The UK Pensions Act 2004 and its implication for companies doing business in the UK

By Jane Paskin.

Key Points:
If you are part of a worldwide group of companies with subsidiaries in the UK you need to be aware of changes to corporates' liability to fund superannuation deficits in the UK.

The Pensions Act 2004 was passed by the UK Parliament in November 2004. The Act and regulations made under it will have significant impact not only on companies in the UK participating in a defined benefit superannuation scheme but also any company, be it UK based or international, that is a member of the group of companies with a defined benefit scheme attached to any company in the group.

In the UK on 6 April 2005 a new Pensions Regulator ("PR") came into being. The PR has extended powers to try and increase solvency in defined benefit schemes and, therefore, prevent any need for them to go into the Pension Protection Fund ("PPF"). The PPF is a new 'compensation' fund established by the Government which in certain circumstances will take on the assets and liabilities of underfunded schemes that are winding up. The two main powers added to the PR disposal are known as contribution notices and financial support directions. The Act also imposes other reporting obligations on participating employers, trustees and others. We will look at the obligation of employers later in this article.

Contribution notices

The PR will be able to issue a contribution notice to a person stating that the person is under a liability to pay a specified amount to the scheme. The notice may be issued to an employer or a person who is "connected with" or "an associate of" an employer. These categories of persons are widely defined and include other group companies (importantly it includes any company in the same group as a participating employer, even if based outside the UK), a shareholder holding one third of issued shares, directors and employees of the participating employer. It also includes persons who are connected with a director of the employer or other group company and could just have a very tenuous connection to the employer, for example, a company which has a common director or even grandchildren and ex-wives of directors of the participating employer.

The PR will issue contribution notices when it believes that that person was a party to an act or omission where one of the main purposes was to either:

• prevent recovery of any participating employer debt which was, or might become, due to the scheme; or
• otherwise than in good faith, to prevent a debt becoming due, compromise or settle such a debt or reduce the amount of such a debt which would otherwise become due.

The act or failure to act must have occurred on, or after, the 27th April 2004 and within the six year period prior to the PR issuing a notice.

Companies involved in a group restructuring will have to be careful that the restructuring, sale or purchase of group companies will not trigger a contribution notice. There is a procedure for advance clearance (see later).

Financial support directions

Financial support directions will be issued by the PR whether the Scheme has begun the winding up process or is an ongoing Scheme,and a participating employer is a "service company" (ie. a company with accounts showing its turnover is principally derived from providing services to other group companies), or has insufficient resources to meet a prescribed percentage of the statutory debt owed by the participating employer to the scheme. In addition there needs to be a "connected" or "associated person" who did have sufficient resources. This could be a 'foreign' registered company or other business undertaking.

A financial support direction requires the person to whom it is issued to ensure that financial support for the scheme is put in place within a specified period and maintained throughout the life of the scheme. This could include additional contributions from non-participating employers of the same group of companies or some form of guarantee to make certain payments in default of other participating employers. The one key difference with regard to financial support directions and contribution notices is that financial support directions will not be issued against individuals.

When the PR is considering issuing contribution notices or financial support directions, the PR must be satisfied that it is reasonable to do so. The PR has issued guidance showing when it will consider it reasonable to issue such notices and directions.

Notification of clearance statements

Companies can apply to the PR for clearances in advance of undertaking certain corporate activities. A clearance statement sets out that PR will not issue a contribution notice or financial support directions as a consequence of the activity unless there is a material change in circumstances. Each person seeking to rely on the clearance statement must make an individual application. The PR has issued guidance on when companies should be applying for clearance statements. The PR wants to know about any event "which is financially detrimental to the ability of a defined benefits scheme to meet its pension liabilities". This could cover a wide range of corporate activities, not only obvious ones, such as sales and purchases of assets and companies, but also the issue of dividends and the buying back of shares.

The Act has also introduced a requirement on both employers and trustees to notify the PR if certain events occur which are likely to affect the ability of a pension scheme to meet its liabilities.

Notifiable events

The following is a list of Notifiable Events for all superannuation schemes:

• a decision by the employer to cease to carry on business in the UK;
• receipt of advice that the employer was wrongfully trading;
• where there is no reasonable prospect that the employer will avoid going into insolvent liquidation;
• the conviction (in any country) of a director or partner of the employer for an offence involving dishonesty; and
• a change in the employer's credit rating from investment grade to sub-investment grade.

Notifiable Events for underfunded superannuation schemes only

The following is a list of Notifiable Events for underfunded schemes:

• any breach by the employer of a banking covenant;
• any decision by the controlling director to relinquish control of the employer;
• two or more changes to the chief executive or any director or partner responsible for finance within the past 12 months; and
• a change in employer's credit rating (other than investment grade to sub-investment grade).

There are other notifiable events which must be acted on by trustees and other persons in certain circumstances.

If a report is not made, without reasonable excuse, the PR has powers to impose a fine on the person who should have reported the event. This places an additional burden on employers who must ensure that staff are adequately trained and that systems are in place that will be triggered when a notifiable event occurs.

The PR has indicated that foreign companies involved in group structures will not be immune from contribution notices and financial support directions. Due to the public and political pressure being placed on the PR, it is anticipated that he will take a robust approach and will not shy away from issuing such notices if the PR deems circumstances so warrant it. Naturally there will be questions about the ability of the PR to enforce such contribution notices and financial support directions against foreign companies, but this will not prevent the PR from issuing such notices and directions.

Foreign companies who have subsidiaries in the UK or are themselves subsidiaries of UK companies need to be aware of the impact these provisions will have. There has been great concern over the effect this will have on economic activity, particularly in the area of M&A where the growing awareness of liabilities to superannuation schemes coupled with new regulations has already helped to stifle some major acquisitions.

The possible sale of Marconi to China's Huawei Technologies is putting the PR's new powers to the test.

Marconi is particularly worried as its superannuation scheme is understood to be £109million short of the assets required to cover pension benefits promised to current and former staff. It is understood Marconi is reluctant to disclose information relating to its financial position to the PR for fear clearance to any sale will not be given without a contribution notice or financial support directions being issued by the PR.

A spokeswoman for the PR admitted it could be difficult to enforce actions against companies based in overseas jurisdictions. "If a company seems like it is trying to avoid its pension liabilities, we can issue a financial support notice or a contributions direction, wherever it is based," she said.

"In the case of overseas companies we would look at what international treaties and local laws existed to help us enforce such actions," she said. "However, we also have a responsibility to ensure the costs of taking action against a company are commensurate with the benefits we are trying to secure."

Under the terms of its mandate, the PR would not be allowed to incur costs that might eventually outweigh the benefits of forcing a company to make additional contributions to its scheme.

One option would be for the watchdog to try to persuade a foreign bidder to guarantee it would meet pension funding requirements in the UK. But this could jeopardise takeover deals in cases where companies need bailing out.

For further information, please contact Jane Paskin.