U.K. Pensions Issues On Sales and Acquisitions - Shares or Assets?
Pension liabilities in UK defined benefit (DB) pension plans have increased dramatically in recent years. Liabilities can be measured in many ways, but the ultimate liability is the cost of buying immediate deferred annuities for plan beneficiaries (the “buy-out” cost). This is the most expensive basis of calculating plan liabilities (much greater than the accounting liabilities under FRS17). Termination of a DB plan creates a debt that is immediately due from the plan sponsors on the buy-out basis. The potential financial strain on a business means that termination is no longer a viable option for most businesses.
On sales and acquisitions involving UK companies, pension liabilities have therefore risen to the top of the agenda. This commentary summarises the issues that may arise on a transaction involving a target with a DB pension plan in the UK and, in particular, the relative merits of a sale of the shares as opposed to the assets of the target company.
The sale of shares of a company which participates in a DB plan will raise significant problems for a potential buyer.
Ongoing Liabilities. If the target company is coming out of a group DB plan, the deficit in the plan in respect of the target’s employees (and former employees) becomes a debt due from the target company to the plan on closing. This deficit is calculated on the buy-out basis. The buyer would usually seek an adjustment to the purchase price for this cost, or an indemnity. This can be avoided only if the target company and the trustees enter into an “approved withdrawal arrangement” under which they agree that the buy-out cost will be paid into the plan over time by another party. The trustees’ fiduciary obligations to the plan mean that they are unlikely to agree to such an arrangement without also insisting on extra security for the plan in the form of an immediate substantial contribution to the plan or a parent company guarantee. Such agreement would then need the approval of the Pensions regulator, which usually takes around two months and must be obtained before closing the transaction.
If the DB plan is a target company plan only, the buyer will be assuming responsibility for the whole of the plan on closing. Whilst a share sale is attractive for the seller in these circumstances, buyers are wary of taking over the DB plan because of the funding obligations and also the new powers of the Pensions Regulator, which can extend obligations to contribute to the plan to group companies, substantial shareholders and directors if the Regulator feels that the plan sponsor is under-resourced or that action has been taken to limit the sponsor’s liabilities to contribute to the plan.
Notifications and Clearances from the Pensions Regulator. If the target company is being sold by a group company, the decision to sell must be reported to the Pensions Regulator (this means at the time the sale process is approved and not at the time of signing of the deed). The Regulator is unlikely to take any immediate action as a result of such notification, but it is in effect put on notice that there may be issues arising in relation to any DB plan of the target company.
If the DB plan is a target company plan only, the parties to the transaction may also seek clearance from the Pensions Regulator before the sale takes place that no liabilities to the plan will be triggered from the parties seeking clearance (usually the buyer and seller groups). Applications for clearance take time and often involve the Regulator demanding that additional funds be paid into the pension plan (usually by reference to a proportion of the purchase price). Clearance provides limited comfort for the seller, and comfort to all parties is limited to circumstances at the time of clearance.
Overall, the involvement of the Pensions Regulator clearly increases the time and costs involved in effecting a share sale transaction.
Asset sales are becoming more popular where UK DB pension plans are involved because of the problems with share sales. There are, however, potential problems with asset sales relating to employee claims and the liabilities of the selling company.
Employee Claims. Generally, pension rights do not transfer on an asset sale, but the right to certain enhanced early retirement pensions do transfer ( e.g., on redundancy). If the DB plan in question provides such enhanced benefits, and these are not replicated by the buyer on transfer, there is the risk of employee claims which, in monetary terms, could be significant. The risk is usually quite remote, but because of the potential costs, the allocation of risk is important to both seller and buyer and is usually dealt with by way of indemnities.
Although occupational pension rights do not generally transfer on an asset sale, employees do have the right to certain levels of contribution into a new occupational pension plan or a stakeholder plan; there is no obligation for these contributions to be made into a new DB arrangement. This is nonetheless a cost that a buyer will have to factor into any asset sale arrangement.
Liabilities of Selling Company. If the selling company is the only employer under the DB plan, the termination of the plan is likely to be triggered by the asset sale, and the company will therefore be required to pay the deficit into the plan on the buy-out basis.
If the selling company is one of several employers in the DB plan, it will be obliged to pay the deficit into the plan on the buy-out basis unless it is able to enter into an approved withdrawal arrangement.
If a selling company retains part of its business, its immediate liability for the buy-out deficit to the DB plan may be avoided, irrespective of whether it is a target company plan or a group plan. However, this will be effective only if it is a bona fide continuation of the business of the selling company. The Pensions Regulator has substantial anti-avoidance powers which may be used to demand the buy-out deficit into the plan if such continuation is not bona fide.
For further information, please contact your principal Firm representative or the lawyers listed below. General e-mail messages may be sent using our “Contact Us” form, which can be found at www.jonesday.com.
John Papadakis, Partner
+44 (0) 20 7039 5272
Rosalind Connor, Associate
+44 (0) 20 7039 5446
This Commentary is a publication of Jones Day. The contents are for general information purposes only and are intended to raise your awareness of certain issues (as at march 2006) under the laws of England and Wales. This Commentary is not comprehensive or a substitute for proper advice, which should always be taken for particular queries. It may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at its discretion. The mailing of this publication is not intended to create, and receipt of it does not constitute, a solicitor-client relationship.