UK Ruling Puts Pensioners Above Creditors?
The Supreme Court has ended three years of uncertainty for thousands of members of the Lehman Brothers and Nortel pension schemes as it ruled that they had a fair claim on the collapsed companies’ assets.Is this really a win for pensioners or creditors? In her article, Norma Cohen of the FT reports, Supreme Court rules pension plans do not rank above other creditors:
In a landmark case that has implications for all future insolvencies, the Court ruled that the schemes had an equal claim on assets alongside other creditors.
Had the case gone against them, the Lehman and Nortel members could have been forced below other creditors in the repayment queue at collapsed companies and set a precedent for administrators across the board.
The outcome was hailed by experts and those involved in the wrangle as a “victory for common sense” that shored up the rights of 40,000 members of Nortel’s scheme and 4,000 former staff at Lehman.
Experts also said it was more likely that both schemes would avoid being forced into the Pension Protection Fund, the lifeboat for retirement funds that pays out less to retiring members.
Nortel, a Canadian telecoms company, collapsed in 2009 leaving a pensions deficit that at the last count stood at £2.1 billion. It followed the spectacular demise the previous year of Lehman Brothers at the height of the financial crisis, with a deficit in its UK pension scheme of £148 million.
The complex case centred on a so-called “financial support direction” issued by the Pensions Regulator in 2010 after administrators were brought in at both companies.
A financial support direction is a demand that companies or their administrators have to stand behind a scheme financially and is ordered if the regulator thinks is a danger that current and future pensioners will not be paid.
In some cases this can involve an injection of cash, or even shares or other assets.
In a joint claim, the administrators argued that the regulator’s demand should be disregarded as an “unprovable debt” as it was issued after the administration.
In response, the regulator said that the financial support direction should be treated as an expense or debt, meaning that the pension scheme had a priority claim on assets or would rank as an equal, unsecured creditor.
Jonathan Land, a partner at PwC who advised the Nortel scheme trustees, said: “This ruling determines once and for all that FSDs will rank alongside other unsecured creditors in UK administrations.
“This is the fairest result and after three years of litigation UK pension schemes and insolvency practitioners will be thankful they finally have clarity on the issue.”
Tony Bugg, global head of restructuring and insolvency at law firm Linklaters, which advised Lehman’s administrators, said: “The concern before today’s decision was the Pensions Regulator had the power to boost the ranking of its claim simply by waiting for a target company to enter administration. The Supreme Court unanimously agreed that Parliament [under the 2004 Pensions Act] cannot have intended such an unfair and arbitrary result.”
The Pensions Regulator welcomed the ruling and said it had never had any intention of frustrating the process of administration. Had the financial support direction been ruled as having no effect, the liability would fall down a “black hole”, the regulator said.
Experts said that the ruling, which overturned a 2011 judgment by the Court of Appeal, would also simplify other company restructurings and future corporate insolvencies.
There had also been a concern that the Pension Protection Fund would have come under considerable strain if it had been forced to take on the liabilities of the Nortel scheme.
Claims from a corporate pension scheme should not rank above other creditors in insolvency proceedings, the Supreme Court ruled on Tuesday, overturning lower court judgments that put pensioners’ interests ahead of others.Similarly, Richard Dyson of The Telegraph reports, 'No priority' for pensions when companies go bust:
The original case was brought in 2010 by administrators to Lehman Brothers and Nortel Networks. They challenged the pensions regulator’s right to bring a legal proceeding, known as a financial support direction, to stand alongside those of other creditors’ claims on the proceeds after a corporate insolvency.
Lower courts had decided they must either rule that pension debts are an administrative expense to be paid ahead of unsecured creditors, or risk the unravelling of legislation designed to protect benefits. Their rulings gave priority to the pension claims.
But legal experts warned that if the lower court judgments stood, as a knock-on effect, companies with defined benefit pension schemes would have to pay much more to access credit.
Kevin Pullen, a partner at law firm Herbert Smith, which represents the Nortel creditors, said that the challenge was made because the regulator did not have a formal claim outstanding seeking a set sum, on the date that Nortel sought administration.
For its part, the regulator’s procedures do not require it to specify an amount when it seeks an FSD. It merely needs to show why an entity should be responsible for offering financial support to a scheme.
The pension scheme was Nortel’s largest unsecured creditor with a deficit of £2.1bn – representing the cost of buying annuities for its pensioners. The comparable figure for Lehman is £148m.
