The concept of employer debt is one of the most critical and fundamental elements of the UK’s defined benefit (DB) pension regime. Put simply, it is intended to ensure that no employer is able to walk away from a pension scheme without paying its fair share of the liabilities as they stand at that time or, alternatively, providing adequate support or mitigation in place of payment.
The employer debt regime is established and implemented through section 75 of the Pensions Act 1995, together with corresponding regulations. As a result, an employer’s share of the liabilities will often be described as its “section 75 debt”. While the Pensions Regulator may intervene in some cases, the enforcement and recovery of section 75 debts is first and foremost the responsibility of the pension scheme trustee.
It is therefore vital that trustees and employers are aware of their options and responsibilities in relation to section 75 debt.
Triggering the debt
An employer debt will be triggered under section 75 where an employer participating in a DB pension scheme becomes insolvent or enters voluntary wind-up, or where the scheme itself is being wound-up and the value of the scheme’s assets is less than the scheme’s liabilities (when measured on an insurance ‘buy-out’ basis).
In practice, however, the question of employer debt arises most frequently in relation to multi-employer schemes. Where a multi-employer scheme remains open to benefit accrual, an employer debt will become payable to the pension scheme if an employer with defined benefit liabilities ceases to employ any active members of the scheme while other employers continue to do so.
Where a multi-employer scheme has been closed to benefit accrual, an employer debt will not be triggered automatically but an employer may still wish to use the employer debt regime in order to discharge its historic liabilities under the scheme, particularly in the context of a corporate re-structure or sale.
While employer debts will often be triggered through corporate activity, they may also be triggered inadvertently where the workforce of a particular employing entity has gradually declined over the years. In either case, extreme care should always be taken by employers to assess whether any particular action or omission will trigger a section 75 debt, and what pre-emptive steps may be taken.
Resolving the debt
The starting point for trustees is that a section 75 debt should be paid in full by the relevant employer. The regulations do, however, set out various alternatives to full payment, which can be used in prescribed circumstances. Any alternative to seeking full recovery should only be considered where the relevant statutory requirements are met and the trustees are satisfied that this alternative approach is in the best interests of the scheme’s members.
One of the most frequently used alternatives is the Flexible Apportionment Arrangement (FAA), which operates by apportioning the liabilities of the departing employer to one or more remaining employers. In order to proceed with this option, the trustees must first be satisfied that the remaining employers will be able to continue funding the scheme in the same manner. This will largely depend on the relative size of the departing employer’s liabilities versus the financial strength of the remaining employers.
Even where that test is met, the trustees may only agree to such an alternative if they believe this to be in the best interests of the scheme’s members. That is a reflection of the trustees’ fiduciary duty to members under trust law. As part of negotiations, therefore, it is not uncommon for an employer to offer the scheme some additional protections, such as a parent company guarantee, security over company assets or other contingent protections.
While an FAA is now the most popular means of addressing section 75 debt, the law in this area has been gradually adjusted over the years and a number of alternative arrangements may have been agreed in the past. For example, the trustees may have entered a withdrawal arrangement or a scheme apportionment arrangement as part of a previous corporate re-structure and the precise terms of those arrangements will remain relevant in determining the scheme’s current liability share.
Key tips for managing section 75 debt
While each negotiation will have its own unique concerns and considerations, we have some key tips that you may find helpful:
1. Keep section 75 debt on your radar
Employers will often overlook the pension implications that can arise from wider corporate projects or re-organisation. As highlighted above, an employer debt can be triggered by a relatively innocuous act, such as an intra-group transfer of employees or a voluntary redundancy exercise. If the debt is unexpected, however, this has the potential to undermine a particular project and may expose the employer to considerable additional costs. Employers should ensure that key decision makers, project managers and HR personnel are aware of the potential for employer debt issues and are able to escalate any concerns effectively.
2. Stay aware of your legal duties and manage conflicts accordingly
As set out above, trustees will need to be satisfied that any action they take is in the best interests of the scheme’s members. While it may be reasonable for trustees to take account of an employer’s future funding or investment plans, any decision taken as to the section 75 debt will need to be based on a robust assessment of the relative benefit this will bring to the scheme’s members. Employers should approach the discussions with this in mind.
3. Understand the default legal position but keep an open mind
In entering any negotiation, employers and trustees should recognise that full payment of the section 75 debt is the default position if agreement on an alternative approach cannot be reached. While this places scheme trustees in a very strong position, they should not discount the possibility that an even better position may be achieved through negotiations with the employer and it is reasonably common for FAAs or other ‘non-payment’ options to be agreed.
4. Take advice
Legal, covenant and actuarial advice will be key throughout any negotiation and trustees and employers should be comfortable that they are receiving the advice that they need. Trustees and employers should ensure that they understand the advice and should not be shy in raising any concerns with advisers if they believe there to be a gap, inconsistency or discrepancy within the advice.
5. Be prepared to explain any actions or decisions taken
In some instances, the Pensions Regulator may raise questions post-event as to the rationale for entering an FAA or other alternative approach. Trustees and employers should each bear this in mind when conducting negotiations and liaising with their advisers.
How Shepherd and Wedderburn can help
Our pensions team has extensive experience advising trustees and employers on section 75 debt strategy, triggers and negotiations. For help with any section 75 debt issues, please contact Louisa Knox or your usual Shepherd and Wedderburn contact.