The new powers of the pension regulator – considerations for banks and borrowers | Denton
Traditionally, the pension regulator (tPR) the powers have not been extended to banks and other lenders who make loans to limited benefit corporations (comics) diets. It was up to the sponsor to ensure that the loan did not materially affect its pension plan and, if so, to provide adequate mitigation for the plan.
If the sponsoring employer fails to do so, the sponsor and related and associated businesses may1 (and their managers) being subject to the exercise by tPR of its powers of moral hazard.
Under these powers, tPR may impose a contribution notice (NC) requiring the company and responsible officers to make a payment to the pension plan to remedy the damage.
What is changing for lenders?
The significant change brought about by the Pensions Act 2021 (Law) is that, while it is still true that moral hazard powers cannot be exercised against a bank, the new criminal powers are applicable to third parties, including banks and other lenders.
Criminal offense and civil penalties
Under the law, commits a criminal offense any person who:
- engage in any activity that has a materially detrimental impact on plan benefits; or
- commit an act that prevents a pension plan from collecting all or part of the debt under section 752 of the employer with the intention that the law have that effect.
The offense can be committed by any “person” (regardless of whether or not they are related to the plan or their sponsoring employer), other than a person appointed and acting in the course of their duties as an insolvency practitioner. Thus, the new offenses may apply to individuals, corporations and administrators of pension plans and their advisers, as well as banks and other lenders.
The offense carries the risk of an unlimited fine and up to seven years in prison. There is also a civil penalty for the same offence, with a fine of up to £1million.
For our previous briefing covering criminal offenses and new civil penalties, click here.
TPR Policy on Criminal Offenses
On September 29, 2021, tPR released its Criminal Offenses Policy (politics) providing guidance on its approach to the investigation and prosecution of new offences. The policy sets out the three different “elements” of a criminal offence: (a) an act element; (b) a mental element; and (c) the defense of reasonable excuse.
In terms of the defense of reasonable excuse, there are three factors that tPR will consider:
- the extent to which the harm to the regime was an incidental consequence of the act or omission;
- the adequacy of any mitigation measures provided to offset the adverse impact; and
- in the absence of mitigation or in the case of inadequate mitigation, whether there was a viable alternative that would have avoided or reduced the adverse impact.
So what is the risk for a pension regulator lender to take criminal action?
While banks and lenders will need to carefully consider the implications of the new breaches when providing funding to DB plan sponsors, they can be reassured that the policy highlights that the tPR:
- will not use these powers in a way that targets an ordinary commercial activity; and
- take a risk-based and proportionate approach.
Only the most serious instances of intentional or reckless conduct will be investigated and prosecuted.
The policy contains a useful case study of a refinancing by the sponsor company of a DB scheme to repay a loan to its parent company. If the lender defaulted on the loan, the lender then called the administrator to enforce its loan against the sponsor. The sample Policy then examines the extent to which the various parties, the sponsoring company, the parent company and the lender may be guilty of a criminal offence.
For banks and lenders, the key takeaway from the policy (and the case study) is that it appears that tPR’s view is this:
- whereas a lender’s decision to bring in trustees (or take other enforcement action) when a sponsor defaults on its loan may satisfy the “act” and “mental” elements of a breach, the lender will generally be well aware that claiming the full debt, fees and accrued interest could result in the pension plan receiving next to nothing from the administration of the employer – the lender will have a defense of reasonable excuse;
- the lender’s lack of proximity to the pension plan means that any negative consequences for the pension plan arising from the lender collecting its debt are not essential to the lender’s objective. The lender is entitled to protect its own interests and claim its debt, and any prejudice caused to the pension plan is only incidental; and
- generally, the lender has no duties or obligations to the pension plan or sponsor.
In the case study presented in the policy, in negotiating the terms of its loan (which were above standard market rates), the lender had not acted arbitrarily and there was no evidence of a lack of honesty or good faith on the part of the lender.
Practical advice for lenders
- The policy states that, when considering the availability of the defense of reasonable excuse, tPR will also consider:
- the extent to which communication and consultation with plan administrators took place prior to the “relevant act”; and
- if there has been a negative (material) impact on the project, the adequacy of any mitigation provided to compensate for it.
The lender should therefore find out from the borrower whether the above measures have been or will be taken. If so, it is unlikely that there has been any detriment to the scheme such as to give rise to a criminal offense (whether by the borrower or the lender).
- Financing terms should be carefully reviewed to reflect any risk to the tPR lender exercising its criminal powers (or imposing a civil penalty) against the borrower and moral hazard powers (as amended by statute). ). In particular, any obligation to notify the borrower and any “event of default” should cover criminal proceedings brought by tPR against the borrower and an NC imposed under the new grounds for imposition of an NC introduced by law.
On the other hand, there are potentially bigger pitfalls for a borrower. Not only will the sponsor of a PD program fall under the new criminal powers, but under the law there are two new grounds for imposing an NC:
- the employer insolvency test: this examines whether, in the event of the insolvency of a company participating in the pension scheme, the amount of any Article 75 debt which the scheme would have recovered would have been materially reduced as a result of a loan/funding; and
- the employer resources test: this test examines whether the “resources” of the company, i.e. its pre-tax profits, are significantly negatively affected by the loan/financing.
A legal defense is available against an exercise by tPR of its powers. A borrower should demonstrate that it has given due consideration to whether or not entering into the financing would cause material harm and:
- have reasonably concluded not; or
- that it took all reasonable steps to eliminate or minimize the expected material harm before reaching that conclusion.
This is very similar to the considerations tPR will take into account when determining whether a defense of reasonable excuse is available in the context of its criminal powers.
Practical steps for the borrower
- A borrower should carefully consider the risk that any financing will trigger the exercise of moral hazard/criminal and civil powers by tPR, obtaining financial/commitment advice (as well as legal advice) if necessary.
- In particular, given the new criminal powers, it would be good practice for the borrower to consider informing the scheme administrators before, rather than after, a formal decision is taken to set up a funding.
- Where there is probable material harm to the plan, a borrower should consider whether financing can be structured differently. For example, could the loan (and any guarantee granted) be taken out by another company in the group, rather than by the employer participating in the scheme?
- Alternatively, mitigation should be provided to the system to remedy the harm. Mitigation can take various forms, such as the provision of additional cash for the pension scheme, funds placed in an escrow account (for the benefit of the scheme) or a guarantee from the parent company with respect to the obligation under debt under section 75.
Notification of guarantee to the lender
Under the draft regulations under the Act, it is provided that the granting or extension of a “relevant guarantee” must be notified to tPR. A “relevant security” for these purposes is a security representing more than 25% of the company’s consolidated revenues or gross assets. If these regulations are implemented as currently planned, any financing involving the granting or extension of a corresponding guarantee must be notified to tPR. The notification will also need to be accompanied by a statement providing information to tPR and the administrators of the pension scheme which describes, among other things, any adverse effects of the security on the pension scheme and any measures taken to mitigate these adverse effects.
Although the new criminal powers provided by the law are potentially serious, with proper planning and careful consideration of pension implications, lenders and borrowers can safely enter into financing and refinancing transactions without breaching these powers.
- The connection and association for these purposes shall be construed in accordance with sections 249 and 435, respectively, of the Insolvency Act 1986.
- A liability under section 75 or 75A of the Pensions Act 1995, in respect of the deficit of the scheme, which is calculated on the assumption that the liabilities to all members are secured by the purchase of annuities from an insurance company.