24: Corporate governance and insolvency reforms have significant implications for DB schemes
Far-reaching insolvency reforms have been introduced by the Corporate Insolvency and Governance Act (the Act) which came into force on 26 June 2020. The Act aims to help otherwise viable businesses survive the pandemic, but also introduces permanent changes to insolvency law which were proposed well before the current crisis.
The Act contains temporary COVID-19 related changes that have retrospective effect from 1 March 2020. These include relaxing wrongful trading laws to limit the risk of personal liability for directors and restricting the use of statutory demands and winding-up petitions. The latter could have implications for schemes enforcing pension scheme obligations in the short term.
Permanent reforms include a new moratorium process and pre-insolvency restructuring plan. In this note we consider the potential effect of these reforms on pension schemes.
New moratorium procedure
In a permanent change to the insolvency regime, a new form of ‘moratorium’ will provide struggling businesses with protection from creditors lasting up to 40 days. This will allow time for restructuring without creditors being able to enforce their debts, crystallise charges or bring insolvency proceedings.
The Act lists a number of debts which must still be paid during a moratorium period, including ‘wages or salary’ arising out of a contract of employment. This is likely to include employer occupational pension contributions for future service but it is not clear whether it will cover deficit repair contributions under a recovery plan (at this stage it is a commonly-held view that it does not).
This means that trustees will not be able to issue a statutory demand or a winding-up petition during a moratorium which will, at least temporarily, limit the options trustees have to take action where employer contributions remain unpaid or are suspended. It may also limit their ability to enforce security such as charges or obligations under guarantees given by the sponsoring employer during the moratorium. Note however that their security will of course remain in place so it will not be possible for an employer to dispose of the relevant assets without trustee consent.
Security provided to trustees to support the sponsoring employer’s covenant is often triggered by insolvency. A moratorium is not on its own an insolvency event under the Pensions Act 2004 (and so gives no right to trigger a s75 debt and does not trigger a PPF assessment period) which means where a company continues to struggle during a moratorium, pension schemes may see a real reduction in potential recovery in a subsequent insolvency – especially in the context of the acceleration of certain debts below.
Acceleration of certain debts
A DB scheme which is underfunded has the right to seek funds from an insolvent company, with the pension debt ranking alongside other unsecured creditors. However a moratorium may have the effect of reducing the potential recovery on an insolvency because it may constitute an event of default for certain lending debts such as bank loans. That could technically accelerate repayment of the loan during the moratorium so that the loan debt falls due in full.
While such accelerated loans will not receive super priority in any subsequent insolvency (which was contained in an early draft of the Act) certain debts, such as bank interest and charges and trading debts during the moratorium will receive super priority which could leave any pension debt further down the creditor ranking on a subsequent insolvency.
However, the purpose of the moratorium is to give breathing space often while seeking to put in place a restructuring proposal. Thus given the going concern statement that the monitor of the moratorium process (effectively an insolvency practitioner) is required to make, in practice we expect companies to have obtained support from their lenders before a moratorium starts. Where lenders have agreed to a moratorium they are unlikely to then accelerate a debt, so the practical risks of this may be low.
The position is potentially further compounded by a proposed re-introduction of Crown preference, whereby certain taxes, NI etc will receive priority in payment over unsecured creditors out of an insolvency estate. This is to be introduced under the Finance Bill, currently expected for December 2020.
New ‘cross-class cram down’ restructuring plan
The Act also allows companies in financial difficulties to develop a restructuring plan to be voted on by classes of affected creditors and shareholders. For trustees, the key point to note is the concept of ‘cross-class cram down’, a new mechanism which prevents dissenting classes of creditors or shareholders from obstructing a restructuring plan which is sanctioned by a court as fair and reasonable.
In order for cram down to apply, at least 75% in value of at least one class of those creditors who have an economic interest or would receive a payment on insolvency must vote in favour. Also, any dissenting creditors must be no worse off than they would be in the most realistic alternative. This could work either way for DB schemes, potentially leaving schemes with a limited say in corporate restructuring or giving them some negotiating power if the company needs to seek their agreement to enforce a cram-down.
Consenting to a cram down (in exchange for a better post-restructuring position) however runs risks for DB schemes if it constitutes a compromise of the scheme’s s75 debt. This is because the compromise of an employer debt in certain circumstances can make a scheme ineligible for the PPF, and also needs to be cleared by the Pensions Regulator.
In practice this may limit the circumstances in which a scheme could agree to a cram-down and in practice, it is likely that trustees will engage with the Pensions Regulator and potentially the PPF before agreeing to any restructuring proposal (particularly following the late amendments to the Act mentioned below).
Where trustees do not agree to a cram-down there is a risk that the pension scheme debt could be prejudiced. At this stage it is not clear how a compromise where the trustees do not agree might affect PPF eligibility but it seems unlikely that a court will approve a restructuring plan which adversely affects the pension scheme if it results in the loss of PPF eligibility – since the most realistic alternative in that case would be insolvency and PPF compensation for members.
Interaction with the PPF and the Pensions Regulator
Under the Act a moratorium will also not be a qualifying insolvency event for PPF assessment purposes (with the PPF effectively being the guarantor of last resort for trustees). The PPF’s position as a creditor when an insolvency starts is therefore also at risk.
However, the Act includes late amendments requiring the Pension Regulator and the PPF to be notified when a moratorium comes into force, is extended or ends. The Act also provides delegated powers to permit further changes to ensure the interests of pension schemes, and ultimately the PPF, are represented in respect of moratoriums and restructuring plans.
These reforms are intended to improve the financial position of employers and increase their ability to keep trading. It is widely acknowledged that a solvent and strong employer is the best security for a pension scheme.
The Act may have a detrimental effect on pension scheme security but the true position and its interaction with existing pensions legislation will not be known until any subordinate legislation is fleshed out, and will also vary depending on the particular circumstances of the scheme and employer.
It is also unclear how the new Act will interact with the proposed Pensions Bill changes, which introduce the potential for higher fines and criminal liability for acts that are detrimental to a pension scheme.