scheme assets may be placed at risk and there are proposals covering notifiable events for employers, trustees and advisors and all parties will need to be aware of their obligations.
These changes will have a significant impact in the corporate market and professional advisers need to consider their impact on transactions including business restructures. Purchasers will undoubtedly be more wary and are unlikely to pursue a deal unless the business has gone through an insolvency event or the transaction has had specific pre-clearance as otherwise they are exposed to the risk of a financial support direction which in all likelihood would jeopardise the viability of any deal.
There are many practical difficulties which will need to be ironed out over the coming months, such as pre-clearance timescales, conflicts of interest and meeting notifiable events requirements, but what is not in doubt is the earlier professional advisers are involved in the transaction process the greater it’s potential for success.
Published in Financial News September 2005 and Financial Solutions September 2005