The New Debt Regulations – Is the ability to defer section 75 debts as good as it sounds?

21 / 03 / 2018

Background

Employers have faced the prospect of having to pay their statutory debt under section 75 of the Pensions Act 1995 when their last active member of a defined benefit multi-employer pension scheme ceased to be in pensionable service (such as through retirement), and at a time when one or more of the employers continue to have active members.

For certain employers it was, therefore, a welcomed change when the Government relaxed the debt legislation in this area, between 2008 to 2012.  The changes included introducing a 12 month period of grace for new members to join a multi-employer scheme before an employer debt is triggered, which was later increased to a 36 month period.  In addition, subject to certain conditions an exiting employer was able to avoid paying its section 75 debt by apportioning its scheme liabilities to another continuing employer, through putting in place a flexible apportionment arrangement.  This solution, however, was usually achievable only where the employers were participating in the scheme in the same corporate group and not where the employers were “non-associated”, such as in a multi-employer scheme for various disparate charities.

Recognising this issue, the Government has now introduced the new debt regulations[1] (coming into force from 6 April 2018).  The new regulations will provide the possibility of debt deferral for such employers.

The deferral of section 75 debts

Under the new debt regulations, scheme trustees would be able to consent to an employer deferring its section 75 debt where the employer ceases to have any active members.  This simple new principle is subject to ‘gateway’ conditions for the employer to defer its debt. There are also listed circumstances which could bring deferral to a premature end.

Gateway conditions

  • One of the gateway conditions is that an employment-cessation event has either occurred in relation to the deferred employer before the two below conditions are met; or would have occurred if the employer had not entered into and remained in a period of grace until immediately before the date on which the deferred debt arrangement is to take effect.
  • The Government originally suggested that a funding test was required as one of the gateway conditions. This has been dropped following the consultation.  Instead, under the finalised new legislation, the gateway conditions include the trustees being “satisfied” (not merely reasonably satisfied) that at the start of the deferral, the employer’s covenant is unlikely to materially weaken in relation to the scheme in the 12 months following the start of the deferral.
  • Although The Pensions Regulator is due to issue guidance on the meaning of “material weakening”, obtaining and considering advice on the employer’s covenant is not straightforward and a potentially time consuming and costly exercise.
  • Another condition includes the scheme not being in an assessment period or being wound-up, and that an assessment period is unlikely to begin in the 12 months following the deferral.

Events prematurely ending the deferral period

  • In certain circumstances trustees may end the employer’s deferral period (this would trigger the employer’s debt).
  • One of the conditions includes trustees being “reasonably satisfied” that the employer’s covenant is likely to materially weaken in the next 12 months. This condition may be problematic for the employer and the scheme trustees.  For example, having deferred its debt, the employer may later find that its section 75 debt arises unexpectedly as its business deteriorates and its financial circumstances weaken significantly, which may in effect reduce the amount the scheme could ultimately recover from the employer. The scheme trustees may then have the unenviable task of having to explain why they did not end the deferral period sooner.
  • The new debt regulations require trustees to regularly monitor the employers’ covenant on an ongoing basis.  There is no doubt that this will create greater responsibility and pressure on the trustees, and until we receive any further guidance as to the form the monitoring should take and the meaning of “material weakening”, there will still be uncertainty in this area.
  • The deferral period may also be brought to an end where the employer and the trustees of the scheme agree that an employment cessation event is to be treated as having occurred. This is restrictive on the employer as it cannot unilaterally make this decision (in contrast, see below regarding frozen schemes).

Wedlake Bell comment

Whilst the new debt regulations seem to be a step in the right direction, in particular for non-profit / charity organisations, the gateway conditions to defer debt are unnecessarily restrictive.

In contrast, in a frozen scheme where all the employers cease to have active members at the same time, the debt is in effect deferred and there are no provisions in the debt legislation enabling trustees to call in the debt on the grounds of material weakening of the employer’s covenant.  An employer, in a frozen scheme, could also choose to give notice to the trustees and pay off its debt at any point.  The Government has felt unable to be flexible in the new legislation.  This, presumably, is to prevent employers from gaming the system and triggering the debt when it is at a low level.

It is worth noting that, depending on what event terminates the employer’s deferral, a debt arising is calculated as at the date the deferral period ends, rather than being calculated at the start of the deferral period.  This may cause the deferred employer concern as its debt could potentially be much greater than originally envisaged (i.e. the employer’s debt may be far greater at the end of the deferral period than at the beginning).

Also, for ongoing scheme funding purposes, the employer may need to continue to contribute to scheme funding even though it has deferred its section 75 debt.

It is important for employers and scheme trustees to understand the new debt deferral provisions.  Whether the new regulations are, however, of any practical use remains to be seen.

[1] The Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2018