New policy and guidance on tougher TPR powers: some helpful clarifications but remaining uncertainty

Company directors, trustees and advisers may be feeling somewhat overwhelmed by the over 200 pages of documentation issued by The Pensions Regulator (‘TPR’) on 29th September and the level of detail to digest at this late stage in the day with the Regulator’s new powers becoming effective on 1 October.

And with the further consultations launched on the financial penalties and how the new powers will overlap, the industry is faced with yet more proposals to absorb and respond to.

For an overview of the new powers and an outline of the detail featured in the new materials published last week you may wish to read our News Alert. Having waded through the suite of documentation, I set out here an overview of some key points for company directors and trustees, as well as some areas where there is remaining uncertainty and where we will no doubt see, through experience, where the new regulatory boundaries lie over the coming months and years.

Criminal sanctions

The new powers introduce tough new criminal offences under which TPR can prosecute ‘any person’ (including company directors, trustees and advisers) and which are punishable by an unlimited fine or up to 7 years in prison – these could be triggered through corporate behaviour which weakens a DB scheme’s sponsoring employer. For more details on the new criminal sanctions, you may wish to re-visit our earlier blog which was published on the launch of TPR’s draft criminal sanctions policy for consultation back in March.

The final criminal sanctions policy published by TPR last week emphasises that TPR does not intend to prosecute behaviour that they consider to be ‘ordinary commercial activity’. Yet, working through some of the examples set out in the final policy highlights that there may be somewhat of an ‘expectation gap’ between what TPR considers to be ‘ordinary commercial activity’ (and where parties may have a ‘reasonable excuse’) and what happens in practice in the usual course of business.

However TPR has clearly responded to some of the practical challenges set out in responses to the consultation on the draft policy. For example, there is a recognition that the timescales of M&A/restructuring can mean that decisions need to be made quickly — and this will be factored into TPR’s decision on whether a party has a ‘reasonable excuse’.

There is also more detail set out on how TPR will determine whether an alternative course of action is viable. There is a recognition that when determining if there is a viable alternative, the DB scheme’s interests would not be expected to be prioritised above other statutory duties held by company directors. An example is given of a third party who, in determining whether or not to extend lending, owes no statutory duty to the scheme and is entitled to act in the best interest of its shareholders.

These and other new examples are helpful. However, there is a notable absence of any examples focussing on the role of the trustee, for example in the context of their contribution setting power in scheme funding negotiations and in M&A transactions. With the backdrop of the criminal offences, and an alternative £1m civil penalty, trustees may be somewhat nervous as M&A transactions are likely to be the circumstances in which trustees are making decisions having the most significant financial impact on their scheme. This highlights the importance for trustees of taking professional advice and clear documentation of their decision-making processes.

Code of Practice 12 (COP12)

The updated TPR COP12 (and related guidance) sets out how TPR will use its new and existing contribution notice powers and provides further examples of activities which may be in scope of the expanded contribution notice powers.

As a reminder, in certain prescribed circumstances, under current law TPR can impose a contribution notice on a company or director, that requires them to pay a large one-off contribution into a pension scheme. Currently there are two tests or triggers for a contribution notice and the PSA21 introduces two additional new tests that, if satisfied, will enable TPR to consider imposing a contribution notice in a broader range of circumstances.

Both COP12 and the guidance have been adjusted in response to some of the feedback received during the consultation on the draft COP 12 – in particular some of the examples in the guidance have been replaced and many have been adjusted. The Code itself sets out four circumstances which are potentially in scope of TPR’s contribution notice powers as follows:

• where sponsor or guarantor support is removed, substantially reduced or becomes nominal;
• increase in debt/prior-ranking security which weakens the scheme’s creditor position;
• ‘some instances’ of paying a dividend; and
• unscheduled repayments to other creditors of the employer over the scheme.

The circumstances above are extremely generic and capture a very wide range of situations which occur in the course of ‘normal business activity’ for groups, such as intragroup cash sweeping arrangements, intragroup dividends and early repayment of intragroup debt. It is interesting that, in the guidance, we now also see a new example in relation to guarantors that TPR consider may fall within the scope of its contribution notice power. The industry had been calling for clarity on this.

