By Stuart O'Brien, Sacker & Partners, London


Section 75 debts - which way now?

Solicitors dealing with defined benefit (or final salary) pension schemes will almost certainly have come across references to section 75 of the Pensions Act 1995. This piece of legislation, supplemented by the Occupational Pension Schemes (Employer Debt) Regulations 2005, provides that when a pension scheme winds up, the scheme's employers are liable to fully fund the scheme.



Since June 2003, this has meant putting enough money into the scheme so that members' benefits can be bought out with an insurance company (the annuity buy-out basis). Although there are a myriad of different ways of valuing pension schemes, this is the most expensive.



Crucially, however, section 75 and the 2005 regulations also bite if, in relation to a multi-employer scheme (one in which more than one company participates), any of the scheme's participating employers cease to participate in the scheme. In these circumstances, the exiting employer becomes (since September 2005) liable for its share of the scheme's deficit on the annuity buy-out basis (referred to as the 'section 75 debt').



Section 75 debts are routinely crystallised in company sales, internal reorganisations and other corporate transactions involving multi-employer defined benefit pension schemes. The issues arising can be complex and often the liabilities in question huge.



There have been two developments in relation to how section 75 debts can be dealt with: the High Court case of L & Others v M Ltd [2006] EWHC 3395 (Ch); and proposed amendments to the 2005 regulations published by the Department for Work and Pensions (DWP) on 7 August 2007 in the snappily titled The Occupational Pension Schemes (Employer Debt) (Amendment) and Pension Protection Fund (Multi-Employer and Entry Rules) (Amendment) Regulations 2007. Consultation closes on 1 October.



L v M - a milestone

This case shed some light on the ability of a pension scheme's employer and its trustees to alter the scheme's rules in such a way that, when the employer ultimately exited the scheme, it crystallised a much smaller section 75 debt than it would have done had the amendment not been made. The key to this was that, although the 2005 regulations set out a default mechanism for calculating a section 75 debt, they also give pension schemes an alternative option. This allows pension scheme rules to provide for deficits to be calculated and allocated differently between participating employers. This has become known as section 75 apportionment.



L v M concerned a complicated restructuring plan devised to prevent M Ltd going into insolvency. As part of that proposal, a section 75 apportionment was put forward under which M Ltd would only be liable to pay a section 75 debt of £1. The balance (about £38 million) would be apportioned to a shell company. The proposal was supported by the Pensions Regulator and the pension scheme trustees (the intention being to ensure a better result for M Ltd's employees than if the company were allowed to become insolvent).



However, there was a technical question as to whether the proposal might, in law, have prevented the pension scheme from being eligible for the safety net of the Pension Protection Fund (PPF). PPF eligibility was crucial to the success of the restructuring (in fact, the plan was that the PPF would take an equity stake in M Ltd post restructure). However, it might have failed because the PPF (Entry Rules) Regulations 2005 bar a scheme from entry if a section 75 debt has been 'compromised'.



The High Court held that the restructuring proposal would not constitute a compromise of a section 75 debt and did not, therefore, jeopardise the scheme's PPF eligibility. One of the key lessons from the decision, however, was that the safest route would be to effect any section 75 apportionment before the employer ceases to participate in the pension scheme.



Since L v M, employers have used section 75 apportionments to facilitate corporate transactions (for example, where part of a business is being sold, resulting in a company ceasing to participate in the group's pension scheme). Sometimes apportionment may be the only realistic way of achieving the sale. However, there are many factors which pension scheme trustees must consider before agreeing a section 75 apportionment.



A new landscape

The draft amending regulations were published partially in response to some of the issues thrown up by L v M, but also as a way of curing some of the other recognised ills of the Employer Debt Regulations. The consultation paper identifies a key policy intention as being to 'frustrate any attempts to use apportionment as a method to abandon a scheme, while retaining its flexibility for employers in corporate transactions and restructurings'.



They introduce no fewer than four potential ways of dealing with a section 75 debt as an alternative to actually paying it. (They also contain new provisions to clarify when the debt is triggered and the default method for its calculation.)



Section 75 apportionments

These are categorised by the amending regulations as scheme apportionment arrangements and regulated apportionment arrangements. Trustee agreement is required for the former and they must be satisfied that the remaining employers (after the exiting employer has left) will be able and willing to fund the scheme so that it will have sufficient and appropriate assets to cover its liabilities. In practice, this simply codifies the test that properly advised trustees would, to a large extent, apply anyway.



A regulated apportionment arrangement will only apply if the pension scheme is reasonably likely to need the PPF within the next year (that is, the scenario in L v M). Such arrangements therefore require approval from the Pensions Regulator and the PPF.



Approved withdrawal arrangements (AWAs)

An AWA - an existing possibility under the Employer Debt Regulations - is an agreement between an exiting employer and the pension scheme trustees which requires payment of only a very small section 75 debt. The balance (usually the vast majority of the debt) is postponed but backed by a guarantor. It must be approved by the Pensions Regulator.



However, currently there are a number of practical difficulties, including wording in the Employer Debt Regulations, which often makes it difficult to get the necessary approval. The result has been that few have been made. Thankfully, the amending regulations relax some of the more restrictive tests.



Cessation agreements

The amending regulations also propose cessation agreements as a simpler alternative to AWAs. These need only be agreed by the trustees, employer and a guarantor(s) (the Pensions Regulator is not involved). However, the amount that actually has to be paid up front is likely to be higher than under an AWA. The trustees must also be satisfied that the remaining employers' ability and willingness to fund the scheme is not adversely affected.



Conclusions

The timing of yet more complicated pensions legislation is not great when set against the backdrop of the government's current deregulatory review, the aim of which is 'to make the private pensions regulatory framework simpler'. However, the fact that employers and trustees are to have more flexibility to manage pensions issues arising on corporate activity is welcome. The key will be for pensions specialists to help companies and pension scheme trustees navigate these new paths through the section 75 maze.