Piercing the Corporate Veil

The Pensions Regulator (TPR) has attempted to flex its muscles by raising public concerns about the hostile bid for British engineering firm GKN by US company Melrose. Though whether it will actually do more and throw a regulatory punch is yet to be seen.

TPR said it is “concerned that the increased leverage involved in the proposed takeover by Melrose is likely to have a detrimental impact on covenant”, affecting GKN’s ability to meet its pensions obligations to defined benefit scheme members. With GKN still trying to fend off the advances of Melrose, negotiations are set to run and run and TPR will no doubt play a significant role in the completion or otherwise of the deal – even though it currently has no power to veto it.

But what can TPR do here? Given GKN’s situation and that of others recently hitting the headlines, businesses need to be on the front foot in terms of understanding what might give rise to such a regulatory intervention.

In certain circumstances, typically involving schemes in significant deficit (GKN’s scheme is facing a deficit of upwards of £1bn on a self-sufficiency basis and £1.9bn on a solvency basis), TPR has powers to pierce the ‘corporate veil’, and force liability on shareholders on a non-fault basis.

TPR was set up under the Pensions Act 2004 to essentially act as a ‘referee’, as opposed to a ‘player’ in relation to the UK’s workplace pension scheme. It enforces compliance with statutory ‘moral hazard’ requirements that can operate to impose joint and several group-wide liability for pension scheme underfunding – without any question of fault or bad faith arising. However it threatens to use these moral hazard powers far more often than its uses them (not least as the cost of regulatory action could run into £millions).

In general, there is no legal obligation on an employer’s wider group, whether in the UK or otherwise, to make good the deficit in that employer’s UK defined benefits pension scheme. It is only when they enter into a direct obligation to support the scheme – e.g. through a parent company guarantee, or other contractual promise – that they are liable to do so. But crucially, TPR can impose statutory liability where none otherwise exists, including on companies and, in some cases, individuals who fall within the statutory tests for being connected or associated with the scheme employer.

The regulator has a wide discretion in deciding use of its powers. But intervention is far more likely to take place behind closed doors rather in public over a period of months if the regulator realises this is necessary to fulfil its statutory duty to protect members’ benefits. Although

through the intervention of the Work and Pensions Select Committee, private commercial discussions are being dragged into the public domain.

What kind of corporate activity piques TPR’s interest? Primarily, it is any activity that means the sponsoring employer is less able to meet the payments needed for the underfunding in the scheme – i.e. an act or failure to act that has “detrimentally affected in a material way the likelihood of the accrued scheme benefits being received”. Clearance Guidance provided by TPR outlines a list of corporate events, known as ‘employer-related Type A events’, which could have the effect of weakening the financial support provided by the scheme’s sponsoring employer.

If a Type A event is being considered, it is important to examine any impact it could have on a defined benefits pension scheme, and companies should establish how to mitigate any detriment caused. If it comes to it, an audit trail of this process could provide a statutory defence against the use of some of the regulator’s powers. A test of the theoretical recoveries to the scheme on employer insolvency before and after the Type A event can be a way to determine whether that commercial action (which could simply be paying dividends) means that scheme benefits are less likely to be received.

If this detriment is not fixed voluntarily, TPR may step in to strongly suggest or require it to be fixed, if it is reasonable to do so.

So why would a business choose to voluntarily pay up and write a cheque to the pension scheme in this situation? After all, there is no legal liability here. Investigations are confidential at the time, but can be made public if TPR considers this appropriate, and reputational damage will naturally result.

Moreover, TPR has statutory powers to compel the production of information to help it carry out its work, using fines and criminal convictions. And a pending White Paper on pensions, expected to be heavily influence by recent corporate failures, may push to give TPR increased powers to intervene in commercial activity.

It follows that it is better to anticipate issues of any Type A event and act accordingly, all the while engaging proactively with scheme trustees.