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Article | Pensions Briefing

DB pension considerations during corporate restructuring

Mind the pension and the impact of the regulatory minefield

Pensions Corporate Consulting
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By Helena Mules and Adrian Bourne | November 21, 2017

Helena Mules and Adrian Bourne consider the potential pitfalls for companies undergoing corporate restructuring and ways to ensure there are no nasty surprises further into the process.

TPR is placing an increased emphasis on understanding and protecting the strength of the employer covenant. However, pension regulation can be prohibitive to corporate activity, and in some cases can result in trustees having material leverage in negotiations. Helena Mules and Adrian Bourne consider the potential pitfalls for companies and ways to ensure that there are no nasty surprises further into the process.

Following the publication of tPR’s employer covenant guidance in 2015 and the ongoing focus on integrated risk management, covenant remains a top priority on both the corporate and trustee agenda.

Indeed, tPR’s funding statement in mid-2017 has again devoted a significant portion of its narrative to delivering key covenant messages to trustees which include the following:

  • To not unduly extend recovery plans.
  • Where affordable, to bring in recovery plan periods.
  • To reduce risk and seek legally enforceable support.

However, for many businesses, it’s the older guidance that outlines some key regulatory powers. These can be a significant blocker to corporate activity, especially to those considering restructuring or M&A activities.

TPR’s clearance guidance issued in 2010 outlines the key concept of “Type A events” and their moral hazard powers relating to contribution notices as well as financial support directions. Both of which, have earned much attention in the wake of the situation the retailer BHS found themselves in. It is these powers that enable tPR to compel support from connected parties to an employer in a scenario, where either, there is a ‘material detriment’ to its covenant, or it has been left insufficiently resourced to support the scheme.

Whilst rarely used in practice and almost exclusively reserved for employer distress scenarios, these powers are wide-reaching. In light of recent tPR comments regarding stronger powers and taking a more proactive approach, businesses need to be more aware of the increased threat of their use and how these powers may impact their corporate plans.

The concept of material detriment focuses on any activity which weakens the strength of the employer covenant because it has an adverse impact on an employer’s ability to meet its ongoing scheme funding commitment, or it reduces the dividend that would be available to the scheme in the event of employer insolvency. Where any actions result in a weakening of the covenant, tPR requires corporates and trustees to negotiate appropriate mitigation. Where mitigation is not forthcoming, or is deemed insufficient, there is a risk of regulatory action.

For most businesses, restructurings are driven by economic and operational decisions. The impacts on their respective UK pension schemes are not normally considered as key drivers or risk factors. Indeed a key issue can be the differing focus of the corporate from both the trustees and tPR. Companies consider operations along business lines and geographies, whereas pension regulation requires rigid reliance on the legal obligations from specific statutory entities.

Furthermore, with many corporates seeking to streamline operations and consolidate activities to improve profitability, as well as to implement efficient competitive structures and financing arrangements, care must be taken to look at the position through the lens of the trustee. Any resultant deterioration in the strength of a pension scheme sponsor could carry a cost to the business, which could then end up being prohibitive to any restructuring process.

Many corporates could indeed benefit from taking covenant advice themselves, on how best to position their corporate activities. This support can also help to unravel the complexities of tPR’s “Multi-employer schemes and employer departures” guidance published in 2012, which outlines regulation that can lead to further potential restrictions on corporate restructurings.

For example, in an M&A scenario, it is often not feasible nor desirable to sell a business with its defined benefit pension liabilities attached. However, in order to transfer such liabilities to another group entity, it is normally necessary to secure trustee consent to implement a flexible apportionment arrangement (FAA). As such, any corporate restructuring which includes the consolidation or restructuring of group entities may be dependent on securing such consent.

Before trustees can agree to a FAA, they must be reasonably satisfied that the remaining sponsoring employers are able to meet scheme contributions when due, and also that the corporate transaction has not been detrimental to the strength of the covenant. However, it is the need to provide consent itself, which puts trustees in a position of leverage, and even in scenarios where a transaction enhances the strength of the covenant, corporates may still find trustees seeking to use the opportunity to improve the scheme’s overall position.

Last but not least, the payment of dividends and share buy-backs are coming under significant scrutiny from all stakeholders. These can be highly emotive issues for trustees, especially if they consider the scheme is not being treated equitably with other stakeholders. This is most pertinent where recovery plans stretch out over many years, and as such, payments to the scheme are materially lower than dividends. Care should be taken when declaring distributions and a review of the scheme position should also occur, to ensure current risks are fully understood. The watchword is to ‘signpost’ dividend strategy in your dealings with trustees and to be mindful of the balance required between the scheme and shareholders. If it falls out of kilter, it can begin to influence even seemingly simple restructurings by muddying the thinking on any negotiations.

In this increasingly complex regulatory minefield, with trustees empowered and tPR emboldened, the key piece of advice for corporates is that where a restructuring includes a pension scheme, think of the risks early on in the process.

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