This emphasises the need for employers and trustees to be monitoring the activities of all companies within the scheme’s covenant net (and indeed to be aware in the first place of which companies this includes!), as well as the wider group. Increasingly, we are seeing this need for monitoring reflected in upfront agreements between trustees and companies on the kind of information which will be shared on a routine basis. This ensures that all parties reduce their regulatory risk and helps ensure that something that has an impact on the pension scheme’s covenant doesn’t get accidentally missed.

Clearance Guidance

The Clearance guidance was last reviewed in 2010 and so was in need of an update in any event, as well as to reflect TPR’s new Contribution Notice powers. As a reminder, Clearance is a voluntary procedure whereby an application may be made to TPR that a particular transaction will not (based on the information provided) result in the use of TPR’s Contribution Notice or Financial Support Direction powers. It is worth noting that a successful Clearance application can also help mitigate the risk of TPR launching a criminal prosecution.

The guidance makes several repeated references to professional independent advice – and goes so far as to say that where trustees do not seek such advice they should document reasons for their decision and their view on the event. While we would have expected trustees to be seeking covenant advice in such circumstances, this gives a strong steer to those who have not engaged covenant advisers in the past.

It’s interesting to see references in the Guidance to the impact of corporate events on the wider group potentially being ‘Type A’ events– including where there is potentially no contractual obligation for the wider group to provide support to the scheme. This includes listed examples of a reduction in the net assets of the wider group (so potentially capturing a parent paying a dividend?); the granting of prior security over assets of wider group and a change in group structure. This is beyond the definitions of the Contribution Notice tests which focus on the scheme’s sponsor. Whilst many trustees appreciate the importance of tracking the activity of the wider group, this is not always the focus, and, this seems to be the first time this has been explicitly referenced by TPR.

Remaining uncertainty there are a few areas where remaining uncertainty–may cause trustees and company directors some angst in the initial period of the new powers being effective, for example:

• How TPR will determine what parties ‘ought to have known’? In the context of the new ‘conduct risking accrued benefits’ offence, this is key. In the final criminal sanctions policy TPR clarifies that they will look at the ‘circumstances as they were at the time of the act’ – but there are no further details on what this means in practice. It will be important for key decision makers (including company directors and trustees) to be asking the right questions to uncover what they “ought to know” in the context of corporate activity. This may be facilitated by developing checklists that are regularly considered by the corporate finance team, and having an information sharing agreement with the trustees, supported by regular (eg quarterly) updates from the company to the trustees – which may involve pension covenant advisers to support both the company and the trustees to identify what matters in the context of the particular group of companies.
• What is considered ‘material’ in the context of the new Contribution Notice tests? TPR has chosen not to respond to requests for guidance on when the materiality thresholds of the two new Contribution Notice tests might be met – with references that these are specific to the circumstances. While it is perhaps understandable that TPR wants to remain intentionally vague and retain their discretion, this leaves considerable uncertainty for the rest of us.
• Can Clearance be sought for events which trigger the new Contribution Notice tests but aren’t ‘materially detrimental’ events?

The updated Clearance guidance appears to make a distinction between a Type A event (where Clearance can be sought) versus an event which may trigger the new Contribution Notice tests. And so it appears that Clearance will not be an option available to directors where a test might be triggered but where the event may not be materially detrimental. There are many examples of this, for example the payment of a material dividend that is covered by cash, by a business that provides its pension scheme with a strong covenant but has a low value balance sheet simply by the nature of its operations (eg a services based company such as an accountancy firm). So it appears that employers will need to take considerably more regulatory risk going forwards in some situations – and trustees may seek to leverage such situations to gain extra mitigation for the scheme.

In conclusion

These new powers have been a long time coming and many sponsors and trustees will have felt overwhelmed with the raft of consultations and requirements that have been published since the Pension Schemes Act became law earlier this year.

With the new powers raising the bar when it comes to TPR’s oversight of corporate activity, sponsors and schemes need to tread carefully and cautiously to avoid falling foul of the rules. Where corporate activity and ‘acts’ could impact the covenant to a pension scheme, companies and trustees will need to understand where the new regulatory boundaries lie and have robust governance processes in place and clear records of decision-making which TPR could request sight of as part of a future investigation.

For some practical next steps to manage the new regulatory risks, click here to read the blog.