Key issues to consider when a corporate insolvency involves a defined benefit pension scheme
Corporate insolvencies hit a high in 2023.
The most recent figures from the Insolvency Service show that the number of corporate insolvencies hit a 30 year high in 2023. The rise in insolvencies applies across all sectors with construction, retail and hospitality hardest hit.
Whilst many companies are struggling, many of their pension funds are in a strong financial position. A recent analysis of FTSE 350 pension funds shows a marked increase in funding levels across company accounts with a near doubling of the level of surplus within defined benefit pension schemes since the start of 2023. (Source: Mercer FTSE 350 analysis, 5 October 2023.)
When a corporate insolvency involves a defined benefit pension scheme, a range of issues come into play. Historically, these issues have generally related to pension scheme deficits and the scheme trustees have often been the company’s largest creditor. That continues to be a common scenario. But increasingly, defined benefit pension schemes are now in surplus, raising interesting issues and opportunities for insolvency practitioners.
The role of the insolvency practitioner
Following the occurrence of an insolvency event in relation to a company, the insolvency practitioner will have several legal obligations. Below is an overview of the key steps that the IP should take.
Initial investigations
The IP should undertake an investigation to establish if the company sponsored any pension schemes and to obtain information about them. In relation to each scheme, the IP should:
- Identify the type of pension scheme. Key questions include:
Is the scheme occupational or contract based (e.g. a group personal pension plan)?
Is the scheme established under trust?
Are the benefits provided on a defined benefit (DB) or a defined contribution (DC) basis?
The most complex issues tend to arise in the context of defined benefit occupational pension schemes established under trust. This is the type of scheme on which this article focuses. - Establish the role of the company in the pension scheme (e.g. as principal employer and /or trustee).
- Request relevant scheme documents including the trust deed and rules, member booklets, member data, the most recent actuarial valuation report, and details of the contributions paid by the company to the scheme and any payments made by the scheme to the company.
- Review the pensions disclosures in the company accounts together with correspondence between the company the auditors and the actuary relating to preparation of the disclosures.
Notifying the PPF and the Pensions Regulator
The IP must inform the Pension Protection Fund, the Pensions Regulator and the trustees of the relevant pension scheme of the company's insolvency by giving notice in accordance with section 120 of the Pensions Act 2004. The notice must contain prescribed information and be sent within 14 days of the IP becoming aware of the pension scheme or, if earlier, the insolvency event taking place.
There is no longer a requirement for the IP to appoint an independent trustee to assist with the administration of the pension scheme. This power is now exercisable by the Pensions Regulator, if it decides such an appointment is necessary.
Reporting breaches of law to the Pensions Regulator
If any breaches of law in relation to the administration of the pension scheme become apparent from these investigations, the IP should report them to the Pensions Regulator immediately.
Adopting employment contracts
During an administration, contracts of employment do not normally come to an end automatically. The administrator has 14 days from the date of his or her appointment to decide whether or not to adopt them. Contracts of employment may provide for contributions to a DC pension scheme to continue. In relation to a DB pension scheme, the contracts may entitle employees to continue accruing benefits whilst they remain in service. The administrator should therefore ascertain whether this will be the case.
Investigating recoveries
The IP should investigate the following:-
- Clawback
There are various scenarios whereby payments made to a pension scheme by a company which subsequently suffered an insolvency event can be set aside and clawed back by an IP. - Directors’ Duties
The IP should investigate the conduct of the directors in relation to the pension scheme. We have seen evidence of directors manipulating the value of pension scheme liabilities recognised in company accounts, effectively strengthening the balance sheet of the ailing business. This and other forms of conduct may provide grounds for action by the IP against individual directors. - Surplus
If the pension scheme is established under trust, the scheme funds will not normally be available to the IP to use to meet the insolvent company's debts. However, the scheme rules may permit any surplus funds to be returned from the scheme to the company. It is becoming more common for the value of DB scheme assets to exceed the value of its liabilities. There are several bases on which the funding level of a scheme may be calculated. The key basis for the purpose of identifying any potentially available surplus is the “solvency” or “buy-out” basis. The scheme rules should be examined and its funding level investigated to identify the scope for any recovery. The process for releasing a surplus can be complex. Notwithstanding this and the usual tax charge of up to 35% on any return of funds to the company, the exercise can successfully realise value for creditors.
For further guidance on corporate insolvency, please get in touch with our expert restructuring and insolvency lawyers.