Legal Due Diligence at front of the transfer of pension obligations to a pension company

1. Initial point for classification

Original pension company and its entry into the company pension obligations by way of universal succession under conversion law as pension run-off measure in line with requirements in the individual case, beneficiary and UVA as the relevant cohort of persons

The so-called original pension company is characterized by the fact that it is created as an independent legal entity exclusively for the purpose of taking over company pension commitments from the employers originally making the company pension commitments (transferring employer) and settling them vis-à-vis the pension beneficiaries. The transfer of the company pension commitments to the pension company shall be effected by way of universal succession under conversion law on the basis of a spin-off. The transferring employers should no longer be liable for the pension commitments to the pension beneficiaries after the expiry of the ten-year conversion liability period (Section 133 (2) sentence 2 of the German Conversion Act (Umwandlungsgesetz, UmwG) if they have provided the pension company with sufficient capital resources in accordance with the criteria of the judgement of the German Federal Labor Court (Bundesarbeitsgericht, BAG) of 11 March 2008 (3 AZR 358/06, Pension company-judgement) (see our article in Personalwirtschaft). Insofar, the observation of the requirements of sufficient capital resources includes – besides further design alternatives – an option for liability exclusion after expiry of the ten-year conversion liability period.

There are many reasons for setting up an original pension company. They are generally based on the intention of the transferring employer to avoid balance sheet volatilities resulting from company pension obligations (particularly under IFRS), to fully fund company pension commitments – and to permanently release the company from its pension commitments. In practice, this need often arises after a change of shareholder, if the new shareholder - for example, in the case of an intended integration of the acquired company of the transferor employer into an existing group structure - does not wish to continue the pension commitments, or if the shareholder wishes to liquidate the legal entity of the transferor employer in the medium term. Alternative pension run-off measures, such as changing the implementation path to a pension fund, are not an option in these cases, as they only result in a balance sheet correction and do not affect the employer's liability under labor law arising from the company pension commitment pursuant to Section 1 (1) sentence 3 BetrAVG.

The original pension company must be distinguished from the so-called derived pension company. In the case of the latter, the employer de-operationalizes the legal entity that made the pension commitments by selling (transferring) the business areas to be continued operationally to a third legal entity - usually by way of a transfer of business with a transfer of the relevant employment pursuant to Section 613a of the German Civil Code (Bürgerliches Gesetzbuch, BGB) - and leaving only the pension obligations and the assets covering them with the legal entity that has then been de-operationalized. The BAG has already ruled that the requirements for sufficient capitalization do not apply to the derived pension company (judgement dated 17 June 2014, 3 AZR 298/13).

The group of persons affected by the transfer of the company pension commitments regularly includes (only) beneficiaries and former employees who have left the company with vested pension rights (UVA). Pension beneficiaries in an active employment are generally not selected by the transferring employer; a transfer of the pension obligations resulting from the pension commitment in isolation from the active existence of the employment is not possible from an employment law perspective.

2. Reasons for careful legal due diligence (LDD) in the original pensioner company

Within the four-phase process of implementing the pension company (see already our Client Alert), the implementation of the LDD can be classified in the first phase (framework concept). It forms an elementary starting point for the preliminary considerations, since it identifies the legal bases relevant for the obligations and its actuarial quantification, and also the relevant pension beneficiaries. The relevant stock of obligations in turn forms the basis for quantifying the required capitalization in accordance with the Pension company-judgement.

In advance, the LDD is also essential for the transferring employer to make its management decision as to which company pension commitments it wishes to transfer to the pension company at all and, associated with this, which pension commitments should remain with it - and in this respect, how the relevant provisions in the conversion agreement for determining the pension commitments to be transferred to the pension company are to be structured in terms of content.

