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Section 75 Pensions Act 1995
Under section 75 of the Pensions Act 1995, a company sponsoring a defined benefits scheme is obliged in certain circumstances to make up any shortfall between the scheme's assets and its liabilities, measured as the amount required to buy annuities for all members in full. The shortfall obligation (also known as a section 75 debt) is triggered when a scheme is wound up or, if the scheme is a multi-employer scheme, when an employer ceases to participate at a time when other employers with active members continue to do so. In cases where a scheme is being wound up by a solvent employer, the trustees may calculate the debt at any date during the winding up. Where the employer is insolvent, the provisions of the Pensions Act 1995 and Pensions Act 2004 (section 75(4A) Pensions Act 1995 as amended by s271(2) Pensions Act 2004) provide that the section 75 debt arises immediately before the insolvency event. The result is that the section 75 debt is a provable debt for the purposes of the insolvency legislation, but, under section 75(8), not a preferential debt. The pension scheme ranks in insolvency proceedings as an ordinary unsecured creditor.

Comment
A longstanding criticism of the Pensions Regulator has been that it has deliberately tried to confer "super creditor" status on pension schemes, despite the clear policy intention to the contrary in the legislation. The impulse to do so may be understandable, given the Regulator's statutory remit to protect member benefits and minimise calls on the Pension Protection Fund, but the result is clear (and equally understandable) concern being expressed by employers and those doing business with employers. The Regulator has tried, unilaterally, to move the goal posts. The Regulator has, for example, sought to influence normal commercial judgements made by healthy companies whose ability to meet pension commitments is not in question, by suggesting (with studied ambiguity) that the payment of dividends might not be appropriate where the company's pension scheme is in deficit. The Regulator has also shown a willingness to use its powers creatively (and possibly unlawfully) such as by threatening to use anti-avoidance powers against parent companies in order to increase scheme funding by employers. The use of regulatory guidance to develop the concept of the company covenant (not found in legislation) and to put pressure on trustee boards and employers to require additional funding or other measures if company performance falls below certain trigger points has implications for the exercise of directors' discretions under the Companies Act 2006. Directors owe statutory duties to a wide range of stakeholders whose interests have to be balanced.

Regulator's anti-avoidance powers
The Pensions Act 2004 gave the Regulator the statutory objectives of protecting member benefits and reducing the risk of situations arising which may lead to compensation from the Pension Protection Fund (PPF).

To help achieve those objectives, the Pensions Regulator was given power to issue contribution notices (CN) and financial support directions (FSD), preventing anything being done to compromise or reduce the section 75 debt, and ensuring that resources elsewhere within the employer group could be used, where reasonable, to meet both continuing pension obligations and the section 75 debt if it fell due. The Regulator's CN and FSD powers do not make specific reference to insolvency.

Comment
The Regulator's CN and FSD powers were a clear signal that it would become increasingly difficult for companies to escape their pension obligations.  While employers were unhappy at the extent to which voluntary promises had become gold plated obligations, the general policy thrust underlying the 2004 legislation was accepted. However, it was generally understood that companies would have some flexibility on funding (the new regime was intended to be "scheme specific") and that pensions issues would not impinge unduly on the ability of the company to run its business. The Regulator's recent insistence that companies will be required to fill deficits more quickly once economic conditions improve, its continued emphasis on "mitigation" for any perceived adverse impacts of any transaction or reorganisation on the covenant, and its continued refusal to publish redacted examples of its regulatory activity in order to promote transparency and consistency are all testing the patience of companies. Many employers say privately that the uncertainty generated by the Pensions Regulator is harming their business.

Contribution Notice (CN)
A CN can be issued under section 38 of the Pensions Act 2004 where the Regulator considers it reasonable and where either the material detriment test is satisfied or there has been an attempt to avoid or compromise the section 75 debt. A CN can be for the full section 75 debt, or a lesser specified amount, and can be made against individuals and companies who are the employer or connected or associated with the employer. Once a CN has been issued, it becomes a debt due from the recipient to the scheme. However, during an assessment period (the period when the PPF is considering a scheme's application for entry), the rights and powers of the trustees in relation to any debt due to them under the CN are exercisable by the PPF to the exclusion of the trustees and the Regulator. Any amount paid by the recipient of the CN to the PPF in relation to the CN debt must then be passed on to the trustees. Any amounts paid to the trustees or where applicable, the PPF, in respect of the CN debt reduces the section 75 debt.  However, where an amount is paid directly to the trustees or to the PPF in respect of the section 75 debt, there is no automatic reduction in the CN obligation, and the person who has been issued with the CN has to make an application to the Regulator for a proportionate reduction. The Regulator will only agree to this if it considers it appropriate.

