When undertaking any type of corporate activity, companies should always consider the impact on their defined benefit pension scheme; any corporate activity that is expected to be materially detrimental to the ability of a scheme to meet its pension liabilities could, unless addressed, lead to The Pensions Regulator (the Regulator) exercising their penal anti-avoidance powers in relation to that event.

Clearance with The Pensions Regulator

Where corporate activity is genuinely materially detrimental, and classed as a Type A event as defined by the Regulator, companies can apply to the Regulator to obtain 'Clearance' in respect of that event. Clearance is a voluntary process and can only be made by parties connected or associated with the scheme and the employer to the scheme. In effect it provides a 'blessing' or assurance that the Regulator will not, at a later date, issue a Contribution Notice or Financial Support Direction in respect of that event (assuming the situation does not turn out to be materially different to the facts disclosed). These are the so-called anti-avoidance powers.

Contribution Notice

A Contribution Notice requires a payment to be made into a scheme. This payment can be applied where it can reasonably be concluded that an act or failure to act has detrimentally affected in a material way the likelihood of the accrued scheme benefits being received.

Financial Support Direction

A Financial Support Direction requires the employer (and those associated and connected) to put in place financial support for a scheme. They can be applied if it is reasonable to do so and if either of the following tests are met:

  • The scheme employer (or those associated and connected) is a service company
  • The employer fails the Insufficiently Resourced Test

Applying for Clearance

It is not always obvious that obtaining Clearance is the best move; often it will come at a price, usually in terms of additional funding. This so-called mitigation depends on the materiality of the detrimental impact on the scheme and the size of the relevant deficit. It is often in the form of cash, although not always, and can also require the company to make good the remaining deficit over a relatively short time frame. Furthermore, Clearance can be limited in scope to precise circumstances communicated in the Clearance application and, therefore, be of limited value if circumstances change. Employers should therefore carefully weigh up the likelihood of the Regulator exercising his anti-avoidance powers against the cost of a Clearance application and the impact this could have on the business' objectives.

While seeking Clearance is a voluntary act made on behalf of a corporate entity, the Regulator would expect the trustees and the employer to have pre-agreed a package of additional funding or security to ensure that the covenant afforded to the scheme is not detrimentally affected. The process then involves completing an application form, providing full details of the corporate event for which Clearance is being sought. Lawyers and the employer's corporate actuary would usually be required to support this process. We would then expect the Regulator to reach a decision within two weeks, if not sooner.

The Clearance application

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The Regulator's code of practice

In relation to the material detriment test

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Materially detrimental events

When determining whether a corporate event has a materially detrimental effect on the scheme, it is important to take a high level view of the impact on employer covenant, pre and post the corporate event.

  • it prevents the recovery of the whole or any part of the employer's Section 75 debt (the buy-out debt due on cessation or winding-up);
  • it prevents the employer's Section 75 debt becoming due or compromises the Section 75 debt;
  • it reduces the amount of the employer's Section 75 debt which would otherwise become due;

or it weakens the employer covenant, because:

  • it has an impact on the ability of the employer to meet its ongoing funding commitments to the scheme, or an impact on those commitments; or
  • it reduces the dividend that would be available to the scheme in the event of employer insolvency.
  • The employer's legal obligations to the scheme; and
  • Its financial position (both current and prospective).

The detrimental impacts described above are then further subdivided into employer and scheme related events:

  • An employer related event is a deliberate act (or failures to act) by the employer that results in a weakening of the covenant. It is important to note that only deliberate acts are included; where the covenant is weakened through normal business activity that was outside the control of the employer then such events are not counted
  • Employer related events only become Type A events if they are material and there is a relevant deficit
  • Scheme related events are always Type A events, regardless of whether there is a relevant deficit, if they are of material financial detriment

Relevant Deficits

A relevant deficit is the largest deficit measured either on the accounting basis (RS102 or IAS 19), the Pension Protection Fund basis (Section 179) or the ongoing Scheme Funding basis (the technical provisions). However there have been cases where the detriment to employer covenant was so significant that the usual definition of a relevant deficit was no longer appropriate and instead a self-sufficiency basis was used.

Example (employer-related) Corporate Events

The Regulator has provided the following examples of relevant corporate events:

  • a change in the level of security given to creditors; for example, through leveraging the business or granting or extending of a fixed or floating charge over assets; 
  • a return of capital or reduction in the overall assets of the employer (or the wider employer group); for example:
  • a change to group structure, including a change of control; for example, a change or partial change to the control structure of an employer or a change to the parties who could be subject to a financial support direction, which reduces the overall employer covenant. This could include, for example, a change to the parent company or the ultimate holding company of the employer;
  • dividend payments (such as special dividends);
  • share buy backs;
  • repayment of subordinated debt;
  • distributions in specie, including de-mergers;
  • a change to the employer in relation to the scheme, including replacement of a participating employer or the merger of two or more employers;
  • sale and leaseback transactions in so far as these lead to a reduction of assets or adversely affect net cash available to support the scheme;
  • the granting or repayment of inter-company loans, particularly where the loan is not on 'arm's-length' terms, where it is not properly documented or where there is credit risk;
  • 'phoenix events' - an arrangement resulting in the employer re-emerging as substantially the same entity following an insolvency event;
  • business and asset sales from the employer or the wider employer group, particularly where the transaction is not at arm's length for fair value, where the sale proceeds are not retained, or where the whole or a substantial part of the operating business is sold; or
  • a corporate event that would reduce sustainable cash flow cover for the wider employer group's funding commitment to the scheme; for example, an increase in debt or a reallocation of debt.

Corporate Restructuring

Where a company undergoes a corporate restructuring, including a merger of two or more employers within the group, there are a number of other "pensions" considerations to be aware of as well as whether to seek Clearance. In particular, the Employer Debt Regulations determine the amount an employer may be required to pay if it ceases to participate in the pension scheme, where there is a shortfall between the scheme's assets and liabilities on a buy-out basis.

An employer debt can be an extremely significant amount but there are a number of options employers could consider to avoid, or at least reduce, the amount payable. One such example allows companies to enter into a scheme apportionment arrangement; this is where the debt is apportioned across the other participating employers in the group, assuming consent from the trustees and other participating employers is granted and various other conditions are met. This effectively means the remaining employer(s) "step into the shoes" of the departing employer and can ensure that routine corporate restructurings within a group of companies do not trigger an employer debt.