Pensions Deficits –

Counting the cost for Private Equity

This article appeared in the MBO Supplement of the Birmringham Post, June 2006 and was written by Anne McCarthy, Associate at Pinsent Masons

What is your first reaction when you hear the words "defined benefit scheme"?  Nowadays there is nothing more likely to cause a sharp intake of breath and collective crossing of fingers on a deal.  Recent reports highlight the widespread underfunding across the board of defined benefit schemes with aggregate deficits in FTSE 100 companies schemes being valued at up to £150bn (depending on the valuation method).  In a year that has seen the private equity industry stand up to some fairly hefty drubbing in the form of the new transfer pricing rules and the hardening of the Revenue's treatment of managements' rollover, have the new powers of the Pensions Regulator issued a knock-out blow?    

The background

A year ago (on 6 April 2005) the Pensions Act 2004 came into force introducing the so-called "moral hazard" provisions which were designed to stop employers avoiding their pensions liabilities.  The Pensions Regulator was given the power to issue "financial support directions" (FSDs) and "contribution notices" (CNs) – orders demanding the recipient to put in place appropriate financial support for a pension fund deficit or actually make good the deficit.  The intention was to ensure that the "pensions creditor" did not fall by the wayside. 

To make life more interesting, the Pensions Regulator hasn't just settled with issuing FSDs and CNs to the relevant employer.  Instead, in some cases, it has the power to issue them to "associated" and "connected" parties which can include directors, group companies and shareholders who had hitherto remained out of the picture. 

This is where things started to get really messy with the possibility that any number of corporate activities would come to the attention of the Regulator and would result in the parties (potentially including any private equity investor involved) being slapped with an order making them financially liable for a scheme deficit.      

Impact

Has this actually affected the number of deals being done?  The position isn't clear with some surveys concluding that the underfunding issue hasn't deterred the willingness of private equity houses to invest whilst other surveys suggest that fewer deals involving companies with defined benefits schemes have been closed.  There is also a concern in the marketplace that investors in private equity funds have grown wary of the issue.     

However, there is light at the end of the tunnel.  Eighteen months ago, a lot of lawyers were scratching their heads as to how they would advise their clients on the risks involved.  At the last minute, and as a result of some very noisy lobbying from employers and the private equity industry, a clearance procedure was included under the Pensions Act.  This allows potential bidders to approach the Pensions Regulator prior to a deal being signed to get advance clearance that the deal will not trigger an FSD or CN being issued. 

The Pensions Regulator considered over 250 clearance applications in its first 11 months of office with only two of these applications being rejected. 

On average the Regulator expects to deal with applications in about three weeks and our experience as a firm is that the Regulator is sticking to its commitment to deal with transactional clearances quickly.  However the Regulator does need time to digest the information and it is important to get clearances submitted as soon as is sensibly possible and in particular to make sure trustees have been given adequate opportunity to consider the issues. Whilst confidentiality is an issue, it can be overcome.    

The Department of Work and Pensions is also starting work on regulations which should provide more guidance on whether participators on a deal, such as private equity funds, face any threat of being "associated" or "connected".   These will hopefully provide some clarity on the issue. 

Conclusion

As ever, the best defence is offence.  If you are involved in a business with an underfunded scheme which is moving to exit it is never too early to start exploring any pensions issues with your advisors.  If you are attempting to secure a deal in a competitive situation be advised that your ability to move quickly with any pensions issues or advance clearance may now be compared to other bidders.  Delaying an application until a day or two before completion in order to pressurise the Regulator into a quick sign off is unlikely to work. 

Rather than issuing a knock-out punch, it appears that the Pensions Act was a body blow, but one that the industry is, to an extent, absorbing.  Whilst the Pensions Regulator is delivering its commitment to turn around clearances quickly, an uneasy peace seems to have been adopted.  However, if the increase in clearance applications continues (now up to about 30 a month) whether the Regulator will be able to continue to do this, and the impact a stretched clearance timetable will have on a deal, remains to be seen.   

If you have any queries, please call:

Clare Turnbull, Head of PR & Communications

Pinsent Masons, on: 0121-623 862