When is a DC scheme not a DC scheme?

Introduction

When doing due diligence on a transaction, lawyers tend to breathe a sigh of relief when they discover the target only has a DC pension scheme. This is because, in theory, in a DC scheme the employer should not be exposed to any major risks, right? Maybe…

In this Alert:

• Key points
• When is a DC scheme not a DC scheme?
• A DC scheme with a funding black hole
• When can the target be responsible for another company’s DB liabilities?
• And when can a creditor be caught out?

Key points

• Due diligence on DC pension schemes should be simple as risk is borne by the member not the employer.
• But new legislation means certain benefits previously thought of as DC could now be treated as DB.
• Buyers should also watch out for hidden DB liabilities even if the target doesn’t participate in a DB scheme.
• It is essential that buyers (and creditors) carry out full and proper due diligence in corporate transactions and then secure the right warranty and indemnity protection.

When is a DC scheme not a DC scheme?

The Supreme Court’s decision in the Bridge Trustees case1 addressed DC benefits where there could be a mismatch between assets and liabilities. For example, many schemes offer an option for a DC member to purchase an annuity from the scheme. This may result in a funding deficit as the assets provided by the member could be insufficient to fund the promises made by the scheme to pay a set level of benefit. The Supreme Court concluded that these benefits counted as DC and were therefore outside the protection of the scheme funding and employer debt regime.

But the Government has legislated to reverse this decision in the Pensions Act 2011. The changes will be retrospective to 1 January 1997.

A DC scheme with a funding black hole

These amendments could have a major financial impact on transactions. If schemes which are assumed to be DC are, in fact, DB for the purposes of the legislation, they will be subject to all of the statutory funding and regulatory requirements which apply to DB schemes.

A buyer purchasing a business with what looks like a predictable pension cost attached to it may – on further analysis – be inadvertently acquiring a business with a funding black hole.

When can the target be responsible for another company’s DB liabilities?

A DB scheme in the seller’s wider group should also raise a red flag and further investigations should be conducted. This is because TPR’s key powers to impose FSDs and CNs can be exercised not only on companies which actually participate in DB schemes, but other companies associated with them.

So just because a buyer is acquiring a target with only a DC scheme, this doesn’t necessarily mean it is “clean” from any exposure to a DB pension scheme. Under its powers, TPR can impose liability on a company for up to 6 years after it ceases to be associated or connected with another DB pension scheme employer.

And when can a creditor be caught out?

In the Nortel/Lehmans case2, the Court of Appeal has (reluctantly) concluded that the FSDs issued to the Lehman Brothers and Nortel groups of companies count as an expense of the administration. The FSDs must therefore be paid before any distributions to unsecured creditors, effectively giving them “super-priority” on insolvency.

The case leaves insolvency practitioners (and creditors) open to the risk of TPR imposing an FSD at a date later than the insolvency and having their own position worsened. Potential creditors may, therefore, wish to do their own pensions due diligence before entering into any arrangements.

Given the importance of this decision for banks and other creditors, the decision is likely to be appealed to the Supreme Court.

1Holdsworth v Bridge Trustees [2011] UK SC 42
2Bloom v The Pensions Regulator [2011] EWCA CN 1124