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Draft Code 12 - code-related guidance

Introduction

These examples illustrate how the material detriment test, the employer resources test, or the employer insolvency test for contribution notices (CNs) and the Code of practice No. 12 Circumstances in relation to the material detriment, employer insolvency or employer resource test might be considered in practice.

You can find definitions of bolded terms in the glossary in Appendix 1 of this code-related guidance.

Points to note

These examples are for illustrative purposes only. They do not illustrate all instances where we may or may not act. The decision to pursue a CN on the basis that any of these tests is met is subject to a series of legislative conditions and procedural safeguards, and the examples below consider simplified scenarios in isolation from other potential material factors which may influence our conclusions.

It is possible for the ‘act’ test to be met (eg via the material detriment test, the employer insolvency test, or the employer resources test), but for us to conclude that it would not be reasonable to issue a CN in the circumstances. The examples do not contain consideration of reasonableness, and in all cases, we acknowledge that there may be factors that mean it would not be reasonable for us to issue a CN.

Some of the situations below which are described as not normally meeting any of the material detriment test, the employer insolvency test, or the employer resources test may, when taken together with other acts, constitute a series of acts which does (as a whole) meet one or more of those tests.

We may also choose to run more than one case in the alternative, for example, on the basis that the employer resources test is met or, in the alternative, because the material detriment test is met.

We have a wide range of powers which we will use appropriately and proportionately. Even where we are pursuing a case in which the material detriment, the employer resources or the employer insolvency test would be met, it will often still be possible to secure the best outcome for the scheme and the PPF (Pension Protection Fund) while avoiding the need to issue a CN.

Examples unlikely to be materially detrimental

We consider that the examples below would not normally be materially detrimental to the likelihood of members receiving their accrued benefits or meet the employer insolvency or the employer resources tests.

General poor trading

Employer A has experienced poor trading as a result of market conditions.

Sale of assets

Employer B sells material assets at fair value. Employer B retains, or reinvests, the cash proceeds from that sale.

Reduction of employer covenant

Employer C’s employer covenant is reduced by an act, but its employer covenant remains strong enough to cover the scheme’s s75 deficit with a significant margin.

Examples likely to be materially detrimental

In contrast to those above, the following examples outline some actions that we consider do fall within the circumstances outlined in the code of practice - ie that could be the subject of a CN meeting the material detriment test, the employer insolvency test, or the employer resources test.

In each of these examples, no or inadequate mitigation was provided to the scheme and the relevant statutory defences were not met. For each example, we have indicated which tests could be engaged. For examples of different types of mitigation, please see our clearance guidance.

Substitution of sponsor - employer covenant becomes nominal [any of the tests]

Company D is moderately profitable and is a sponsor of a scheme with a large deficit.

Its parent company, which has no legal link to the scheme, takes steps to bring about the substitution of Company D with Company E (a shell company with no assets) as sponsoring employer.

Disposal - employer covenant is reduced [any of the tests]

Employer F sells a profitable part of its business to another group company outside the employer covenant, resulting in a loss of employer covenant that is material to Employer F’s ability to support the scheme. The consideration due to Employer F is passed to the parent company by the declaration of a dividend.

Guarantor – employer covenant is reduced [Material Detriment and Employer Insolvency Tests]

The employer covenant provided by Employer G to its pension scheme is predominantly attributable to a guarantee provided by its parent company, H. The scheme has a substantial deficit. Company H is acquired by a private equity fund by means of a leveraged acquisition, which substantially reduces Company H’s ability to stand behind the guarantee.

Transfer of scheme liabilities – employer covenant is reduced [Material Detriment and Employer Insolvency Tests]

Company J has transferred its employees to Company K. The employees’ benefits are transferred from scheme 1 (for which Company J is solely responsible) into scheme 2, in relation to which Company K is the sole employer. Both schemes are in deficit, and so the assets transferred are insufficient to match the transferred liabilities.

Company K is loss making and has lower net assets than Company J. It offers a materially weaker employer covenant to the accrued scheme benefits compared to that provided by Company J.

Restructuring – employer covenant is reduced [any of the tests]

Employer L is the sole sponsor of a scheme, and owns Company M, which generates substantial profits and holds significant property assets. Its ownership of Company M provides the majority of Employer L’s employer covenant strength. Employer L is part of a group owned by Company N.

Employer L transfers ownership of Company M to Company N as part of a group restructure. The consideration owed to Employer L is settled by way of an intercompany debt which is unsecured, non-interest bearing and has no repayment date. There is evidence of liquidity constraints within the group that calls into question whether the intercompany debt would be repayable if required.

Manufactured insolvency – employer covenant is removed [any of the tests]

The management team of an otherwise viable and solvent company, Employer O, took steps to manufacture its unnecessary insolvency to buy its business out of administration without the scheme. The scheme received an insolvency dividend, but the insolvency should not have occurred at that time.

Increase in debt/prior-ranking security - weakening of scheme’s creditor position [Material Detriment and Employer Insolvency Tests]

As part of a group restructure, all companies within a corporate group agree to be responsible for the group’s increased borrowings. In particular, Employer P provides a new first-ranking charge over each of its main assets in support of the borrowed funds. Before this arrangement there had been limited security over any of Employer P’s assets. The restructuring provides no benefit to Employer P’s business and would have a material impact on the scheme’s expected recovery from an insolvency of the group.

Leveraged acquisition - weakening of scheme’s creditor position [Material Detriment and Employer Insolvency Tests]

Employer Q is acquired by new owners, which subsequently raise a substantial amount of debt secured on Q’s business and assets to finance a dividend to the new owners. This would have a material impact on the scheme’s recovery from an insolvency of the group.

Payment of unusual dividends to parent company – some instances of paying a dividend [Material Detriment and Employer Insolvency Tests]

Employer R pays a significant dividend to its parent company. It has a material impact on the employer covenant, as the dividend significantly reduces:

a) the hypothetical recovery to the pension scheme on an insolvency of the employer and/or
b) the ability of the employer to meet the deficit recovery payments due in accordance with the prevailing schedule of contributions and/or
c) the employer’s ability to support the downside risks within the scheme’s funding and investment strategies

Unscheduled repayment of loan - payment favouring other creditors [Material Detriment and Employer Insolvency Tests]

Employer S makes a repayment of an unsecured intercompany loan, before it is contractually due, when it is facing financial difficulty and has diminishing financial headroom. Employer S’s pension scheme has a substantial deficit.

Appendix 1: Glossary

Act in the context of this guidance, an act also refers to a failure to act, or a series of acts and/or failures to act.

Employer covenant is the extent of the employer’s legal obligation and financial ability to support a defined benefit scheme now and in the future – taking account, as applicable, of any guarantors or other contingent arrangements. The support of parties other than the employer can be taken into account as long as it (i) provides sufficient support for the risk(s) being run, (ii) is appropriately valued, and (iii) is legally enforceable and realisable at its necessary value when required.

Scheme means an occupational pension scheme[1] other than a money purchase scheme[2], a prescribed scheme, or a scheme of a prescribed description, for the purposes of section 38(1) of the Pensions Act 2004.

Footnotes

[1] See section 1 of the Pension Schemes Act 1993 (as amended)

[2] See section 181(1) of the Pension Schemes Act 1993 (as amended)