Case Studies

Case study 1 - Conflicts of interest

As is typical with smaller companies that have defined benefit schemes, the trustee board had two company-nominated trustees who were directors of, and in one case, a major shareholder, of the Principal Employer. Keen to do the right thing, they had appointed an independent trustee alongside the two member-nominated trustees. This gave a good balance to the board, and the company could not be accused of stacking the odds in their favour by having a majority of 'company men' on the board.

When we were first appointed, we conducted an audit of the governance procedures, and suggested that a formal conflicts of interest protocol be adopted by the trustees. This document described the nature of the situations that could cause actual or potential conflicts of interest, and how this would be handled.

The scheme actually had a number of participating employers, and the Principal Employer notified the trustees that one of the companies was to be disposed of. This type of corporate restructuring is very common, but needs very careful scrutiny by the pension scheme trustees to ensure that the employer covenant - that is, the willingness and ability to fund the scheme - is not adversely affected, and the security of the members' benefits undermined.

Any liabilities within the scheme that relate to employees of the company to be disposed of also need to be dealt with properly - see Case Study number 2 - 'Securing member benefits in a corporate restructure' for another example of how we were able to help the trustees deal with this challenging situation.

The purpose of this case study, however, is to examine how we were able to help resolve the conflicts of interest that arose due to the fact that the two employer-nominated trustees were directors/shareholders of the company to be sold.

The conflicts of interest protocol was the first port of call. This stipulated that any trustee who faced this situation should abstain from the decision making process. That was easily agreed - the remaining trustees would make the decision on behalf of the board of trustees.

Matters were a little more complicated than this, however. In the interests of clarity, I haven't mentioned that the trustee board was actually a company in its own right, and the individuals carrying out the trustee duties were directors of this company. This is useful way of giving protection to the individual trustees, as any financial liability is generally considered to be limited to the assets of the trustee company rather than to the individual directors.

An added twist in this situation was that there was a vacancy for one of the member-nominated trustee positions, due to the departure of one of the trustee directors. This meant that only two trustee directors were not in a position of conflict in relation to the proposed corporate restructuring.

It was important to ensure that any decision taken by, or on behalf of, the trustee was taken properly, in accordance with the Trust Deed and Rules that govern the activities of the scheme.

The Trust Deed stipulated that decisions could be made by 'a majority of the trustee directors'. This posed a problem, as two of the four remaining trustee directors were conflicted. The situation was resolved following an examination of the Memorandum and Article of Association of the trustee company. The directors were able to delegate decision making powers to a sub-committee which could act on behalf of the trustee company. The sub-committee was duly created, with the non-conflicted member-nominated trustee and the independent trustee as its members, and the decision making process was deemed to be acceptable to all parties.

The important points in this case study are as follows:

  • Able Governance is able to help trustees to have the correct tools and protocols in place ready for events such as these
  • The knowledge and skills that are often lost to the decision making process when the company-nominated trustees are required to absent themselves from the process can be replaced by a suitably experienced and knowledgeable independent trustee, such as Able Governance
  • Able Governance was able to suggest a suitable course of action, based on our long experience, and this saved the potential expense of commissioning an investigation into the dilemma by the professional advisor

Case study No 2 - Corporate Restructuring

The Principal Employer for this scheme was purchased by a large mega-corporation. This was good news for the trustees, as this provided the potential for a strengthening of the employer covenant via parent company guarantees etc.

Time passed, and then the trustees were informed that the parent company intended to sell the Principal Employer, but the purchasing company did not wish to take on the liabilities of the pension scheme.

The first question that we asked as trustee was whether or not the parent company would provide funds to allow the benefits to be secured in full and the scheme wound up. The answer to this was a resounding no, but what they did propose is that another company within the group be substituted as Principal Employer.

As independent trustee, all eyes turned to us and these are the issues that we had to consider:

  1. Would the strength of the employer covenant be weakened as a result of the change of Principal Employer?
  2. How could we prevent wind-up being inadvertently triggered, with the consequent debt on the employer claim?
  3. Would the new Principal Employer be on the hook as 'statutory employer' in the event of an insolvency event?
  4. What legal hoops must we go through to ensure that the security of the members were not adversely affected by the change, and so that the trustees do not expose themselves to censure by the Regulator and potential claims from members?

We tackled the employer covenant question by commissioning a review of the financial strength of the existing employer and of the proposed new employer. This step is considered mandatory by the Pensions Regulator, and is an unavoidable expense of the exercise.

This review revealed two conflicting factors: on the one hand the new employer was far larger than the incumbent, with much better cash flows. On the other hand, the recovery in an insolvency situation suggested that the present employer would secure more of the scheme benefits than the proposed employer. This information was used to negotiate additional funding for the scheme as part of the settlement.

The second point, about the statutory employer position, was particularly important as it would determine whether or not the scheme remained eligible for entry into the Pension Protection Fund (PPF) if an insolvency event occurred. The resolution to this issue was to take the following steps:

  1. make the company a Participating Employer of the scheme via a deed of participation
  2. pass a rule amendment to re-open the scheme to new entrants
  3. admit an employee of the new employer as a member for minimal benefits
  4. enter into a Flexible Apportionment Arrangement with the new Participating Employer in order to make it responsible for all of the liabilities in the scheme, including those of the existing employer.

This process required the trustees to obtain professional covenant advice, actuarial sign off in respect of the 'Funding Test,' and robust legal advice to ensure that all necessary steps had been completed correctly.

As a result of this rigorous process the trustees were able to allow the existing Principal Employer to be divested of its responsibilities to the scheme, safe in the knowledge that the remaining Employer was capable of, and legally responsible for, the funding of the liabilities of the scheme.

The final step was to contact the Pensions Regulator, as this transaction is considered to be a Notifiable Event

The important learning points in this case study are as follows:

  • A seemingly innocuous corporate restructuring can have significant consequences where there is a defined benefit scheme involved
  • Disposal of a company that has pension scheme responsibilities can trigger a debt on the employer if not handled correctly
  • Correct professional advice is essential to ensure that the trustees do not inadvertently undermine the security of the benefits. This is no time for penny pinching!
  • Great care must be taken to avoid a situation in which the scheme is rendered ineligible for entry into the PPF
  • An Independent Trustee, such as Able Governance, is indispensable in this situation due to:
    • familiarity with the process
    • lack of conflicts of interest
    • reduced learning curve
    • benchmarking of professional costs

Contact Able Governance for a no-commitment discussion if you find that you are facing a similar situation.