Impact on defined benefit pension schemes: contributions holidays

There has been much discussion in the pensions press of the recent guidance from the Pensions Regulator (tPR) regarding suspending or reducing deficit recovery contributions (recovery plan payments) in the midst of this difficult trading time for many.

The Pensions Regulator (tPR)’s guidance regarding suspending or reducing deficit recovery contributions (recovery plan payments) has caused much discussion. Here we discuss the practical and legal issues.

Trustees may be facing requests from scheme sponsors to vary or suspend contributions being paid into the scheme. We, therefore, thought it would be useful to focus on the more practical and legal aspects to this issue and, in particular, how any commercial agreements reached between trustees and employers should be put in place.

By way of background, all schemes have in place a schedule of contributions even if they are fully funded on a technical provisions basis. Those that are not fully funded on the technical provisions basis are also required to have a recovery plan which sets out the date by which it is intended that any shortfall be eliminated.

What options are available to trustees and employers once a commercial decision has been reached?

We think there are broadly three options:

• simply breach the schedule of contributions/recovery plan and report to tPR if necessary (see further below);
• put in place a new schedule of contributions and recovery plan in accordance with legislative provisions including obtaining the necessary certification from the scheme actuary; or
• document the agreed amendment by way of a short form letter or deed, obtaining the advice of the scheme actuary to that arrangement if it amounts to a revision of the schedule of contributions and recovery plan (likely).

What are the disadvantages of simply not paying deficit recovery contributions when they are due?

Trustees and employers would need to check the scheme trust deed and rules for any specific requirements governing employer contributions. Trustees should also check the schedule of contributions and recovery plan as to their exact wording and in particular any detail around payment dates.

Trustees should consider whether the scheme’s governing documents give them any powers to trigger wind up of the scheme where an employer fails to pay contributions due. Triggering a scheme wind-up could lead to a section 75 (employer) debt becoming due and would almost certainly lead to a debt being due from the employer for failure to make the required contribution. It is likely that both trustees and employees will want to avoid this outcome in the present time, particularly given the volatility in the value of scheme assets, and what that would mean in terms of the scheme being funded above or below PPF level of benefits.

In addition, many employers might find themselves in a scenario where they are in breach of banking covenants for failure to make agreed contributions to the scheme. Many bank documents contain specific provisions dealing with this, and if they do not, the breach might be caught by a general clause in their banking documents, or other financial agreements.

What about the need to report to tPR?

Helpfully, trustees are not required to report all failures to pay contributions. Trustees are only required to report in circumstances where they have reasonable cause to believe that the failure is likely to be of material significance to tPR.

Regulator guidance also makes it clear that trustees do not need to report when they have entered into a payment arrangement with the employer for recovery of any outstanding contributions, and the employer is paying those in accordance with that arrangement.

Consequently, it is more likely than not that a report will not be needed, particularly where the payment holiday is for a limited time only. The one exception to this would be if the failure to pay contributions posed a material risk to members benefits being paid.

What about the need to tell members?

tPR guidance suggests that where trustees have reported a failure to pay, they should also notify scheme members. However, there is no legal requirement to do so. The guidance is silent on the position where no report has been made.

In these uncertain times, notifying members might lead to worry among members who may not understand the position fully. We are not suggesting that members should be misled, but given the likelihood that arrangements are likely (finger crossed) to be short lived, trustees might decide that there is no need to notify members, at least initially.

What are the downsides of entering into a whole new schedule of contributions?

A new schedule of contributions would need to be certified by the scheme actuary. This may lead to additional cost and delay. Option three, where actuarial advice is still obtained, may be preferable. The benefit of a written agreement over a whole new schedule is that a written agreement is relatively flexible and can be kept under review as the financial position of the employer over the next few months becomes more clear. A written agreement is more in line with tPR’s current suggestion that arrangements should be in respect of the next three months only. Obviously, this could change depending on the pandemic’s impact on the financial health of country.

Are there any other issues to look out for?

We have seen suggestions that where an employer is simply not paying agreed contributions, this could amount to a loan to the employer. Loans are strictly prohibited in respect of the majority of defined benefit pension schemes. It is not necessarily the case that a loan is created, but having an agreed position in writing would allay this issue.

What should be included in any written agreement?

Schedules of contributions and recovery plans amount to contractual commitments between employer and trustee. As such any amendment to those contracts needs to be legally binding. You should speak to your usual pensions contact on how best to document any agreement. It is likely that a deed will be needed although deeds do not need to be completely formal. Letters can be executed by deed. We cover some of the practical aspects here.

Any such agreement should cover the following:

• Duration and review of the current arrangements;
• when catch-up payments will be made;
• ongoing information to be provided by the employer in respect of its financial standing during the contribution holiday or reduction;
• a negative pledge that dividends will not be made to shareholders so that the scheme is treated equitably;
• what is intended to happen if an insolvency event takes place during the holiday period, including the directors obtaining a business review from an insolvency practitioner;
• what is intended to take place if the business of the employer improves significantly.

If you wish to discuss any of the above, please contact your usual pensions contact.