Employer pension obligations in corporate acquisitions

Corporate Acquisitions: Employment Insights - Episode 5

Natalie Wood, Associate Solicitor, discusses managing pensions during corporate acquisitions with our expert guest, Maria Riccio, Pension Specialist Lawyer. 

Maria talks us through employer's obligations under the Pensions Act 2008, emphasizing the critical role of workplace pension schemes and auto-enrolment. 

She further explains the differences between occupational and personal pension schemes, and the crucial trust documents and contractual paperwork that come into play. Maria breaks down the complexities of defined benefit, defined contribution, hybrid schemes, and small self-administered schemes, ensuring you understand how these can impact your business transactions. 

We also explore employee pension protections under TUPE and the thorny issues of Beckman and Martin liabilities. This episode is your roadmap to avoiding pension pitfalls in corporate acquisitions. 

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Chapters

• 6:54 Share purchase: employee's pension post completion
• 11:00 Pension Scheme Considerations for Business Acquisition
• 21:46 Employee Pensions in Asset Purchase

Transcript

Natalie Wood : 0:04 

Hi, I'm Natalie Wood, an Associate Solicitor in the Boys Turner Employment Team. In this employment podcast series, we've been looking at the different elements of corporate support work that we do as employment lawyers, which is integral to any corporate acquisition. In this episode, we're going to be discussing the pension issues that often crop up when dealing with these corporate acquisitions. These can be tricky, and we'll be looking at the common issues and risks that arise and hopefully provide some guidance to both buyers and sellers. I've been speaking to Maria Mauricio, who is a pension specialist lawyer, and she started by giving me an overview of an employer's pensions obligation. 

Maria Riccio: 0:38 

I think, in terms of the basic points, every employer now has to have a workplace pension scheme. That was a result of the pensions act in 2008, so before we had auto enrolment we all know this is auto enrolment. Before we had this, employers that had five or more employees had to designate a stakeholder pension scheme and allow those employees to join it if they wanted to. So it wasn't compulsory and it didn't require the employer to contribute. So they weren't very popular because the employees couldn't be bothered if the employer wasn't paying anything into it. Hence the introduction of workplace pension schemes and auto-enrolment. So auto-enrolment whilst the employer has an obligation to provide a workplace scheme, they don't have to auto-enrol all their employees it depends on their age and their earnings brackets, but broadly, those that do have to be auto-enrolled are what are known as eligible job holders. 

Natalie Wood : 1:56 

So in terms of the different types of pension schemes I know there's a few in that, and we often see in corporate transactions that employers, and even the most sophisticated employers, tend to get confused about the different types of schemes. So they get confused between what a personal scheme, a personal pension scheme is, sorry, rather than you know what an occupational pension scheme is. So just be helpful, I suppose, if you, if you could outline sort of the different types of pension scheme. 

Maria Riccio: 2:25 

Well we obviously have occupational schemes and personal pension schemes. Now, an occupational pension scheme is generally set up under trust, so there are different types of occupational scheme. The main ones that will crop up are what's known as defined benefit schemes. Now, these are the ones you may have seen banded about saying final salary or career average revalued earnings schemes CARE for short. There are also defined contribution schemes, or also known as money purchase schemes. You can get hybrid schemes that have got a bit of both in them, so a bit of DB, a bit of DC. You can get sectionalised schemes. Now these are usually industry-wide schemes where an industry comes together. The employers don't want to set up their own separate schemes, but under this umbrella they can all become participating employers. A good example of that is the social housing pension scheme. And you can also get master trusts. Now, these are examples of workplace pension schemes, like NEST and the People's Pension. And we also come across quite regularly in transactions small self-administered schemes, or SAS for short. Now, these schemes are often operated in smaller family dominated companies where the directors are also the owners of the business. 

Maria Riccio: 4:14 

Now, if you were tasked at trying to work out, have I got an occupational scheme or have I not. Usually you will find a whole load of trust documents floating about. So they will be deeds, declarations of trust or resolutions. Now if it's a sectionalised scheme, so something like the social housing scheme, again there will be participation agreements in that scheme. So you will see those as well. For small self-administered schemes, they're always under trust, um, so you will find deeds, resolutions etc. So broadly, that's the type of thing you'd be you'd be looking for. 

Maria Riccio: 5:01 

So if something like that came across your desk, you will probably think, yeah, that's probably an occupational scheme, whereas personal pensions they are contractual, provided by insurance companies. Now, they're just basically, like I say, they're personal pensions. If an employer has what's called a group personal pension plan, all that is is a collection of personal pensions that they've branded by reference to the name of the company, but they are individual pots of money and they will almost certainly be DC or defined contribution. The paperwork on these is a bit more limited, but you'll probably find guidance booklets, maybe illustrations. There might be the original application that the employer made to set up the group personal pension, that type of thing. 