The Regulator argued it could not have made such claims because they take months to prepare and it did not have access to the information to compile them.
Mr Pullen said that despite Wednesday’s ruling, the Nortel administrators will continue to challenge the regulator’s right to bring the financial support direction, and will ask for the matter to be aired before the regulator’s tribunal.
But legal experts welcomed the decision, saying it clarifies where pension debts rank in insolvency proceedings.
Charles Maunder, partner and head of the banking, restructuring and insolvency team at law firm Michelmores, described the judgment as “a victory for common sense and fairness to all creditors”.
Stephen Soper, the pensions regulator’s executive director for defined benefit funding, welcomed the Supreme Court ruling.
“This will be welcome news for many thousands of pension scheme members and will provide clarity to insolvency practitioners on how to treat a pension scheme liability,” he said.
“In this case, the regulator was forced to defend against arguments that an FSD issued against an insolvent company would be ineffective and disappear down a ‘black hole’.”
Such a ruling would have posed serious threats to the finances of the Pension Protection Fund which insures the underfunded schemes of insolvent employers, he added.
The verdict was the result of a case brought by the administrators of the UK divisions of investment bank Lehman Brothers and Canadian telecoms group Nortel, and is viewed as a "landmark" because of its implications for other companies that go bust where pension schemes are in deficit.Finally, in her article, Charlie Thomas of aiCIO reports, Lehman, Nortel, and a More Certain Future for Bankrupt Company Pensions:
Nortel, the Canadian firm which collapsed in 2009, had a £2.1bn shortfall in its European scheme. The pension entitlements of more than 40,000 workers were implicated. The funding gap at the UK division of failed investment bank Lehman was far smaller at £148m.
UK pensions watchdog The Pensions Regulator had submitted a claim when Nortel and Lehman went into insolvency asking for pension members to be paid ahead of other claims. It used a mechanism known as a "Financial Support Direction" (FSD) to do this. But the Supreme Court yesterday ruled the pensions should not be ranked above other unsecured creditors in an insolvency.
The FSD, introduced in legislation in 2004, is designed to protect employees in under-funded schemes by trying to ensure companies support their pension promises. But, according to insolvency practitioners and lawyers close to the case, FSDs create uncertainty for scheme members and inadvertently increase the chance of schemes being pushed into the Pension Protection Fund, the "lifeboat" arrangement for funds of failed businesses which are in deficit.
PwC, adviser to the trustees of the Nortel UK pension funds, said it was a "great result for members of pension schemes", enabling insolvency practitioners "to make quicker distributions to all creditors".
Lenders to companies whose schemes are in deficit, or others seeking to restructure such firms, are expected to be reassured. Giles Frampton of R3, the insolvency trade body, said: "The Nortel decision is to be welcomed in that it appears to restore a fair balance between the rights of pension funds and other creditors in administrations."
Chasing pension money from parent companies who have gone bust has been materially weakened, after the Supreme Court ruled that the UK Pensions Regulator's financial support directions (FSDs) and contribution notices no longer have priority in a line of creditors.This landmark decision highlights the legal complexities of what happens when companies with defined-benefit schemes go under. The Supreme Court decision basically puts creditors and pensioners on equal footing, reassuring lenders to companies whose schemes are in deficit, as well as pensioners worried that creditors will have first claims on assets if a company goes under.
Overturning a previous Court of Appeal judgment from 2011, Lord Neuberger, Lord Mance, Lord Clarke, Lord Sumption, and Lord Toulson concluded that the Pensions Regulator does not rank ahead of any creditors, including unsecured creditors, banks, and bondholders, and should instead be considered pari passu: that is, equal.
The ruling, which happened this morning, in the matter of the Nortel Companies, in the matter of the Lehman Companies, and in the matter of the Lehman Companies (No. 2), has widely been heralded as a success for common sense. If the court had decided to uphold the Court of Appeal's findings, any large pension deficit would likely have swallowed up all assets recovered after an insolvency, leaving all other creditors with nothing.
Another unintended consequence of the original judgment was that businesses with final salary pension schemes may have found it more difficult to borrow money, as the decision of the lower courts saw liabilities ranking as an expense, increasing the costs of lending. This should also have been dealt with by the court's decision today.
"The concern before today's decision was that the Pensions Regulator had the power to boost the ranking of its claim simply by waiting for a target company to enter administration. The Supreme Court unanimously agreed that Parliament cannot have intended such an unfair and arbitrary result," said Tony Bugg, global head of restructuring and insolvency at Linklaters, who also advised the Lehman Brothers' administrators.
