Reports of a possible financial restructuring of Arcadia Group are yet another example of the maelstrom that is continuing to engulf UK high streets.
Alongside the closure of stores, the reports suggest that the Group is:
- seeking to halve its annual pension contribution in respect of pension scheme deficits
- considering a change in the way in which pension increases are calculated
- considering a company voluntary arrangement (CVA).
In this article we look at some of the issues that need to be considered by pension scheme sponsors when such actions are being proposed.
Where a defined benefit pension scheme is in deficit, the scheme's trustees and employer must agree a recovery plan which sets out the amount of deficit reduction contributions (DRCs) that will be paid by the employer and the period over which they will be paid. The Pensions Regulator (tPR) expects trustees to agree funding to eliminate the deficit over an appropriate period and also to try to make sure that the scheme is treated fairly among competing demands on the employer.
For some time tPR has been under pressure to toughen the approach it takes regarding underfunded schemes and the Government has recently published its intentions on strengthening tPR's powers. In its recent annual funding statement, tPR sets out its broader expectations for the funding of defined benefit schemes including that it would expect to see a strong funding target and short recovery plan where dividends and other shareholder distributions exceed DRCs; conversely if the employer is recognised as weak and unable to support the pension scheme, it would expect the payment of shareholder distributions to have ceased. In the next few months, tPR intends to contact pension schemes where it has concerns around equitable treatment or long recovery plans.
TPR has powers that it can use when it believes that various funding requirements, including the legal requirements relating to a recovery plan, have not been met. One of these powers is to direct how, and over what period, a pension scheme deficit should be funded. Whilst it will try to achieve an appropriate outcome by first engaging with the scheme's trustees and employer, tPR has started formal enquiries with the option of using these powers and currently has several ongoing investigations.
TPR can intervene in other ways if a pension scheme is not being treated appropriately. These can vary from one-to-one supervision through to the issuing an improvement notice, issuing penalties or an anti-avoidance investigation, depending on the risk posed by the pension scheme.
Employers experiencing difficulties meeting their contribution commitments are encouraged to work collaboratively with the pension scheme trustees to consider the options available and to involve tPR at an early stage.
Switching to CPI for pension increases
For many pension schemes struggling to deal with large deficits, changing the inflationary measure used for increasing pensions in payment has been mooted as a potential means of reducing scheme liabilities.
Before 1 January 2011, the legal requirements for increasing pensions in payment (and revaluing benefits of deferred members) were based on changes in the Retail Prices Index (RPI) subject to a cap. Since then, it has been possible to use the Consumer Prices Index (CPI) instead of RPI. As CPI is generally lower than RPI, a pension scheme's liabilities can be significantly reduced by switching.
The wording of a pension scheme's rules will determine whether the switch to CPI takes effect automatically following the change in the legal requirements. This has resulted in something of a lottery depending on the wording of the scheme's rules:
- rules that track the legal requirements move automatically to CPI
- rules that refer specifically to RPI may only be able to be amended to switch to CPI for increases to pension earned in respect of future service, and
- rules that refer to RPI but with a discretion to use an alternative inflationary measure may be able to switch but, in practice, many such cases have ended up in court seeking clarification of whether a switch is permissible.
If there is a discretion to move to CPI, employers and trustees will need to decide whether the discretion should be operated in practice. This will involve considering all relevant factors, for example, analysing any historic provisions and any variations across different benefit categories, and considering member communications on pension increases more generally. Switching from RPI to CPI will require consultation with affected active and prospective members of the pension scheme.
Winning approval for a CVA
Last summer, in the wake of CVA proposals from Mothercare and Carluccio's which involved site closures and rent reductions, we looked at how successful CVAs had been and whether they would continue to win approval. In the intervening months, more retailers have been subject to CVAs including:
- Homebase and Paperchase
- Debenhams, whose administration was shortly followed by a CVA
- House of Fraser and Office Outlet whose CVAs were followed by administrations, and
- Select, which entered a CVA in 2018, went into administration in May 2019, and is now intending to launch a further CVA post-administration,
and there is speculation that Arcadia Group (amongst others) will join the list.
We mentioned in our earlier article that the Pension Protection Fund (PPF) has the ability to vote a CVA down where it holds sufficient of the unsecured debt. The PPF is concerned that CVAs can be exploited for financial advantage or for abandoning pension responsibilities. The PPF's approach will depend on what the CVA is trying to achieve:
- The pension scheme is compromised and is likely to enter the PPF. The PPF will apply the restructuring principles set out in its guidance, Guidance to the PPF Approach to Employer Restructuring, including that the pension scheme will receive money (or in rare circumstances assets) which are of a significantly higher value than it would have otherwise received through the insolvency of the employer. For the PPF to vote in favour of a proposal, all employers and their advisers proposing a CVA are expected to comply with these principles. The PPF will discuss all CVA requests with tPR, which will assess them against its own published principles. PPF agreement to a CVA does not imply clearance from tPR. Where tPR has not provided clearance, the option for it to use its anti-avoidance powers remains on the table.
- The pension scheme is to be rescued and remains whole. Although it may appear that the pension scheme is unaffected, the PPF's view is that this is not necessarily the case - the employer covenant is likely to be weaker, addressing a single issue (usually related to property) is not likely to provide an overall solution for the employer and, post-CVA, the pension scheme may not be treated equitably with other creditors, such as banks. To vote in favour of a proposal, the PPF expects all employers and their advisers proposing a CVA to show how they have addressed a list of specific issues. It will work closely with tPR to minimise the risk to scheme members and to the PPF itself.
The PPF has recently published a new guide for scheme trustees, Contingency planning for employer insolvency, which sets out "simple but effective steps" that the PPF recommends schemes put in place to mitigate some of the risks resulting from "employer distress". The PPF suggests that trustees should make sure that they have access to relevant experience in managing a pension scheme where the scheme employer may become insolvent. The guidance specifically mentions experience in CVAs and regulated apportionment arrangements (these are arrangements which allow an employer who stops participating in a pension scheme to apportion its share of the employer debt that would otherwise be due to the scheme to the remaining participating employer(s)).
Each of the proposals considered in this article raises myriad issues and difficulties. Added to these is significant regulatory scrutiny by both tPR and the PPF. Combined, the proposals comprise a major challenge to attempts at financial restructuring. If you would like to discuss any of the issues raised or require assistance with other pensions matters, please contact a member of our Pensions team. We work closely with our restructuring and insolvency team and our retail sector group to give a seamless service.