Comment
CN powers have been extended since the Pensions Act 2004. The previous "bad faith" element is not now essential for a CN, although this was a clear component of the political consensus which saw the Act onto the statute book. The new material detriment test means that pension considerations are a much more pervasive element in any corporate activity than was originally envisaged. It is important that consideration is given to the impact of any relevant corporate activity on the pension scheme, and that the reasoning behind the conclusions reached is fully documented.

A CN can therefore be seen as a punishment, since it accelerates the section 75 liability that otherwise would not arise other than in prescribed circumstances (see "Section 75 Pensions Act 1995" above). It is intended to deter behaviour which could impact on members receiving their accrued benefits and the likelihood of the PPF having to step in. In practice, particularly as there is little understanding and/or confidence in what the Regulator will regard as reasonable, commercial activities of all description are having to be carefully scrutinised. 

Financial support directions (FSD)
An FSD can be issued by the Regulator where a scheme is either "insufficiently resourced" or where the employer is a service company. There must be other connected or associated companies which are able to meet 50 per cent of the section 75 shortfall, and (as with the CN) the Regulator must consider it reasonable to issue the FSD. The FSD is a direction to the target entity to put in place support until such time as the scheme winds up. The support could be to create joint several liability among group employers, a parental guarantee, or the injection of additional resources. To comply with the FSD the recipients must propose arrangements which are deemed reasonable by the Regulator. To the extent that they fail to do so, or to the extent that the arrangements proposed are not deemed appropriate by the Regulator, then the Regulator may issue a CN under section 47 Pensions Act 2004. Like section 38 CN's (see "Contribution Notice" above) a CN made for this purpose specifies the whole or a part of the section 75 debt. It can be made in favour of a number of recipients, all of whom should be told about the notice issued to the other. It may specify joint and several liability. Similar provisions as with a section 38 CN apply (see above).

A FSD, by contrast to a CN, ensures that other group companies are forced to assume the liability of a weak sponsor. It is this potential risk that is a particular concern to companies in M&A transactions. While a very material change in relation to pension liability, the punitive element - the acceleration of the section 75 debt - only comes into play if the recipients fail to put in place appropriate support. 

It should also be noted that the test of being insufficiently resourced or a service company, is an objective one i.e. was the company a service company or insufficiently resourced within the two year look-back period? If it was, then it is within the target for a FSD, notwithstanding that by the time the FSD is issued, circumstances may have changed. However, those circumstances will be relevant in relation to the question of reasonableness. 

The Nortel decision
In Nortel and Lehman, the High Court found that an FSD which had not been issued prior to the commencement of administration was not a provable debt within the terms of the insolvency legislation, although nothing in the FSD regime excluded companies in an insolvency process from being made targets of an FSD or CN. Accordingly, the claim would fall into a "black hole" unless it was recognised in some other way. Following the authority of a line of cases beginning with the House of Lords decision in Toshoku, Briggs J felt compelled to hold that a statutory liability which was not otherwise recoverable fell to be regarded as an expense of the administration. As a result, the pension creditor would be given "super creditor" status. The pension scheme would have priority over all other unsecured creditors and floating charges (which would normally include, for example, charges over assets such as book debts and stock). Only those creditors whose security comprised fixed assets would continue to have priority over the FSD or CN. 

Comment
Briggs J was clearly unhappy with the judgement he had felt obliged to give. He noted that the outcome is damaging to the rescue culture at the heart of modern insolvency law, and is likely to prove unfair to the creditors of an insolvent target.  While some have suggested that an appeal should be made direct to the Supreme Court, it is understood that an appeal is to be made to the Court of Appeal in the usual way.

Certainly, the case produces a very inconsistent result. It enables the Regulator to exercise its discretion as to when it brings FSD proceedings against an associated company in order to improve the priority status of the FSD. If an FSD is issued prior to insolvency proceedings, then the pension creditor is an unsecured creditor in respect of its provable debt in the usual way. By delaying issue of an FSD until insolvency proceedings have been initiated, the FSD is given priority as an expense, which is materially detrimental to that company's other creditors. This result is odder still when one considers that the pension scheme will at the same time only be an unsecured creditor of the sponsor itself.  

Briggs J wondered if the unfairness of the result would be mitigated by the Pensions Regulator and Tribunal observing a self-denying ordinance under which they would give effect to the pari passu principle. Even if this was considered realistic, it does not give the certainty that companies and those dealing with them have a right to expect. The law must be clarified. However important pensions are, and however unpopular it may make politicians for saying it, pensions are only one of a number of competing interests. We have already protected the few at the expense of the many in pension terms. Do we want to make doing business in the UK even more difficult as well?