Statutory defence

Establishing a statutory defence to reduce pensions risk in a transaction

August 2018

Harry Morgan, a Director in the Financial Advisory – Pensions team, looks at the impact of corporate transactions on pension schemes and how employers may protect themselves from regulatory intervention via a ‘statutory defence’.

Buyers and sellers of businesses with defined benefit pension schemes need to consider the impact of any corporate transaction on the scheme, especially changes to the strength of the employer covenant. They need to be mindful of the risk that pension trustees, if they perceive a weakening of covenant, could seek to tighten valuation assumptions and/or change the investment strategy. This could ultimately increase cash contributions payable to the scheme. Moreover, The Pensions Regulator (“TPR”) has wide ranging powers to sanction buyers, sellers and connected parties in certain circumstances.

Now, amid heightened political and regulatory focus on protecting DB pension schemes, we see stakeholders taking an increasingly diligent approach to this important process. This includes expanding the level of work in creating and documenting a valid “statutory defence” as protection from TPR action.

As context, the last 12 months have seen business leaders in front of Select Committees and on the front page of newspapers and now TPR is considering using its powers in the pursuit of Directors. The regime will likely toughen further if TPR is granted new powers, as envisaged in DWP’s White Paper1 and subsequent consultation paper2.

It is therefore not surprising that stakeholders are stepping up measures to minimise the risk of being targeted by TPR’s anti-avoidance powers, namely:

  • Contribution Notices which require the employer(s), or a connected/associated party (potentially including Directors and other individuals) to pay cash to the scheme. TPR can impose a Contribution Notice on employers where, amongst other criteria, it is of the opinion that an event is “materially detrimental to the likelihood of accrued scheme benefits being received”; and
  • Financial Support Directions which require the target to put in place financial support to the scheme, which does not necessarily need to be a cash payment. This is targeted at schemes which are “insufficiently resourced” or where the employer is a Service Company.

Whilst TPR has a voluntary clearance process to provide assurance that it will not use its anti-avoidance powers, this is not widely used, with only 9 clearance applications in the 12 months to March 20163. Nor does clearance prevent future use of TPR's powers, should further information come to light that the regulator believes is pertinent to their investigation.

As an alternative to clearance, employers can seek immunity from a Contribution Notice where it has a “statutory defence”. There are three tests which must all be met to establish this defence4:

  1. Before the event, consideration is given to the extent to which there may be material detriment to the likelihood that the pension scheme members would receive their accrued benefits.
  2. Where there is considered to be a potential detriment, reasonable steps are taken to eliminate or minimise these.
  3. At the time of the event, the employer can reasonably conclude, having regard to all prevailing circumstances, that the event is not materially detrimental to the likelihood of members receiving their accrued benefits.

In our experience stakeholders in M&A scenarios are increasingly seeking support in considering the impact of the deal on the pension scheme, mitigating as appropriate and establishing/documenting a statutory defence. This provides assurance that the scheme is being treated appropriately and enables the employer to proceed with the transaction with more protection from TPR's anti-avoidance powers supported by contemporaneous analysis

Typically, establishing a statutory defence will involve carrying out an assessment of the impact of a transaction on the employer covenant, comparing the covenant offered to the scheme ‘pre’ and ‘post’ transaction. Inter alia, this will consider any changes to the businesses with a legal obligation to support the pension scheme and the earnings, cash generation and balance sheets of those businesses. The work will assess both the ongoing covenant, and the insolvency covenant, i.e. the Scheme’s position in a theoretical insolvency.

In many cases, it may be appropriate to take into account any mitigation which is being offered to the trustee by the employer to reduce or offset potential detriment.

Assuming this assessment concludes that the transaction is not materially detrimental, the output of this process can be used as evidence of the employer’s statutory defence. A further benefit is that the document can be provided to the trustees to assist them in rapidly understanding the transaction and its impact on the employer covenant, and therefore potentially reducing the time the trustees require to undertake their own due-diligence.

In summary, any business contemplating a transaction should take steps at an early stage to minimise pensions risks, including the risk of TPR using its anti-avoidance powers, through carefully considering and documenting its statutory defence.


1 Department for Work & Pensions: Protecting Defined Benefit Pension Schemes, White Paper dated March 2018

2 Department for Work & Pensions: Protecting Defined Benefit Pension Schemes – A Stronger Pensions Regulator, Consultation dated June 2018

3 The Pensions Regulator, response to Freedom of Information request, 2016

4 Pensions Act 2008, Explanatory notes, clause 383 - 385

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