This is significant beyond cases with defined benefit pension schemes - it opens the door to other statutory liabilities being paid as administration expenses.
The Pensions Act 2004 allows the Pensions Regulator to impose liabilities in relation to underfunded pension schemes.
- Financial Support Directions (FSD's) - these create an obligation on a connected or associated company ("the target") to put a legally binding agreement in place to remedy the underfunding. The target must agree the terms of the arrangement with the Regulator, and examples are agreements for joint and several liability in relation to the scheme, agreements to pay specific sums of money, and so on. A finding of fault is not necessary, and FSD's can only be issued where a complex test related to the resources of the target and the pension scheme is met.
- Contribution Notices (CN’s) - these impose a liability on the target to pay a specific sum of money, and depend on fault, as the Regulator must show that there has been non-compliance with an FSD or an attempt to evade responsibility.
In all cases, the Regulator can only impose liability where it is reasonable to do so, and this involves balancing the interests of the target, the other group companies, and the interests of their employees and creditors.
In the Nortel and Lehman cases the Court of Appeal had to consider what happens when an FSD or CN is issued to a company in administration.
Is the liability an expense of the administration, an unsecured claim in the administration, or a claim which falls outside the administration?
The High Court had held that the liability was an expense of the administration. The Court of Appeal upheld this decision.
The Court of Appeal’s decision
The real problem for the court in this case is that the pensions legislation appears to have been drafted without any consideration of how it should be applied where the target is insolvent. The judges were left to sort out the problem caused by poor drafting.
A further problem arises from the anomalous nature of FSD's and CN's. The liability to pay depends on the Pension Regulator’s view of what is "reasonable", subject to a right of appeal. It is not possible for companies or their advisors to predict with certainty whether or not liability will arise.
The Court of Appeal agreed that the liability was not a provable debt - it arose after the date of the administration, and so it could not be a normal unsecured claim. It therefore had to be an administration expense, or "fall into the black hole" and remain unpaid. As administration does not absolve a company of its obligations to meet statutory liabilities, and administrators have to comply with statutory liabilities, the obligation to pay an FSD or CN has to be an expense of the administration.
The result is that the Pensions Regulator potentially has the benefit of super-priority over the administrators' fees and the floating charge. This was clearly not what Parliament intended, but neither was the alternative of the claim disappearing down the black hole.
This applies only where the liability arises for the first time after the company goes into administration. If the liability arises earlier, the claim is unsecured. The Court of Appeal commented that there may be argument that liability should be deemed to arise when the Pensions Regulator notifies the claim under the statutory provisions of the Pensions Act, rather than when the final notice is issued.
The case is likely to go to the Supreme Court, but there could be a long delay before any judgment is given.
Practical points
1. The administrator's costs and expenses and the rescue culture
Administrators and other stakeholders cannot predict in advance how much it will cost to comply with an FSD imposed after the date of the administration. This may make it impossible to predict the outcome for creditors, or even to be sure that the costs of the administration will be paid in full.
The court has the power to make a prospective order under Rule 2.67(3), which means that it can alter the priority of the payment of expenses where it is just to do so. In an appropriate case, the administrators could go to court to obtain an order that any liability under an FSD or CN should be payable after the administrators' remuneration and the other costs of the administration.
This offers some comfort to insolvency practitioners, although as the court’s power is discretionary, they cannot be completely certain of the outcome of any application. It is hard to see how the court could simply refuse an application to vary the order of priority where the alternative is the company going into liquidation, but there is no guarantee the court will allow all the remuneration and expenses which the administrators want.
2. Secured creditors
If a FSD is issued before the target goes into administration, the liability will be an unsecured claim ranking behind the claims of the holder of a floating charge. If it is issued after the date of the administration, it becomes a necessary disbursement which ranks ahead of the floating charge.
3. Other statutory claims and the importance of timing
The decision in Nortel and Lehman does not apply only to pensions cases. It establishes a principle that any statutory liability which arises for the first time after the company goes into administration will be an expense of the administration.
A detailed examination of the stage of the proceedings in question may be necessary prior to any appointment. It may be advisable to wait until a particular stage has been reached before the appointment is made.
4. Other creditors - the "Pari Passu" Principle and equal treatment
The effect on other creditors is clearly unfair. The liability under an FSD or CN depends on the exercise of the Regulator's discretion. In contrast to other creditors, whose claims are limited to whatever is allowed under the general law, an underfunded pension scheme can claim for whatever the Regulator considers reasonable, reducing the assets available for other creditors in the process.
Reducing the amount payable to other creditors by an unpredictable amount could adversely affect a rescue of the company via a CVA. It is unlikely to be possible to implement a CVA until the amount of any liability under an FSD or CN is ascertained. The delay in dealing with this could harm the prospects of a successful CVA, as could the reduction in the assets available to unsecured creditors.