Pension schemes take priority over insolvent company debts, Court of Appeal confirms

The Regulator's claim will take priority where it has already begun action against a company over a pension scheme which is in deficit when the company becomes insolvent.

The Court has backed an earlier High Court ruling. In his judgment, Lord Justice Lloyd said the High Court was right to find that where the Pensions Regulator had begun to raise a Financial Support Direction (FSD) in relation to a deficit in a company's pension scheme, that FSD would rank above the claims of other creditors, including banks.

Mr Justice Briggs' application of the existing law in the High Court was correct despite the resulting "oddities, anomalies and inconveniences", the judge said.

The case related to a claim made by the Regulator on behalf of former employees of Nortel Networks and Lehman Brothers' European division who had been members of defined benefit pension schemes. When the companies went into administration Nortel's scheme was approximately £2.1 billion in deficit, while Lehmans' was approximately £148 million in deficit.

Restructuring law expert Richard Williams of Pinsent Masons, the law firm behind Out-Law.com, said that the decision had major repercussions for creditors and insolvency practitioners working with companies that have defined benefit pension schemes that are in deficit.

"The uncertainties for lenders and insolvency practitioners continue and indeed are increased by the new judgment," said Williams. "On the other hand, trustees of pension schemes will continue to regard themselves as having a stronger hand when dealing with a deficit. The judgment may encourage them to take a more aggressive negotiating stance, since contribution claims can now rank highly in an insolvency to the detriment of other stakeholders."

Williams said that the cases would likely proceed to the Supreme Court for further appeal if Parliament did not clarify the effects of the judgment.

A defined benefit pension scheme is a scheme that promises a set level of pension once an employee reaches retirement age no matter what happens to the value of the pension investment. This means that the employer running the scheme bears the risk that the investment will lose value.

Members of defined benefit pension schemes whose employers can no longer afford to pay the pensions they have promised can claim compensation from the Pension Protection Fund (PPF), which is funded by contributions from eligible schemes.

Since 2004 the Pensions Regulator has had wide powers to seek financial contributions or support to meet a pension scheme deficit from companies connected to or associated with the pension scheme employer through FSDs and contribution notices.

These powers prevent the "moral hazard" that companies in the same group could leave the scheme without adequate funds knowing that the PPF would cover the deficit. When Lehmans and Nortel went into administration the Regulator began the process of issuing an FSD against companies within the two groups that did not participate in the pension schemes.

When a company is placed into administration or liquidation, not all of its debts can be paid. The law therefore dictates the order in which different debts can be settled. Secured creditors, who hold fixed charges indicating that a specified asset can be used to satisfy a particular debt, are normally paid first. Any surplus is then made available alongside the proceeds of the sale of other assets to settle the expenses of the administration, employee claims and other debts. This means that in the majority of insolvencies unsecured creditors will remain unpaid or only receive a small percentage of the debt.

The Court of Appeal confirmed that the Regulator's claims for contributions ranked as expenses of the administration because the claims were made after the administrators were appointed in each case. Had the claims been made before the administrators' appointment the claims would have ranked lower in the hierarchy, as an unsecured provable debt.

Delivering the original judgment in the High Court, Mr Justice Briggs described the regime as unfair to the other creditors and "a legislative mess".