"An insolvency pits employees, pensioners, suppliers and other creditors against one another each fighting for a share of a limited pool of funds. The Supreme Court rightly decided that only the clearest of legislative intent should enable one group of creditors to claim priority over another.
"In the context of an insolvency regime which already gives some creditors preferential treatment, it is right that these decisions should be for Parliament to decide."
A Pyrrhic Victory for the Regulator?
Jennie Kreser, partner at law firm Silverman Sherliker, told aiCIO the judgment meant the likelihood of recovery for pension schemes has been "somewhat reduced".
"The Supreme Court said that in coming to its decision, it has overturned a line of cases (which the court below couldn't do) as they were contradictory and not consistent with corporate insolvency situations, having been based on individuals who were insolvent.
"This will be a disappointment to the Pension Regulator and to the members of pension schemes who will, as a result, find their position weakened when trying to bolster schemes with significant deficits, who would otherwise look to other group companies for help."
But the Regulator's statement suggested it welcomed the clarity the Supreme Court had provided, and cheered the fact it had successfully argued against a suggestion that an FSD issued against an insolvent company would be ineffective and "disappear down a black hole".
The Regulator had originally pushed for FSD liabilities to be considered an administration expense or as a provable debt. Even though the administrative expense argument was ruled out by the Supreme Court, the regulator was happy to have the provable debt argument sustained.
Stephen Soper, the Pensions Regulator's executive director for defined benefit funding, said: "This will be welcome news for many thousands of pension scheme members and will provide clarity to insolvency practitioners on how to treat a pension scheme liability.
"Since the challenge was first made, we have made clear that we have no intention of frustrating the proper workings of the administration process. Today's judgment will provide clarity to the UK's restructuring and rescue practitioners that FSD liabilities have to be recognised in insolvent situations but do not have priority over administration expenses or secured debts."
Another potential downside was highlighted by law firm Allen and Overy: the surrounding legislation needed fixing in a number of areas, including in relation to overseas enforcement of FSDs.
"Because this decision now makes it work for FSDs in UK insolvencies, I can't see a root and branch reform of the FSD aspect being likely now," Jason Shaw, senior associate at the firm, said.
The Pension Protection Fund's head of restructuring and insolvency, Malcolm Weir, said the PPF had always argued FSDs and contribution notices should be treated as provable debts, and that the organisation would now look at the judgment to assess the implications for the Nortel and Lehman schemes, and any future recoveries it may make as an unsecured creditor.
The full judgment can be read here.
What does this mean for Lehman and Nortel Network's pension schemes?
In a nutshell, don't expect a swift happy ending.
Both schemes are currently in the Pension Protection Fund assessment period, with Nortel entering in March 2009, and Lehman Brothers' entering in two separate tranches in October 2008 and August 2009.
The Pensions Regulator has issued FSDs to target companies associated with both pension funds-Lehman Brothers' targets were issued with an FSD in September 2010 and Nortel's targets received their FSD on June 25, 2010.
Both sets of targets referred the matter to the Upper Tribunal court, contesting the grounds for the FSD issuance, and both cases were then stayed, awaiting the outcome of the Supreme Court hearing.
Following today's judgment, those Upper Tribunal cases can now resume, resulting in one of two options: either the Upper Tribunal sides with the Regulator and grants permission to hand down the FSD, or it sides with the targets.
Both results could also find themselves subject to appeal, if a point of law can be found, meaning the cases could escalate to the Court of Appeal. There's also parallel cases being heard in the US and in Canada to determine the claims of the Nortel trustees, which were submitted off the back of the FSD issuance. Those are listed to take place in January, 2014.
All of which means it's unlikely the members of both schemes will have closure on the ongoing legal rows for many months to come, if not years.
This case also highlights the need to reform pension systems. As I've stated many times, companies should worry about their core business, not pensions. Instead, pensions should be treated as a public good and managed by large public pension funds that operate at arms-length from the government and in the best interest of their contributors and beneficiaries. The sooner we realize this, the better off we'll all be.
Below, the legality of Detroit’s historic bankruptcy filing is being challenged in the courts. At issue are the unfunded pensions and health benefits promised to city workers. Retired Detroit policeman Don Taylor joins NewsNation’s Tamron Hall to discuss the hardships the city’s bankruptcy filing has imposed on him and other municipal employees. Sadly, Detroit's cries of betrayal are being heard all over the world and I fear a bleak future for private and public pensions.