PRINT THIS PAGE Dealing with pension fund trustees20/06/2007. Source: SJ Berwin. Simon Witney 
In May, says SJ Berwin, the UK's Pensions Regulator clarified its guidance on clearance applications. Probably because that clarification came in the same week as the trustees of the Boots' pension scheme flexed their muscles in anticipation of a buy-out, it attracted significant press attention - and was seen by most as a further impediment to buy-out deals. But that may be a misleading interpretation of the announcement. It may be true that the "clarification" encourages trustees to be even more robust in the face of future leveraged deals, but the impact of that will be limited - trustees have not been timid recently. And this is not a signal to any fundamental change in the Regulator's approach, and could even be helpful to those who want the comfort of a clearance before doing a deal.
Since 2005, pension rules in the UK have made it possible for certain actions by companies (and those connected with them) to be attacked (after the event) on the grounds that they prejudiced the ability of a defined benefit pension scheme to meet its obligations. The Pensions Regulator has sweeping powers to force those concerned to make good the resulting loss. There is, however, a clearance procedure that allows anyone who could be attacked under these rules to seek confirmation that a proposed course of action will not put it at risk.
In guidance that was originally issued in April 2005, the Regulator stressed that he expects clearance applications to be made only in relation to events which are "financially detrimental" to the ability of the pension creditor (that is, the relevant defined benefit pension scheme) to meet its pension liabilities, and that, for a particular event to be financially detrimental, the relevant pension scheme had to be in "deficit".
That guidance also stated that the appropriate test for determining whether or not a scheme is in deficit is by reference to Financial Reporting Standard 17 (or IAS 19) - unless the trustees have fixed a more onerous funding standard (in which case that measure should be used) or when there is no relevant FRS17/IAS19 valuation available (in which case the full "buy-out" deficit measure should be used). In practice, however, this has been widely interpreted as meaning that if a scheme is fully funded on the FRS17/IAS19 basis, there need be less concern about any weakening of financial strength of the employer arising as a result of a commercial transaction.
In last week's clarificatory guidance (issued in anticipation of new general guidance on clearance applications, expected later this year), the Regulator stresses that where there is a significant weakening of the employer covenant as a result of a transaction (and/or assets to which the scheme currently has recourse are being removed from the employer's group), it is appropriate to consider making a clearance application regardless of the funding level of the scheme.
Moreover, in such circumstances, the Regulator says that trustees should consider whether to seek additional funding so as to materially enhance the scheme's funding level in excess of FRS17/IAS19.
This statement has not been made primarily in relation to buyouts, although it will be relevant to all deals involving high levels of leverage. The reference to trustees seeking additional funding has already been widely noted in the media and within the private equity industry generally, and that is certainly likely to further embolden trustees in negotiations. But the fact that the Regulator has made it clear that he is willing to consider clearance applications even in cases where a scheme's funding level exceeds 100% on the FRS17/IAS19 basis - which was not previously thought to be the case - may actually offer additional comfort to those contemplating a deal who want to ensure that there is no future risk.
Simon Witney
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on its services to the private equity industry please contact Jonathan Blake or Simon Witney in its London office +44 (0)20 7533 2222 or visit our website at www.sjberwin.com
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