Defined benefit pension schemes: new criminal offences for corporates, lenders, counterparties and advisers
The controversial Pension Schemes Act 2021 (the Act) has now received Royal Assent and it is anticipated that certain criminal offences under the Act will become law by the autumn*. The controversy surrounding the Act centres on a number of wide-ranging measures with potential criminal liability which strengthen the powers of the Pensions Regulator (TPR) in relation to defined benefit pension schemes (DB Schemes). The Act also brings parties such as lenders, contractual counterparties and professional advisers into the regulatory spotlight for the first time.
New criminal offences: unlimited financial penalties and up to seven years’ imprisonment
The Act introduces two new criminal offences which could result in up to seven years' imprisonment and unlimited financial penalties. Broadly, the offences are:
- doing an act or engaging in a course of conduct without reasonable excuse that detrimentally affects in a material way the likelihood of accrued pension benefits being received, where the person knew or ought to have known that the act or course of conduct would have that effect (the Section 58B Offence); and
- avoiding or compromising a debt under section 75 of the Pensions Act 1995 (which an employer owes to the trustees of an underfunded DB Scheme in specified circumstances), without reasonable excuse (the Section 58A Offence).
The Pensions Minister, Guy Opperman, has confirmed in a written response to Parliament that these offences will not be retrospective and will apply where the relevant act (or series of acts) occurs after the offences come into force. The Section 58B Offence concerns the industry the most (and is the main focus of this briefing), as its scope is wide enough to encompass many ordinary course corporate activities. In a significant expansion of TPR's powers, the offences can also be committed by any person involved with the activity in question (subject to a limited carve-out for insolvency practitioners) - this includes company directors, lenders, contractual counterparties and professional advisers.
Whilst the existing moral hazard regime allows TPR to take action where corporate activity has a materially detrimental effect on a DB Scheme, this action is limited to issuing financial penalties – in the form of contribution notices and financial support directions - against employers, connected and associated entities (as defined in the Insolvency Act 1986) and, in some cases, individuals. With the coming into force of the Act, the possible criminalisation of such corporate actions, together with the potential application of the offences to "any person", reflect a real step-change in the regulatory landscape.
"Reasonable excuse" and TPR guidance
To be found liable under either offence, it must be established that the relevant party had no "reasonable excuse" for the particular course of conduct. There is no definition of "reasonable excuse" contained in the Act but TPR intends to publish guidance on the use of the new criminal sanction powers following an industry consultation; it is hoped that the guidance will be issued prior to the new offences coming into effect.
However, as with all regulatory guidance, it will not be legally binding and will simply set out TPR's own view of how the Act will operate. There is also a concern that the guidance will be too broadly drafted to provide much comfort to the relevant parties when considering a transaction involving a group with a DB Scheme.
Ordinary business activities potentially in scope
Whilst the Government's original intention was focused on punishing directors (and any connected persons) guilty of "wilful or grossly reckless behaviour" in relation to a DB Scheme, this test has been intentionally dropped from the wording of the Act. The wording of the offences therefore covers the same broad range of ordinary corporate activities as are included under the existing regulatory regime (see further below), but without any requirement for recklessness. This leaves many ordinary business activities undertaken by (or with) a corporate group with a DB Scheme potentially within the scope of a criminal offence.
During parliamentary debates leading up to the Act, Government ministers sought to give reassurance that there was no intention of frustrating legitimate business activities carried out in good faith, but that if the elements of the offences are met then TPR should be able to respond appropriately. Despite this reassurance, the potential for criminal liability for "any person" involved in an activity may lead to counterparties being particularly cautious when dealing with corporates which have DB Schemes in place, and may make restructuring and rescue transactions more risky.
What types of corporate activity could be caught by these new offences?
Subject to the question of "reasonable excuse", the key consideration under the Section 58B Offence will be whether an act (or failure to act) materially and detrimentally affects the likelihood of accrued pension benefits being received. We have set out below the key areas and activities which could potentially fall within the scope of the Section 58B Offence and, as regards restructuring activity, the Section 58A Offence.
