Supreme Court quashes Nortel/Lehman pension rulings

INSOLVENCIES could see higher returns to creditors following a Supreme Court ruling on pension payments today.

In a case which will dramatically change the insolvency landscape, PwC and EY administrators were in court arguing that pension payments should no longer enjoy the luxury of receiving priority treatment over other creditors in the event of a corporate collapse.

The Supreme Court overturned a ruling that will now see defined benefit pension payments paid as unsecured creditors, as opposed to having an ‘expense of administration’ categorisation.

Currently in an insolvency process, pensions are paid first as an expense of an administration – leaving less funds in the pot to pay other creditors such as the taxman. Priority payments are made towards expenses of an administration, followed by secured creditors such as lenders. Anything left in the pot is then paid out to unsecured creditors such as HMRC. Usually in an administration unsecured creditors are given less than 10p for every £1 owed.

However, the latest ruling will see pension payments pushed down to unsecured creditor status, leaving more funds in the pot to be divided between the creditors.

In a judgment in the Nortel/Lehman case handed down this morning, the court found that financial support directions (FSDs) were in fact provable debts that should rank alongside the claims of other unsecured creditors. FSDs are support payments requested by The Pensions Regulator (TPR) to be paid by the business to fund defined benefit pension schemes.

The Court today ruled unanimously that the moral hazard powers handed to TPR in the 2004 Pensions Act were not designed to give pension liabilities expense status.

The latest ruling reverses earlier decisions by the High Court and Court of Appeal which had effectively allowed FSDs to be given super-creditor status i.e as an expense of the administration.

Jonathon Land, partner at PwC and adviser to the trustees of the Nortel Networks UK Pension Trust Ltd, said: “This is the fairest result and after three years of litigation UK pension schemes and insolvency practitioners will be thankful they finally have clarity on this issue.

“Insolvency practitioners will now also be able to more accurately estimate the financial impact of FSDs in UK administrations and ultimately make quicker distributions to all creditors.”

Linklaters global head of restructuring and insolvency Tony Bugg, who advised the Lehman administrators, added the decision was “highly significant” and a “victory for common sense”.

“An insolvency pits employees, pensioners, suppliers and other creditors against one another each fighting for a share of a limited pool of funds. The Supreme Court rightly decided that only the clearest of legislative intent should enable one group of creditors to claim priority over another. In the context of an insolvency regime which already gives some creditors preferential treatment, it is right that these decisions should be for Parliament to decide,” he said.

PwC administrators to Lehman Brothers, and EY administrators for collapsed communications company Nortel Network, joined forces to try and overturn the previous court decisions.

The initial litigation began when it was unclear whether the FSDs would be paid after unsecured creditors, meaning they would have received nothing.

Following today’s ruling TPR executive director for defined benefit funding Stephen Soper said: “We are pleased that the Supreme Court has decided that an FSD issued against an insolvent target is effective. This will be welcome news for many thousands of pension scheme members and will provide clarity to insolvency practitioners on how to treat a pension scheme liability.

“In this case, the regulator was forced to defend against arguments that an FSD issued against an insolvent company would be ineffective and disappear down a ‘black hole’. Such an outcome would have had serious consequences for our efforts to protect members’ benefits and the Pension Protection Fund.

“Since the challenge was first made, we have made clear that we have no intention of frustrating the proper workings of the administration process.”

The European administrators of Nortel brought the issue to the Supreme Court (alongside PwC administrators of Lehman Brothers) following the crystallisation of a $3.1bn (£2.7bn) claim from the UK pension scheme. PwC has been acting as the financial adviser to the Nortel UK Pension Scheme since 2009.

Head of restructuring and recovery at international law firm Mayer Brown Devi Shah said this would bolster the rescue culture in the UK. She added that rescuing a business had become risky and uncertain due to the large pensions liabilities following the previous rulings.

“The previous Court of Appeal decision caused considerable issues for restructuring professionals on the ground – they had to consider potentially large pension deficits when assessing the prospects of companies on the verge of insolvency, making rescue of the enterprise a risky and uncertain business. Today’s Supreme Court decision lifts that burden,” she said.

“The banks should also hopefully be more comfortable lending after today’s decision, as they would have demanded more favourable terms or even refused funding if this judgment had gone the other way.”

A version of this story appeared on Accountancy Age’s sister publication Professional Pensions, published earlier today.