On 18 December 2013 the High Court handed down another judgment in the long running litigation (summarised in further detail below) concerning the liabilities of certain Lehman Brothers entities to the trustees of the Lehman Brothers defined benefit pension scheme (the Lehman Scheme) following the issue by the Pensions Regulator (TPR) of a financial support direction (FSD) against a number of entities within the Lehman Brothers group. As with the Supreme Court's judgment in Re Nortel Companies; Re Lehman Companies [2013] UKSC 52, the court was faced with the difficult task of reconciling complex provisions of the relevant pensions legislation with general principles of English insolvency law.
The court held that in circumstances where, as a result of the issue against them of FSDs with which such companies have not complied, multiple companies within the same group are potential targets for contribution notices (CNs), there was no implied limit in the relevant pensions legislation which meant that the aggregate amount of the financial contributions required by those CNs is restricted to the amount which would be required to fund the pension scheme deficit under section 75 of the Pensions Act 1995 (the Section 75 Debt).
As a result of this judgment, where there is more than one target company for a CN, each of the CNs which TPR can issue against each of those entities can potentially be for the full amount of the Section 75 Debt. Where there is only one target company however, the CN will necessarily be limited to the total amount of the Section 75 Debt.
Legislative background: Pensions Act 1995 and Pensions Act 2004
Under section 75 of the Pensions Act 1995 when a company (an Employer) that has a final salary pension scheme enters into an insolvency process (including administration) and there is a deficit in its pension scheme, an amount equivalent to the Employer's share of the deficit becomes a debt due from the Employer to the trustees of the scheme. The Section 75 Debt is a provable debt deemed to have arisen immediately prior to the occurrence of the relevant insolvency event and determined by the scheme's actuary by reference to the scheme's assets and liabilities immediately prior to the event triggering the liability. The trustees of the pension scheme will rank as unsecured creditors of the Employer and the Section 75 Debt claim will rank pari passu with other unsecured creditors of the Employer.
As part of the “moral hazard” powers introduced by the Pensions Act
2004 (the 2004 Act) in order to
prevent companies “dumping” their pension liabilities on the Pension Protection
Fund, where an Employer is deemed to be a “service company” (i.e. its principal
purpose is providing the services of its employees to associated companies
within the group) or is “insufficiently resourced” (as defined in sections 44(3) - (4) of the 2004 Act) in each case within the
period of two years before the date TPR determines to issue the
relevant FSD (now amended to the date on which a warning notice in respect of an FSD is given),
TPR may require, by the issue of an FSD, the Employer and its associated and connected companies (referred
to as “target companies” and which are usually (but not limited to) companies
that have benefited from the services of the Employer) to provide financial
support to the under-funded pension scheme. The issue of an FSD is subject to a statutory
reasonableness test and the 2004 Act lists a number of criteria relating to such
reasonableness including the relationship of the target company to the
Employer, its financial circumstances and any connection or involvement of the
target company with the pension scheme.
An FSD does not
specify what financial support is required from the target company. Instead, upon receipt of an FSD, it is the
responsibility of the target company (along with the other target companies (if
any)) to propose to TPR the financial support it will put in place which will in some manner deal with the pension scheme deficit and which must remain in place until the scheme is wound up. "Financial support" for these purposes means an arrangement approved by TPR which falls within section 45(2) of the 2004 Act and includes an arrangement where all the members of the Employer's group are jointly and severally liable for the whole or part of the "employer's pension liabilities" and an arrangement where a holding company is liable for the whole or part of the "employer's pension liabilities". Under section 45(4) of the 2004 Act "employer's pension liabilities" mean any amounts payable by the Employer under the relevant schedule of contributions and liabilities for any debt which is or may become due to the scheme from the Employer "whether by virtue of section 75 of the Pensions Act 1995 or otherwise." If, following the issue of an FSD, TPR does not receive a proposal from the target company or it does not approve the proposal, TPR may impose, by the issuance of a CN "to any one or more of the persons to whom the direction was issued", a specific monetary liability payable by the target company towards the pension deficit. Under section 48(1) of the 2004 Act the sum specified may be "either the whole or a specified part of the shortfall sum in relation to the scheme." If, at the time of non-compliance with an FSD, a Section 75 Debt was due from the Employer to the scheme, the "shortfall sum" is defined under section 48(2) of the 2004 Act as "the amount which [TPR] estimates to be the amount of the debt at that time." In cases where no Section 75 Debt is actually due, section 48(2)(b) of the 2004 Act provides for there to be a notional calculation of the section 75 liability.
TPR's power to issues a CN is expressly limited under section 47(3) of the 2004 Act which provides that a CN may be issued to a person "only if [TPR] is of the opinion that it is reasonable to impose liability on the person to pay the sum specified in the notice." Matters to be taken into account in this regard include, as with the FSD regime, the connection or involvement of the target company with the scheme and the financial circumstances of that company.
