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Regulator's position on FSDs "unlikely" to frustrate business rescue culture, it says


The Pensions Regulator will never "deliberately delay" action against a company over a pension scheme in deficit in order to have its claim rank as a priority administration expense should the company subsequently become insolvent, it has confirmed.

It has issued a statement (7-page / 62KB PDF) outlining how it would use its power to issue a financial support direction (FSD) against a company over a pension scheme in deficit. The document is intended to provide "clarity and comfort" to the industry following a 2011 Court of Appeal decision that the regulator's claim will take priority over that of other creditors – including banks – if the action has already begun when the company becomes insolvent.

"We fully recognise the importance of an effective restructuring and rescue culture, and do not intend to frustrate its proper workings, nor those of the lending market," said Stephen Soper, executive director for defined benefit regulation with the watchdog. "We've met with many of the key players in the sector to explain our approach and we hope that today's statement provides further reassurance."

The regulator said in its statement that it would have "regard to the creditors' claims" when assessing whether the proposal of financial support made by an insolvent company was "reasonable" given the circumstances of the case. This reflected the fact that trustees of the pension scheme would also have ranked as an unsecured creditor had the FSD been issued before the insolvency event occurred, it said.

"We expect that this will result in a level of support which achieves broad equity between the trustees of the scheme and unsecured creditors of the FSD recipient," it added.

However insolvency law expert Alastair Lomax of Pinsent Masons, the law firm behind Out-Law.com, said that further reassurance from the regulator as to its "good intentions" did not resolve the "underlying issues" left after the Court of Appeal found against companies in the same groups as Lehman Brothers' insolvent European division and Nortel Networks.

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 an insolvent company which operated a defined benefit pension scheme for its employees. These powers, which the regulator can exercise through the use of FSDs and contribution notices, prevent the "moral hazard" that solvent companies in the same corporate group could leave the scheme without adequate funds knowing that the Pension Protection Fund (PPF), which provides compensation to scheme members whose employers can no longer afford to pay the pensions they were promised, would cover the deficit. The company subject to an FSD must make a proposal for financial support for a pension scheme which can include a cash payment or a guarantee, and any proposal requires the regulator's approval before it can be put in place.

When Lehmans and Nortel went into administration the regulator began the process of issuing FSDs against companies within the two groups that did not participate in the pension schemes. The administrators for 20 companies in these groups had claimed that the liabilities under the FSD were neither provable debts nor an expense of the administration, meaning that they would, in effect, fall down a 'black hole' as part of the insolvency process.

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. The judgment is being appealed to the Supreme Court and is scheduled to be heard on 14 May 2013, according to the Pensions Regulator.

Lomax explained that, as a result of the decision, the law "put a significant amount of control" over the outcome of the insolvency process for other creditors into the hands of the Pensions Regulator.

"This is unsatisfactory for other stakeholders, particularly for banks whose credit decisions involve an assessment of any loss on default and certainty that early intervention can mitigate that loss," he said. "Perversely, as a result of the Nortel/Lehman decisions, early intervention could make things worse for banks and other creditors - which is a disincentive for creditors to provide normal credit terms to businesses which are either employers in a defined benefit pension scheme or associated with those employers."

However, he added that it was difficult to see what else the Pensions Regulator could offer to parties involved in similar cases "short of capitulation in the ongoing appeal". In its statement the regulator stated that while it could not change the order of the priority ranking in the event of an administration or liquidation, it was unlikely to "object to a subordination of the FSD's liabilities behind the administrator's reasonable remuneration".

"Certainly insolvency practitioners will welcome the regulator's support for taking the steps necessary to ensure that they will be paid if they take an appointment in such cases," Lomax said. "More generally, creditors will also appreciate that, when assessing the proper level of its prior-ranking claim post-insolvency, the regulator will take into account what the pension scheme would have received had it issued its claim pre-insolvency when it would have been unsecured."

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