Corporate transactions

Pensions are increasingly understood and valued by employees and their representatives. They are therefore relevant to employee relations and corporate reputation in addition to their financial and operational consequences. For the reasons explained elsewhere (see Why we are where we are and Pensions risk) pensions issues play an increasing part in corporate transactions.

Main issues
Given the extent of risks associated with final salary schemes, it is essential to know whether a target currently participates or has in the past participated in such a scheme. A corporate transaction could potentially trigger a section 75 debt, raise employer covenant concerns or result in regulatory intervention. Thorough due diligence to uncover the target’s pension history is therefore vital. It is not sufficient to rely on the position disclosed in the company’s accounts – a full examination of the scheme’s financial and legal risk position is needed.

Thorough due diligence to uncover the target’s pension history is vital

The earlier that pensions issues are confronted the more successful a buyer is likely to be in mitigating any risk (see Strategy). It may be possible to negotiate a price adjustment if a scheme is underfunded, and to secure indemnities or other protections to compensate for material legal and regulatory risk identified as part of due diligence – but the buyer’s ability to do this depends on a clear grasp of the potential pensions risk at the outset. The question of regulatory clearance should also be considered.

Money purchase schemes present less risk, but due diligence should focus on whether the company has duly complied with all its contractual obligations to employees and, increasingly, the extent of due process around provider selection, default investment choices and monitoring, cost and governance arrangements. Compliance with auto-enrolment must also be checked.

Preparation is key since trustees may try and negotiate ‘mitigation’ for any perceived loss of security

Pension obligations also differ depending on whether the transaction is structured as a share or asset purchase.

Consultation and disclosure issues arise in corporate transactions. It is usually desirable to engage under cover of a confidentiality agreement with the trustees of any scheme sponsored by the target employer. It is an opportunity to establish a good working relationship, but preparation is key since trustees may try and negotiate ‘mitigation’ for any perceived loss of security (see Relationship Management).

Liabilities may not be contained
Acquiring a company that sponsors its own pension scheme is, broadly, a question of due diligence. It may not be easy (particularly where a final salary scheme is concerned) to determine the full extent of the risks being assumed, but the principle is at least clear. The buyer takes on the company with all of its obligations. Making an assessment of pensions risk and weighing it against the commercial opportunities presented by the acquisition is, in many respects, similar to balancing other commercial risks, such as those caused by contaminated land, poorly negotiated contracts or costly and uncertain litigation.

Financial liability can ‘bleed’ from the target to the buyer and other group companies or bodies that are ‘connected or associated’

There is, however, an additional factor that arises where a target participates in a final salary scheme. Financial liability can ‘bleed’ from the target to the buyer and other group companies or bodies that are ‘connected or associated’. The reason? A tough regulatory framework introduced in 2004 that is designed to prevent companies with defined benefit liabilities walking away from them and dumping them on the Pension Protection Fund – the statutory safety net. Ongoing risk can be contained if a scheme is adequately funded, but if trading or other difficulties arise the target company cannot be put into insolvency without a risk of regulatory action against better-resourced group companies. These so-called ‘moral hazard’ provisions are complicated, and professional advice is needed to assess the risk of a contribution notice or financial support direction (see Strategy).

It will be necessary for a buyer to devote attention to the funding and management of the scheme if it wants to avoid difficulties should it wish to sell the company on in due course (see Governance Audit) .

Legal complexity
Acquiring a company that is one of a number of employers participating in a multi-employer final salary scheme presents its own very complex legal issues. Withdrawing from the scheme could trigger the payment of an amount needed to buy all the target’s pension liabilities with an insurer. It is lawfully possible to avoid such an outcome, but extreme care needs to be taken to ensure that such arrangements are effective, and advice sought on the extent to which they need to be cleared by the Pensions Regulator (see Strategy).

Business transfers
Acquiring a company’s business assets rather than its issued share capital raises different issues. Broadly, employees’ employment contracts are transferred to the purchaser on the same terms and conditions. There is an exception for pension rights – but not all pension rights. Various legal cases have explored the extent of the pensions exclusion, and legal advice will be needed to confirm what pensions rights will transfer. These issues are likely to arise in particular where a scheme has a public sector element, since rights on early retirement and redundancy (a feature of many such schemes) will have to be carried over.

Once the commercial deal is clear then the pensions issues are similar to those in other corporate transactions

Joint ventures
The principal pension decision in any joint venture is whether employees are to remain in the parents’ existing pension schemes or whether the JV should establish its own arrangements. Depending on the circumstances – and in particular what is envisaged after the initial period usually contemplated in the JV agreement – it may make sense for the JV to take over one of the parties’ existing schemes. Once the commercial deal is clear then the pensions issues are similar to those in other corporate transactions (see Strategy).

Internal reorganisations
Any internal reorganisation should be structured in order to avoid the unintentional and unnecessary triggering of a buy-out debt. As ever, legal advice at an early stage is essential.

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