Dr McDeal title Pension risks in the M&A dating game

A rose by any other name? Do you know what you are getting?

If you acquire or invest in an employer, you could encounter one of three common types of pension arrangement: a group personal pension plan, a defined contribution pension scheme or a defined benefit pension scheme. With a GPPP or a DC scheme, the employer’s liability is mostly limited to paying the contributions on time. With a DB scheme ,the member is told what pension he should get and the benefit is provided by a scheme set up under trust. The following relates to DB schemes only.

Ugly friends: Can I leave pension liabilities behind when acquiring an employer?

A DB scheme attaches to the sole or principal employer (often the top company in a group). If you acquire shares in the principal employer, the scheme comes too. It is not usually possible to segregate the liabilities for active employees from the pensions and former employees. You can sometimes separate a company from its scheme, but don’t try it at home without advice. On an asset purchase, you should not ordinarily get the scheme, but you may still get pension liabilities.

Who pays for dinner? What determines employer contributions?

The employer meets all of the bulk of the cost. Contributions are determined by the scheme’s rules and overriding law. The scheme rules might give the power to set contribution rates to the trustees, the employer or the scheme actuary. UK statute currently imposes the minimum funding requirement (MFR).

Posh nosh or cheap and cheerful? What’s the right valuation basis to use?

DB scheme assets and liabilities are valued differently for different purposes. Trustees will use an on-going basis to value assets and liabilities - this assumes salaries continue to grow and pensions are paid from the scheme. MFR is the statutory basis for valuation, and generally the lowest. It assumes all employees left service the day before the valuation date. A scheme-specific funding requirement (SSFR) will replace MFR from September 2005. “Discontinuance” and “buy-out” look at liabilities on winding up and are similar: the estimated and the actual cost of securing all liabilities with annuities - the most conservative bases. FRS17 attempts to recognise the funding position of the scheme in the employer’s accounts. It is not linked to the real funding requirements of the scheme or the employer’s ultimate liability.

Breaking up: can I give the scheme the elbow now?

If an employer “withdraws” from a pension scheme (ie, if the scheme goes into winding up or the employer goes into liquidation or stops participating), it may have to pay a share of any deficit on the MFR basis at that time (an “employer debt”). This is an immediate liability. By exception, if the scheme terminates (after June 11 ,2003) when the employer is solvent, the employer debt is based on the deficit on a full buy-out basis. The Government wants the buy-out basis to apply to all withdrawals, probably from early 2005. This means that it may be cheaper to continue the scheme and spread the cost over time.

Moral hazard: what your mother didn’t tell you.

From April 2005, “connected parties” may be required to add their support to the scheme. If you are a connected party of an employer with a DB scheme, or acquiring, or raising finance for, such an employer or a connected party, you need to be aware that the new Pensions Regulator will be able to impose financial support directions (FSD) and contribution notices if reasonable to do so. A contribution notice will catch a person involved in avoiding an employer debt, by requiring them to pay a contribution instead. An FSD could be used to require the employer’s associates to provide financial support for the employer’s DB scheme, if the employer is either a service company or is insufficiently resourced.

I have had a relationship with a participating employer: should I be worried?

FSDs can only go to the employer or a person who is connected or associated. Contribution notices apply to persons in that category in the relevant period which were either a party or a knowing assistant to avoidance of an employer debt. The relevant period starts with the act/failure to act. Individuals generally escape liability, so individual directors or shareholders cannot be issued with an FSD. Partnerships, including limited liability partnerships, are probably going to be caught.

There will be guidance soon. The draft Government guidance suggests a low risk of FSDs if no benefits are taken out of an employer with an underfunded scheme. Extraction of value through dividends increases the risk. Corporate group structures or private equity structures with companies managed independently and with no financial cross-over between them appear unlikely to lead to one company being required to support the pension scheme of another. Purchasers of businesses from companies with an underfunded scheme are unlikely to be affected.

The new Regulator will operate a process for issuing

This prescription was written by Giannis Waymouth, who is a senior associate specialising in pensions law at international law firm Allen & Overy LLP.

Please check the original pdf for these details.