Maria Riccio: 6:02 

Personal pension, that type of thing. Occasionally, you might find that there are separate personal pensions to the group personal pension. You find that sometimes key people that join a company might already have their personal pension and may want the employer to contribute to that instead of using their own scheme. Now, if that were the case, you would find paperwork might be more limited. You'd probably find information about the contributions that are being paid to it. But you also have to be careful to make sure that that dovetails properly with the auto enrolment obligations that an employer has, so that it does get quite tricky. 

Natalie Wood : 6:54 

So we've talked about the differences between share and asset purchases in previous podcasts and have highlighted how the nature of the transaction can affect key areas of concern for a buyer and the potential liabilities, and we can come on to those. But starting first with a share purchase, what happens to an employee's pension post-completion and what would a buyer want to know or understand through the DD process from a pension’s perspective? 

Maria Riccio: 7:28 

Okay, well, generally if the target employer is the main employer in a pension scheme, we call that the principal employer and it's a single employer scheme. So in other words, xyz company has got its own pension scheme and it's only for them. There's no other employer in it and that is the company. That's the target. Xyz company is the target, then that scheme that it operates will generally follow on purchase. So the purchaser will acquire that scheme. 

Maria Riccio: 8:09 

It's more complicated if XYZ company participates in a multi-employer scheme because unless it's the principal employer of that scheme it is likely to the scheme will be left behind and the employer will then have to set up something different, or the purchaser post-completion. But if they're coming out of a defined benefit scheme, then there are some significant tricky issues relating to that, mainly to do with funding and leaving behind liabilities. So it's too complicated to really address at this point, but it's so basically, it things are different, can be very, very different if you are in a multi-employer scheme, if the target is in a multi-employer scheme. So the typical points I think that a purchaser is going to want to know when they're undertaking due diligence is they'd want to know about compliance with the governing rules of the pension scheme um law, obviously, and any regulatory inquire requirements. So, um, when I talk about regulatory, there's a lot, there's lots of elements of that, but primarily people are going to want to know have have they complied properly with auto enrollment. That that will be a key area. 

Maria Riccio: 9:47 

They'll want to know the status of those pension schemes. So if they're acquiring the scheme, are they open or are they closed? What type of benefits are provided? They'll want to know a list of all the employees who are members and what the respective contribution levels are. I want to know about complaints. Have there been any complaints, anything taken to the ombudsman, to the regulator or even, beyond that, to the High Court, whether any changes are in process or proposed. And if it's DB, then the funding position is going to be absolutely critical. So if there's a deficit, depending on the size of that deficit, that's going to have a major impact on the whole transaction. 

Natalie Wood : 10:39 

And have you ever seen sort of an issue in relation to defined benefit schemes or sort of a deficit causing sort of an end to a potential transaction I have yeah so I've seen it. I've seen it quite a few times wow, so very, very important area for employers to be, or buyers to be mindful of it is very important. 

Maria Riccio: 11:00 

So then, of course, if there's a small self-administered scheme, how is that going to be dealt with? Because, of course that, because it's a small self-administered scheme, how is that going to be dealt with? Because they're normally linked with the owners of the current business. The new buyer is not going to want to take that, so there has to be ways of working around how that can be detached away before the transaction happens, and that can have quite a lot of complications as well. So a good timeframe needs to be factored in to the whole transaction, if that were part of it. They also need to know about past schemes that they may have participated in to make sure were they actually wound up properly? Could there be any potential liabilities that still remain? Their sex equalization equalization is a massive issue. Has it been done properly or not? 

And then, of course, if there have been any past TUPE’s which could have involved. 

Natalie Wood : 11:58 

That lovely word that all of our clients love to hear TUPE they love hearing that one, but we'll talk about that a bit more later. I think yeah so presumably also a lot of new owners have their own pension arrangements too. 

Maria Riccio: 12:20 

They do, and of course that's one of the other things is how they're going to dovetail everything. Uh, if they end up acquiring a pension scheme, you know, for example, it could be more generous than the ones they're providing. It's a bit easier if they're not, obviously, but, uh, they will want to know that because they want, they will want to have consistency of benefits right across for all their employees. And, of course, if they end up acquiring a DB scheme, I would imagine probably the first thing I'm going to want to know is how, how can we get rid of this as quickly as possible with at least with minimal pain, yeah, so so yes, they will need to to know that the funding is the main issue because, as I said earlier, most DB schemes are underfunded and that, of course, affects the profitability of a target or a group being acquired a major, you know, massively, potentially so. But even if you've got a well-funded scheme, you know the buyer is still exposed to volatile pension liabilities going forward with a DB, the assumptions that have been used for that scheme in terms of how it's valued may not actually be borne out in practice and they are heavily regulated and so nobody really wants them anymore. 

