Defined Benefit Schemes and Struggling Businesses- the elephant in the room

Posted by Ron Burgess on
Throughout 2016 and so far in 2017, defined benefit pension schemes have made headline news for all the wrong reasons. 

Firstly, BHS and its massive pension deficit shone a spot light on the way in which pension schemes in deficit can prevent the rescue of businesses.

More recently, the Pensions Regulator has agreed to regulated apportionment arrangements ("RAA's") in respect of Halcrow Group Ltd, Hoover Ltd and Tata Steel.

The Regulator is loath to agree to RAA's unless the circumstances are extreme and it correctly maintains very stringent entry threshold requirements to close the existing defined benefits scheme and replace it with a defined contributions scheme. All three of Tata Steel's trades unions have recommended to their members acceptance of the Tata Steel offer indicating their recognition of the seriousness of the problem and the adverse impact on member's job security.

Clearly defined benefit pension schemes are having can have a huge impact on struggling businesses and can mean the difference between a turnaround and liquidation.

Current Financial Climate

The continuing uncertainty over Brexit and the inauguration of Donald Trump in the US has led to volatility in the markets, which in turn has had an adverse impact on pension schemes, often increasing the size of the deficits. It is not clear when the markets may return to a more predictable pattern.

Many businesses are facing huge increased financial pressures and squeezed profit margins

Issues

Directors of a struggling business have a duty to act in the best interests of the company's creditors. Very often the pension scheme is the single biggest creditor.

Directors must consider whether the business can realistically support a pension scheme with a significant deficit. They will obviously look at up to date cash flows and management information, but they should also consider taking specialist professional pension-related advice when making decisions.  Pension-related issues often crystallise when the scheme valuation is being completed and deficit repair contributions are being negotiated but directors of struggling businesses should not wait for that process to commence before confronting the problem.

Options

For directors faced with a pension deficit and a struggling business, the options are rather limited and expensive to implement. At the one end of the continuum, there is a business that can be rescued with an informal business plan coupled with, say, a de-risking plan in respect of the pension scheme – maintaining the status quo is the first option. The more radical options as regards pensions, such as those that either tip the pension scheme into the Pension Protection Fund or create a new pension scheme with less costly benefits, are gathered towards the other end of the continuum where insolvency is inevitable, if not immediately, then within the next 12 months. 

Other options that the directors could consider would include an administration or insolvency process (e.g. administration with a pre-pack disposal of the business or coupled with a wind-down of the business) or some form of consensual restructuring agreed with the scheme trustees, the PPF and Regulator (e.g. a scheme compromise, or, PPF entry via an RAA or a CVA). 

The bar to entry with any of the options is very high to avoid companies "dumping" their pension scheme into the PPF.

For any deal to be done with the PPF, the pension scheme must receive significantly more than it would receive on a formal insolvency process being triggered and which it might have received if the Regulator exercised any of its powers.

About the Author

Ron is a Partner in our Pensions team in our London office. He provides advice to trustees, corporate clients, insolvency practitioners and other stakeholders in the pensions industry.

Ron Burgess
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