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Restructurings and rescues involving United Kingdom businesses have been radically affected by new legislation on United Kingdom pension plans. Any restructuring involving an entity with a defined benefit pension plan in the United Kingdom now needs to be considered in the light of this legislation, which may result in the redesign of transactions and can also result in plan liabilities falling on those involved in the rescue. PENSION LIABILITIES Liabilities of United Kingdom pension plans have increased dramatically in recent years, as a result of increased life expectancy, and falling investment returns and bond yields. Although liabilities of pension plans can be measured in many ways, the cost of purchasing annuities provides an objective measure. This “buyout” method may yield a liability in excess of the net assets of the plan, and perhaps even those of the plan sponsor. The buyout calculation is based on the cost of providing immediate and deferred annuity policies for each beneficiary of the plan. Since June 2003, termination of a defined benefit plan creates a debt that is immediately due from the plan sponsor, measured by the buyout calculation. Previously, liabilities associated with a plan termination were far less onerous for businesses, although entirely inadequate for meeting the liabilities of the plan to provide pensions. Hence, a plan termination, which was often an appropriate move when a business was suffering financially due to the cost of its pension plan, is no longer likely to be an option for most businesses. The pension liability may also be a deciding factor in distressed or troubled situations, due to its adverse impact on cashflow. The increased costs of pension contributions directly affect business cashflow, and thus the question of whether the business is solvent and can continue. Furthermore, for company financial statements on or after Jan. 1, 2005, United Kingdom GAAP now requires that pension plan deficits be reported as a liability on the plan sponsor’s balance sheet. This deficit calculation, while smaller than the buyout calculation, may result in breaches of financial covenants in agreements with lenders, triggering events of default, and reducing or curtailing credit for the business. THE PENSION PROTECTION FUND New United Kingdom pension legislation has resulted in the creation of two bodies that will greatly impact restructuring — the Pension Protection Fund (“PPF”) and the Pensions Regulator (the “Regulator”). The PPF was established to provide pension benefits for beneficiaries of pension plans whose sponsors have become insolvent. While it is modeled closely on the US Pension Benefit Guaranty Corp. (“PBGC”), the United Kingdom government was mindful, when establishing the PPF, of the $23 billion deficit reported by the PBGC at the end of 2004. Like the PBGC, the PPF takes over the assets and liabilities of a pension plan upon the sponsor’s insolvency, providing pensions to plan members up to certain prescribed limits. In addition to the assets of the pension plans it assumes, the PPF will be funded by a levy on all United Kingdom pension plans. The board of the PPF will set the charge. In the first year, the PPF expects to raise approximately �200 million. A pension plan will qualify for consideration by the PPF if the plan sponsor becomes the subject of an insolvency proceeding after April 5, 2005. If this is not the first insolvency event, the PPF may consider the plan but is not obliged to do so. Any insolvency practitioner appointed in relation to the plan sponsor will be obliged to notify the PPF, the Regulator and the plan’s trustees of the insolvency event. The trustees of the plan are also obliged to notify the PPF if they become aware that the plan sponsor is unable to continue as a going concern. The PPF must then consider whether to assume responsibility for the plan. Once the PPF has been notified, the plan enters an assessment period. The assessment period provides the PPF time to consider whether it will assume full responsibility for the plan, while also preventing any dissipation of assets. For the duration of the assessment period, benefits paid by the plan are reduced to the limits on benefits that the PPF would pay. The assessment period is expected to last at least 12 months and the board of the PPF has indicated that it expects to complete assessments within two years. If assessment shows that the plan assets are less than the liabilities for the benefits protected by the PPF, the plan will be considered for entry into the PPF. The determining factor is whether a rescue of the plan is possible. Any appointed insolvency practitioner will be obliged to notify the PPF as soon as it is certain whether a rescue of the plan is possible. A plan rescue involves outside support, such as a party agreeing to support the plan sponsor as a going concern or agreeing to become the plan sponsor for some or all of the plan and to support it financially. In practice, this is very unlikely except perhaps in a management buy out where continuing the pension plan is part of the agreement. If the insolvency practitioner confirms that no rescue is possible, the PPF will be obliged to assume responsibility for the plan. Once the PPF has assumed responsibility for the plan assets and liabilities, the PPF acts in the place of the trustees as a creditor of the plan sponsor. The PPF will aggressively pursue the debt of the sponsor to the plan, which is based on higher liabilities than those that the PPF is bound to pay. However, as the plan is an unsecured creditor, the PPF is unlikely to receive a substantial amount from an insolvent business, although certain small amounts of pension liabilities still stand as preferential debts on an insolvency. PENSIONS REGULATOR The legislation created the Regulator to regulate United Kingdom pension plans. One of the Regulator’s roles is to ensure that plan sponsors and their group companies do not walk away from pension liabilities. This has resulted in a number of powers that may substantially affect restructuring or investing in distressed United Kingdom businesses. In particular, the Regulator has the power to compel associated and connected parties