There are concerns among the UK private equity community that amendments to the UK Pensions Bill could have disastrous consequences for the private equity industry. The concerns relate to amendments to clauses 35 to 38 of the Bill, which could expose private equity firms and company directors and, potentially, individual shareholders, to unlimited liability for shortfalls in pension provision. There are fears institutional investors will be deterred from investing in private equity funds by the rules, which imply they would have to plug pension gaps in companies they have bought and want to sell. The proposals go against the principle of limited liability upon which institutions invest in private equity funds.
Pensions minister Malcolm Wicks in April announced the Government had plans to reform regulations governing the position in relation to the application of debt on withdrawal from associated multi employer pension schemes. This is to ensure there is comprehensive protection for scheme members against employers that seek to rid themselves of their pension liabilities.
At present when an employer ceases to participate in an ongoing pension scheme, for example upon acquisition by a purchaser, a statutory debt arises if the pension scheme is underfunded at the date of the sale. Until now, the measure for determining whether a pension scheme is underfunded has been by reference to the minimum funding requirement (MFR.) This has caused relatively few problems since few schemes are underfunded measured on the MFR basis, which tends to underestimate the true level of a pension scheme’s liabilities.
However, the government intends to introduce regulations that will require debts arising upon employer cessations of participation to be calculated by reference to the cost of fully securing pension benefits, which is a more realistic and more onerous basis than the MFR for determining pension liabilities.
According to Dr Wyn Derbyshire, partner at law firm SJ Berwin, given that many final salary pension schemes in the UK are underfunded as measured on the newly proposed basis, the regulations, if implemented, will inevitably lead to increased costs for sellers of subsidiaries since buyers will insist on being fully protected against any statutory debts that may arise upon the acquisition of a target company. This will require sellers to ensure their pension schemes are fully funded, at least in respect of employees and former employees of the target company, and it is likely certain deals will become uneconomic to carry out from the seller’s perspective if these changes are implemented.
In addition, under the Pensions Bill as presently drafted, the Regulator (a new supervisory institution to be created under the provisions of the Pensions Bill) would have the power to investigate acts and omissions which occurred on or after June 11, 2003 and which were intended (in the Regulator’s opinion) to enable employers to avoid debt on the employer obligations, meaning the Regulator could in theory investigate transactions which have been entered into since that date. Where the Regulator decides such act and omissions have occurred, it can require the employer and associated or connected parties to make a payment to the pension scheme of an amount deemed by the Regulator to be the value of the avoided debt.
Any attempt to structure a transaction to avoid a debt could in principle be deemed by the Regulator to be an evasion of payment for which not only could the departing company be liable, but also the shareholders and directors if they were aware of such proceedings.
Derbyshire voices concern not only for the private equity industry, but for the UK economy and work force as a whole. He says: “It appears that nobody has actually assessed the potential long term damage of this on the economy and on jobs. How much is this going to cost the economy?”