3. Anchor points in the implementation of the LDD of the company pension commitments

Legal bases/implementation methods, (ineffective) modification, pension adjustments according to Section 16 BetrAVG, other hedging instruments

The starting point for the LDD is the consideration by the transferring employer of which specific company pension commitments are to be transferred to the pension company. From the point of view of conversion law, all existing company pension commitments and, in this respect, in particular, all implementation methods can be considered. In practice, the employer typically focuses on company pension commitments that lead to IFRS obligations (i.e., particularly company pension schemes in the implementation paths of direct commitment and of – lump sum funded – pension fund (pauschaldotierte Unterstützungskasse).

Typical anchor points of the LDD include:

(1) Specific content of the individual pension commitment; in particular, pension commitments assumed by the transferring employer:

In this context, the legal review must focus on the design of the specific framework parameters (benefit content, any regulations on pension adjustments). This is particularly important in order to achieve a uniform understanding of the content when negotiating with the subsequent legal entity of the original pension company.

Particular care is required in this context for company pension commitments which the transferring employer itself has taken over from a third party (e.g. due to the establishment of the employment with the pension beneficiaries concerned as a result of a transfer of business pursuant to Section 613a BGB, in which the transferring employer has taken over the company pension commitment made by the previous employer, or due to universal succession under conversion law from mergers/spin-offs/separations). This is because the transferring employer has misapplied such pension commitments in individual cases due to a regulation that is sometimes ambiguous in terms of content and/or an incorrect understanding (resulting from this) of the content of the employees administering their implementation and has thus created risks for legal disputes by beneficiaries regarding higher pension benefits.

(2) Modification of the affected pension commitments:

In this context, the legal review must extend in particular to the assessment of the effective replacement of the relevant company pension commitment by the successor arrangement. If the specific replacement was subject to the legal principles of the BAG on proportionality in accordance with the three-step theory, the actual implementation of the replacement must be reviewed for its compatibility with these legal principles.

(3) (Omitted/incomplete) pension adjustments:

If the transferring employer has only incompletely implemented or even completely omitted pension adjustments pursuant to Section 16 (2) BetrAVG for the relevant company pension commitments (or the relevant provisions in the company pension commitment), the effectiveness of these partial/omitted adjustments must be reviewed as part of the LDD. This is particularly important in view of the principle of catch-up adjustment under company pension law (see also our Client Alert), which, in the case of an ineffective partial or omitted adjustment, also includes the reference period in which/for which the transferring employer did not carry out the adjustment in accordance with Section 16 (2) BetrAVG.

(4) Pension beneficiaries:

To this end, the LDD must check whether all pension beneficiaries covered by the specific legal bases of the company pension commitments to be transferred are taken into account in the quantification in accordance with the actuarial reports. Particular attention must be paid to third parties who received the company pension commitment through the relevant employee of the transferring employer; in addition to surviving dependents (current spouses/life partners, etc., (half-) orphans), this group of persons also includes former spouses/life partners, etc., who have acquired claims from the relevant company pension commitment as a result of internal pension equalization.

(5) Other security instruments:

Finally, with regard to the company pension commitments affected by the transfer to the original pension company, the LDD must check whether other security instruments exist, specifically in the form of a reinsurance policy or a (double-sided) CTA. If the pension commitments concerned are secured by an existing CTA, the transfer of the trust assets contributed to the CTA by the transferring employer from the trustee to the transferring employer/original pension company is generally only possible if the original pension company has equivalent security for the pension commitment secured by the CTA - at least with regard to the insolvency resistance of the trust assets. The specific requirements for equivalence are generally derived from the trust agreement between the transferring employer and the trustee.

4. Result of the LDD and its embedding in the further process of implementing the original pensioner society.

The result of the LDD is directly incorporated into the quantitative determination of the obligation - and at the same time forms a reliable basis for further considerations, including the determination of the required capital resources of the original pension company in accordance with the BAG's Pension company-judgement, as well as the concrete design of the security instruments to be implemented by the original pension company - as a rule - for the further implementation of the company pension commitments after the execution of their transfer under conversion law.