of the plan sponsor to provide funding for the pension liabilities. It can do so either when it believes that that party has acted with a main purpose of reducing or removing any liability from that sponsor to the pension plan or reducing the chances of recovering the liability (a “contribution notice”). Alternatively, if the Regulator believes that the plan sponsor is “insufficiently resourced” to meet the pension plan liabilities, it may issue a financial support direction requiring an associated or connected party to become jointly and severally liable or otherwise assist the funding of the pension plan, for example by contributing assets to the plan. Financial support directions and contribution notices may be issued against any associated or connected party of the plan sponsor. Associated and connected parties for these purposes include both United Kingdom and overseas entities who have a one-third control of the sponsor, for example, by shareholding or board control. A stated purpose of these powers of the Regulator has been to protect the PPF from having too many plans transferred to it as part of restructuring processes. Mindful of the enormous problems faced by the PBGC, these powers are intended to allow the Regulator to guard against the PPF being used in a restructuring to protect pensions by way of the PPF guarantee but, at the same time, to remove the pension liability from the plan sponsor and make it once more a viable business. The Regulator, however, has also stated that it sees its role as protecting jobs. Therefore, it has argued, so long as it can be shown that a given restructuring will protect a substantial number of jobs, the Regulator may be willing to refrain from issuing contribution notices and financial support directions on any associated or connected party. The Regulator’s stated position suggests that restructurings should not be at substantial risk from these pension provisions as most restructurings are likely to save a good number of jobs that would otherwise be lost as the result of impending insolvency. However, the Regulator’s view on this issue will evolve over time, particularly as its present position is likely to increase the number of plans entering the PPF, increasing pressure on PPF assets. Most restructurings where there is a pension liability will involve some attempt to ensure that the liability does not remain with the ongoing group and are likely to result in discussions with the Regulator. New investment or sales as a going concern may create issues for the Regulator. After substantial industry pressure, a clearance procedure was included in the new legislation to provide some certainty for contacting parties as to their pension liabilities on any transaction. CLEARANCE PROCEDURES The clearance procedure is operated by and is binding on the Regulator so long as it has received full information and circumstances do not change. The Regulator has encouraged plan sponsors and other interested parties to use its clearance procedure. An ambitious restructuring should, in most cases, be put before the Regulator in advance for discussion. The clearance procedure may add significantly to the time to complete a restructuring. The Regulator’s guidance on clearance procedures suggests a good deal of pre-planning before approaching the Regulator. In particular, the procedures contemplate working with the plan trustees to provide full information and consultation regarding the plan liabilities. The chances of successful clearance applications increase dramatically if it can be shown that the trustees, fully aware of the implications, have agreed to any arrangement. If clearance is to be sought, it is usually advisable to start by obtaining confidentiality undertakings from the plan trustees, and then discussing the new structure as fully as possible with them. Thereafter, and if possible with the trustees’ consent to the new structure, the plan sponsor and the other parties to the restructuring should approach the Regulator. The Regulator aims to give a response within two to three weeks of an application. It may be possible to expedite the clearance procedure. The trustees and sponsor of a plan have a separate obligation to provide the Regulator with notice of certain events as soon as they become aware of them. Such notification is intended to provide an early warning to the Regulator of any possible calls on the PPF. The triggering events include a range of matters relating to the financial strength of the sponsor, such as a change in credit rating or a breach of a banking covenant. They also include a number of matters relating to changes in group structure, such as a decision to sell the plan sponsor. The obligation arises and notification should occur as soon as the sponsor or trustees become aware that the triggering event has occurred. The Regulator, once notified, is likely to investigate the plan and its sponsor to establish whether that event or other surrounding circumstances may give rise to a financial support direction or contribution notice. In these circumstances, application for clearance on a restructuring becomes very attractive because the Regulator, already aware that there are some financial issues in the sponsor’s business, will be monitoring its activity closely. CONCLUSION The changes to the United Kingdom legislation on pensions have required a substantial re-assessment of the restructuring of troubled or distressed businesses which operate a defined benefit pension plan. In particular, these issues need to be considered early in a transaction to ensure that no party finds itself taking on pension liabilities that it was not agreeing to meet and that no party is subject to a requirement to make an immediate contribution to the plan. Early consideration must now be given to including the trustees of the plan in the restructuring process, as well as the Regulator, which will all increase the risks in reaching a satisfactory outcome. Corinne Ball is a partner at Jones Day. Partners John J. Papadakis, in the London office, and John R. Cornell, both in the firm’s employee benefits practice, assisted in the preparation of this article along with associate Ross S. Barr.

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