Prior proceedings relating to the Lehman Scheme
Lehman Brothers Limited (LBL) is, for the purposes of the FSD regime, a service company and also the sponsoring employer of the Lehman Scheme. As a service company, it acted as the main employer in the UK for Lehman Brothers and, as required, seconded staff to other members of the Lehman group. When, together with a number of other Lehman entities, it entered administration on 15 September 2008 it triggered a liability of £119 million under Section 75 to the trustees of the Lehman Scheme (the Trustees). This Section 75 Debt is a provable debt in the administration (and any subsequent liquidation) of LBL.
On 24 May 2010, TPR issued a warning notice (as a precursor to the issuance of an FSD) against a number of companies within the Lehman group. 74 companies were originally subject to this warning notice, subsequently reduced to 44. On 13 September 2010, the determinations panel of TPR (the determinations panel being the independent body with statutory authority to issue FSDs) issued a determination notice in which it concluded that LBL, as the principal employer of the Lehman Scheme, was a service company and that it was reasonable to issue an FSD against six of the 44 Lehman entities subject to the warning notice.
The determination notice was referred to the Upper Tribunal by both the Trustees and the Lehman entities, with the Trustees arguing that the remaining 38 companies the subject of the warning notice should also be subject to an FSD. In June 2012 the Upper Tribunal rejected an application by the 38 Lehman entities to strike out the reference made by the Trustees to the Upper Tribunal, this being upheld by the Court of Appeal in June 2013. The next stage in these proceedings (to take place early in 2014) will be a directions hearing for the substantive references to the Upper Tribunal. A background summary to the process and procedure for the issuing of FSDs and subsequent appeals relating thereto can be found here.
In July 2013, the Supreme Court confirmed that a liability under an FSD ranked as a provable debt of a company and not as an expense of its administration. The Supreme Court also held that possible claims under yet to be issued CNs (for non-compliance with an FSD) are contingent liabilities capable of proof in the administration or liquidation of potential targets (see the South Square briefing on this case available here for further analysis/background).
The matter for decision in this case
As part of these ongoing proceedings, the administrators of 14 Lehman entities applied to the court for directions as to whether, in circumstances where two or more CNs could be issued, there was an aggregate limit of the shortfall sum (i.e. £119mn in this case) which could be collectively specified in, and recovered under, the relevant CNs or whether, subject to the requirement to act reasonably, TPR could specify sums which, collectively, exceeded the applicable shortfall sum and, likewise, recover in excess of the shortfall sum. The application turned solely on the statutory construction of the relevant provisions of the 2004 Act.
This application for directions was financially (as well as legally) significant as the shortfall sum of £119 million (being LBL's Section 75 Debt at the time it entered administration in September 2008) was somewhat lower than the subsequent estimates of the Lehman Scheme's buyout deficit (which ranged from £214 million to £275 million by the first half of 2013). As a result, if the administrators were wrong in their contention that the amount which could be specified in the CNs was limited in aggregate to the shortfall sum (i.e. the £119mn Section 75 Debt), the target companies' liabilities under the CNs could be in excess of £100mn more than would be the case if the court found in favour of the administrators.
The arguments for liabilities under multiple CNs to be limited, in aggregate, to the "shortfall sum"
The Lehman administrators' principal argument rested on the proposition that as under section 48 of the 2004 Act the shortfall sum (i.e. the Section 74 Debt) in relation to a single entity was unambiguously the maximum that could be specified in a single CN, it was implicit that this also operated to limit the aggregate amount that could be recovered in circumstances where there were multiple target companies for a CN in respect of the same non-compliance with an FSD. Whilst the administrators accepted that there was no express limit in the legislation to this effect, they submitted that the court should imply such a limit on the basis that the purpose of TPR's ability to issue CNs is to enable scheme trustees to recover up to, but no more than, the outstanding or notional Section 75 Debt. In support of this basic proposition, the administrators' counsel cited the following arguments:
1. the "shortfall sum" under section 48 of the 2004 Act is defined by reference to the actual or notional Section 75 Debt;
2. in circumstances where there is only one target company the shortfall sum would clearly be limited to the Section 75 Debt, so if Parliament's intention was that the scheme should recover the full pension scheme deficit it is arbitrary that this should depend on whether there is one or multiple target companies; and
3. under section 50(6) of the 2004 Act any sums paid pursuant to a CN are treated as reducing the amount of the Section 75 Debt which suggests that the purposes of CNs is to recover the actual or potential Section 75 Debt and no more.
Lehman Brothers Holdings Inc (LBHI), the ultimate parent company of the Lehman group and a significant direct and indirect creditor of a number of the Lehman entities the subject of potential CN liabilities, made a number of submissions in support of the administrators. In particular, LBHI argued that the applicable provisions in the 2004 Act should be construed consistently with the statutory insolvency regime, which is designed to achieve as speedy as possible resolution of claims and related matters hence the ability under the Insolvency Rules to value contingent claims. It would be consistent with this objective that the relevant pensions legislation should specify the maximum, total amount that could be claimed against a group of insolvent companies as, in total, the Section 75 Debt. To allow the recovery of an aggregate amount exceeding the Section 75 Debt would lead to greater uncertainty as it would be difficult to estimate the aggregate amount of the CN liability and therefore the liability of each target company.