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As the new regulatory regime (and in particular the Section 58B Offence) will apply to lenders and advisers, all parties involved in the financing of a group with a DB Scheme will need to give much greater consideration to the impact of the financing on the pension scheme. This increased scrutiny will be needed both before entry into a transaction and potentially also on an ongoing basis, as there is likely to be a wide range of scenarios which could fall within the scope of the Section 58B Offence. We have included below some examples of the ways in which different types of financing transactions may impact a DB Scheme, but we are hopeful that TPR guidance will go at least some way to clarifying the application of the Section 58B Offence in these types of scenarios:
The above examples are only intended to be illustrative, and the question of what constitutes a "reasonable excuse" will be of paramount importance in determining potential liability. Any relevant activity will therefore need to be considered on a case-by-case basis. |
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| Restructuring | |||||||||
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The new offences are likely to have a significant impact on the restructuring market. While directors and restructuring professionals are familiar with navigating the moral hazard regime which has a similar scope to the Section 58B Offence, the harsher criminal penalties are likely to have an inhibitive effect. This is because, at least in theory, most restructurings of a group with a DB Scheme could fall within the scope of the offence. The unfortunate fact is that, even with the best intentions, where a restructuring is unsuccessful, any resources spent on progressing the restructuring or additional debt incurred to finance it (particularly where secured) is likely to impact accrued pension scheme benefits in a detrimental way, bringing the restructuring within the scope of the offence if TPR can establish that it was carried out without a "reasonable excuse". Although the Section 58B Offence is likely to have a major impact, the Section 58A Offence is also relevant in the restructuring sphere. The key consideration here will be whether the act (or failure to act) prevents the recovery of a section 75 debt due to a DB Scheme, prevents such a debt becoming due or otherwise compromises such a debt. The wide scope of this offence could theoretically catch any compromises of employer debts through CVAs or compromises outside the Pension Protection Fund, together with arrangements permitted under legislation such as regulated apportionment arrangements. However, as TPR is usually a party to the negotiation of such arrangements it would seem likely that its involvement would assist in establishing "reasonable excuse". When pursuing a restructuring, directors should always have a close eye on the potential benefits of the restructuring for all of the creditors (including the DB Scheme) and its prospects of success, and these are likely to be factors that form a central part of a "reasonable excuse". However, unless TPR guidance is clear on how this will be applied in a restructuring context, directors will have to tread very carefully. And with "any person" falling within the scope of the offences, all stakeholders involved in a restructuring of a group with a DB Scheme (including prospective purchasers, lenders and advisers) will need to give greater consideration to its impact on that pension scheme. All parties will be conscious that any charges under the new offences brought in a failed restructuring case may be coloured by hindsight. Faced with this prospect of potential criminal liability when considering a restructuring, directors may not be willing to take the risk, preferring instead to place the company into insolvency pre-emptively. Alternatively, they may find that their hands are tied because lenders are unwilling to provide the new financing required to support the restructuring due to concerns about the offences. We await publication of TPR guidance in the hope that this might provide reassurance, but in any event, we expect to see a flurry of clearance applications to TPR in restructurings involving DB Schemes to provide stakeholders with more comfort to proceed, though this is unlikely to provide complete protection. See below for a more detailed discussion of the extent to which clearance might help. |
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Companies with DB Schemes are already used to considering the effect of a variety of corporate actions on their schemes in order to lessen the chances of TPR using its existing powers. We await with interest, and some trepidation, the TPR guidance but in the meantime, the following considerations are worth noting on the Section 58B Offence.
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Is there a clearance process?
The current process by which TPR gives reassurance that it will not issue a contribution notice or a financial support direction is known as clearance. Clearance is a voluntary process that, for example, an employer (and any associated and connected persons) may undertake to seek comfort that certain events that are materially detrimental to the ability of the DB Scheme to meet its pension liabilities will not result in TPR exercising its current regulatory powers. Clearance applications are relatively rare, largely due to the length of time it can take TPR to consider applications.
It is unclear how clearance will work in relation to the new offences and indeed whether it will be available at all, as it is highly unlikely that TPR will (or even can) issue clearance in relation to criminal sanctions. However, it is possible that parties may seek clearance for a transaction under the current regulatory regime and then look to offer this as evidence that they had "reasonable excuse" should they later face investigation or criminal liability under the new offences. This approach could result in TPR being swamped with clearance applications and corporate activity being hindered by significant delays. We saw a similar trend in the aftermath of the Pensions Act 2004.
What next?
With these two new offences shortly to become a reality, any group with a DB Scheme (and any person advising or doing business with it) will need to think carefully about whether any activities, including "business as usual" activities, potentially fall foul of the Act. We expect there will be a greater need to evidence (albeit privately) the rationale for a particular action so that this can be taken into account when considering whether there is a "reasonable excuse".
Whilst TPR's anticipated guidance will be relevant to the question of "reasonable excuse", certainty on the scope of the new offences will need judicial guidance. Until the courts have had the opportunity to weigh in, we will go through a period of heightened uncertainty, as the Act gives rise to genuine risks that will need to be considered on a case-by-case basis.
Pending judicial consideration, the offences will attach to an uncertain category of actions that could catch ordinary-course business done in good faith at the time. This could mean that parties take a much more cautious approach when dealing with groups with DB Schemes. However, the degree of uncertainty and risk may be too much for some directors, counterparties and lenders, particularly where there are any solvency concerns, putting distressed companies with DB Schemes at risk of missing out on opportunities for rescue and assistance that they very much need.
* Based on Guy Opperman's written response to Parliament on 11 January 2021.
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