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Nortel and Lehman FSD/CN pensions liabilities an administration expense

Date: 18th October, 2011   |   Author: Chris Laughton   |   Comments: 2

Financial Support Directions and Contribution Notices issued by The Pensions Regulator after a target company has gone into administration give rise to liabilities that rank as administration expenses under Rule 2.67(1)(f) Insolvency Rules 1986.

So found the Court of Appeal as it dismissed the appeals in the Nortel and Lehman cases.

In a serious blow to the rescue culture, the court found that it could not under the relevant statutes classify such liabilities as provable debts and, since classifying them as debts payable only once other creditors had been paid in full (the "black hole" result) cannot have been the intention of Parliament, classifying them as administration expenses was the only option.

It seems likely that the decision will be appealed to the Supreme Court, but the Court of Appeal gave some indications that the underlying statute fails to achieve what perhaps it might:

  1. Given the precedent set in relation to section 75 by the 1995 [Pensions] Act, and given the relationship between the obligation under a financial support direction and the liability under a contribution notice, on the one hand, and the section 75 debt on the other, it might not have been surprising to find that the 2004 [Pensions] Act provided that the liability under a contribution notice was a provable debt in the insolvency of the relevant target company. One looks in vain for any such express provision in the 2004 Act.  
  1. This conclusion does lead to some curious consequences. Given the close relationship between the section 75 debt and the liability under a contribution notice, it is odd to find that while the section 75 debt is provable in the insolvency of the employer, the contribution notice liability is payable with much higher priority as an expense in the insolvency of the target. It is the more odd that, as is not disputed, the employer can itself be a target, so that, by service of a contribution notice, it appears that the Pensions Regulator can produce a situation under which the priority of the relevant part of the debt is enhanced (to the extent of the amount payable under the contribution notice) from being merely provable (and expressly not preferential) to being payable as an expense. (The point of allowing for service of a financial support direction on the employer is said to be that, in particular circumstances, there may not be a section 75 debt, for example if there is no question of insolvency, but this argument from anomaly can be made, even if less strikingly, by reference to how the liability would rank if there were such a debt.)


  2. On the other hand it might be said to be at least as odd, and a good deal more so, if the liability under a contribution notice had a lower priority than that of the section 75 debt, being relegated to the black hole, and if a potential target company could avoid the effect of the financial support direction regime by putting itself, or being put, into administration before any decisive step could be taken by the Pensions Regulator to impose any liability under this regime. Even if the issue of the Warning Notice is the critical stage, the possible target company (or at least the group) would be likely to have plenty of notice before that stage that the Pensions Regulator was interested in it, not least because it will have been the subject of requests for information under section 72 of the Act.


  3. There is force in the argument that the potentially very large liability under an eventual contribution notice, and the open-ended nature of the obligation under a financial support direction, could be a serious impediment to the rescue culture which underlies the administration regime.

The troubling part of this judgment, to my mind, is its consideration of the justification for Parliament not having specified that the liabilities arising from financial support directions and contribution notices would be provable debts:

In a situation in which the regime applies, because the employer was either a service company or insufficiently resourced, then even if the targets are themselves insolvent, they may still have more assets available than the employer does, despite the insolvency. We were told that this is the case in the Nortel insolvency, where, apart from the effect of an eventual financial support direction and contribution notice, creditors of the targets would be expected to receive a significantly higher level of dividend than those of the employer. The legislation has a valuable and realistic purpose if it enables some redistribution of assets in such a situation, where otherwise the creditors of the targets would be able to share in a greater volume of assets, partly as a result of having had the benefit of services (including employees) provided by the employer, but without having to pay in full for the provision of those services, in particular without having to contribute appropriately to the pension liabilities in respect of its employees.

The reality is that Parliament gave relatively little thought to the liabilities being administration expenses. Why should unconnected creditors suffer more than the pension scheme (or the PPF)? It is no less a disincentive to the moral hazard of group companies passing risk to the Pension Protection Fund in the event of an employer's insolvency if the group companies attract massive unsecured claims.

This is a case where the statute needs to be changed.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author. If you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597. 


Discussion and Comments

By Vernon Holgate on Wednesday 19th October, 2011

My reading of the Nortel case was that the tPR found that a serious under funding situation developed because the parent company (blatantly) denuded the UK business of financial support and this impacted the pension scheme.  This form of moral hazard is not uncommon in distressed businesses but appears to have occurred when times where not that bad.  Because the parent preferred itself and the UK management and trustees fell asleep on watch; the tPR found itself looking at on-going funding issue post insolvency.  You can not wind the clock back but you can attempt to remedy this by retrospective funding orders and send a message to other companies and trustee boards in similar situations.  So from a regulatory point of view their was very little choice and creditors need to take account of any moral hazard risk stemming from management decisions which disregard the underlying funding requirements of the current Scheme Specific Funding regime.  Had Nortel done so I assume the scheme would be better funded but still insolvent and the insolvency may have occurred that bit quicker and their would have been no FSD or CN.  Creditors need to satisfy themselves that organisations are not floating the spirit and intent of the funding regulations and pension scheme trustees need to wake up in some cases and play their part (negotiate and be watchful, involving the Regulator early where they suspect they are getting the shorter and dirty end of the stick).  Commercial life probably can go on in the light of this judgment if these points are borne in mind.

Vernon Holgate FPMI – Capital Cranfield Trustees

By Chris Laughton on Monday 31st October, 2011


You are right - from a regulatory point of view tPR had no choice in Nortel. I also agree that the moral hazard risk to which you refer will and should impact creditors.

It is the extent of that impact which is currently offensive.

Liabilities arising from FSDs or CNs in relation to insolvent companies should be unsecured claims, ranking equally with all other ordinary creditors. There is no commercial justification for their being super-priority claims in the form of administration expenses.

You suggest that creditors should be satisfying themselves that organisations are not flouting the spirit and intent of the funding regulations. That is both unrealistic and usurping the regulatory responsibilities of tPR, from one perspective!

Of course the black hole solution would have been inappropriate; but the “right” result could not be achieved here because the 2004 Act failed to specify that FSDs and CNs give rise to unsecured claims.

The law should be changed.



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