Counsel for LBHI also submitted an alternative argument (supported by the administrators) that, whilst the aggregate amounts specified in the CNs could be more than the shortfall sum, the shortfall sum represented the maximum which could be recovered in aggregate under the CNs.
The arguments for liabilities under multiple CNs to be limited only by reference to the "shortfall sum" for each CN
TPR and the Trustees argued that, on a plain reading of the relevant statutory provisions, neither the aggregate amount which could be specified in multiple CNs nor the aggregate recovery under those CNs should be limited to the shortfall sum. Any limit on the amounts specified in a CN derived from the requirement that the exercise of TPR's powers must be reasonable and, in this respect, it would not be a proper exercise of TPR's powers to require payment of sums which in total exceeded a scheme's liabilities.
In support of this argument, counsel for TPR and the Trustees relied on the fact (which seems to have had particular resonance with Justice David Richards) that the power to issue CNs arose on non-compliance with an FSD, not on the failure to pay a Section 75 Debt and therefore it was artificial to try to limit the ambit of multiple CNs to solely section 75 liabilities. Related, they argued that the FSD provisions should not be construed on the basis that they only operate on an insolvency since TPR's powers also applied more generally in circumstances where companies continue to trade and benefits continue to accrue to members under the relevant scheme. In response to LBHI's submissions, it was noted that the difficulties in assessing the liability of each target company could also arise if there was an aggregate cap equal to the Section 75 Debt.
The High Court's decision
The High Court held that the relevant provisions of the 2004 Act only limit the amount of each CN to the liability for the Section 75 Debt. As a result, in circumstances such as the Lehman administrations where there were multiple target companies TPR could, subject to the other relevant provisions which TPR is required to take into account (e.g. the requirement for it to be reasonable for TPR to impose liability on the person to pay the sum specified in the CN), issue multiple CNs each for the total liability in respect of the Section 75 Debt. The court also held that, as well as issuing CNs which, in aggregate, amount to more than the Section 75 Debt, it is also possible for sums in excess of the Section 75 Debt to be recovered under those CNs.
In reaching this judgment, the court appears to have been particularly persuaded by the argument that, given that there were specifically worded limitations on TPR's powers to issue CNs, if (as the administrators had submitted) Parliament had intended that the total aggregate amount which could be specified in the applicable CNs should not exceed the shortfall, then such a limit could have been expected to be expressly provided under the 2004 Act. In fact, the only express limit imposed by section 48(1) on the amount specified in each CN is the shortfall sum and TPR is able to state either the whole or a specified part of that sum in any notice. In addition, in considering the overall scheme of the pensions legislation and TPR's statutory objectives, the court was of the view that this militated against the imposition of implied limitations. The court also had regard to the "elaborate scheme" for the imposition of liabilities by TPR under its "moral hazard " powers, including the requirement for TPR to act reasonably and the right for targets to refer a determination to the Upper Tribunal, as another reason not to imply limitations. A further rebuttal to the administrators’ implied limitation argument was that in the case of the insolvency of a group of companies where one or more of the persons to whom CNs had been issued were insolvent, it would necessarily be the case that, where an aggregate cap was implied, total recoveries would be much less than the shortfall sum.
Justice David Richards resisted the link made by the administrators to the aggregate amounts which may be stated in multiple CNs to the Section 75 Debt by reference to the fact that the purpose of the FSD regime was not limited to protecting a scheme in the event of an employer's insolvency but also to protect an active scheme. Of particular relevance in this regard was the definition of "financial support" for an "employer's pension liabilities" (as referred to above) required to be put in place in response to the issuance of an FSD which refers not only to section 75 liabilities but also any amounts payable by the Employer under the relevant schedule of contributions and liabilities for any debt which is or may become due to the scheme from the Employer "whether by virtue of section 75 of the Pensions Act 1995 or otherwise." Related, the court noted that non-compliance CNs were issued in response to non-compliance with one or more FSDs, not in response to the non-payment of a Section 75 Debt.
The court also disagreed with the arguments made by LBHI's counsel that failure to imply an aggregate cap into the CN regime would be inconsistent with the statutory insolvency regime, noting that the estimation of contingent liability in respect of a potential contribution notice was, in principle, no different from the estimation of many other contingent liabilities.
The judgment also raises a possible insolvency "domino" scenario as, where the employer in a group enters an insolvency process and the Section 75 Debt arises against it, other companies in the group which may otherwise be solvent may consider themselves to be insolvent if they perceive that they could be liable under a CN for a debt equal to the total Section 75 Debt.