Maria Riccio: 13:54 

So a buyer is going to want to obviously negotiate suitable commercial terms to protect from those funding risks. In some situations the scheme stays with the seller's group, so the target then is going to leave that scheme and that can then bring about a deficit on exit, so a trigger, okay. So of course there's all of that that will need to be dealt with. How are you going to deal with that? That is an extremely difficult area. All of these are case by case. 

Natalie Wood : 14:35 

You can't really say that there's one size fits all so presumably that that's something the pensions regulator would sort of be interested in. If if there's sort of a material detriment scheme, they would be very interested in that. 

Maria Riccio: 14:46 

Yeah, I, if there's sort of a material detriment scheme, they would be very interested in that. Yeah, I'll talk a bit more about material detriment. So, yes, uh, so yeah, even if the parties are broadly happy with everything, um, if, um, that exit does produce what is called a material detriment, then the regulator is going to be all over it. Material detriment we also call it moral hazard. It's another, you know. 

Maria Riccio: 15:19 

So is there a moral hazard risk? Now, for example, if that target is financially strong in the current pension scheme but then it comes out of that pension scheme and then it leaves behind the pension scheme which is then weakened by its exit, then there is material detriment. Now, if there's any concern about whether there could be material detriment or not, the parties could consider going to the regulator to seek clearance of the transaction. Now, if the regulator gives clearance to the transaction, then they are in effect saying we don't think there's moral hazard here, so we wouldn't use our powers to issue either a contribution notice or financial support direction. So it it's. 

It's basically giving a stamp of approval, really before the event it's. 

Natalie Wood : 16:17 

Before the event how long would it take for for an employer to get obviously just sort of being mindful of transaction time scales? They can often be tight. Is that a fairly quick process or no? 

Maria Riccio: 16:35 

No, I don't know. I I mean clearance is not very popular anymore and I think the reason for that is that because it's been around for a while, when it first came out and people were panicking about, when they were assessing something, whether or not it could be moral hazard or not, I think employers and advisors are a bit more au fait about whether something looks like it could be or it's not, whereas before it was more blurry. So, I think that, to err on the side of caution, a lot of employers would decide well, we're going to go for clearance anyway. So it's not quite as popular anymore. But I mean really, I mean there could be some situations where you, you know, you think it might be a better thing to do than not. Now. In terms of their time scale, they used to run at maybe eight weeks or something like that. I mean because there's a lot to be done, because it's not just a question of the employers or the parties to the transaction wanting to do it, the regulators going to want to see that the rent, that the trustees of the pension scheme are happy with what's happening, so they come in. Everyone's got to be separately advised, obviously. So there's a whole host of things that have to happen before even something ends up with on the regulator's desk. So it's not a quick, it's not a quick process. So, yeah, it does need to be factored in. If that were something that needed to be done, okay. 

Maria Riccio: 18:16 

Then going on, there's obviously equalization issues. They can create a massive funding obligation if equalization hasn't either been done or it's not been done properly. So you see that quite regularly. There's also contractual promises outside of the scheme, so of course, they can create another heavy burden of liability that you certainly wouldn't wan. And, in terms of DC, you'd want to know that the contributions had been deducted properly and paid over properly. Because, with DC, because the benefits derived from the contributions that are paid, plus investment on top of those contributions that are paid, plus investment on top of those contributions, if those haven't been paid on time, then those members have lost investment performance, so you could end up being exposed. 

Natalie Wood : 19:16 

To top up effectively so there's a lot of potential liabilities for prospective buyers there. Is there anything that they can do to sort of mitigate these risks? 

Maria Riccio: 19:32 

well, obviously we'd always go for standard warranties. We'd want to get those drafted as widely as possible if you're acting for a buyer, to cover the specific risks that we see coming out of the due diligence. Now, of course, if there's any matter that is then disclosed against those warranties that ends up being concerning to the buyer, then we probably look at considering an indemnity specific to those points. Considering an indemnity specific to those points, for example, a Beckman type indemnity or one that relates to funding, if it's defined benefit scheme. Now, in terms of indemnities, well, that's going to be based on several factors. I mean, first of all, what's the negotiating strength as a buyer? Would they be able to actually be able to negotiate and get one? What is the overall value of the transaction compared to the liability and the likelihood of it actually being called upon? So those things that we'd need to think about before you'd even suggest going down that route. 

Natalie Wood : 20:48 

And presumably, conversely, a seller would want to try and tighten warranties as much as possible, not give away too much, and in indemnities think about things like caps, time limits, etc. 

Maria Riccio: 20:59 

Yeah, absolutely, they'd want a cap. They'd probably want a cap in terms of amount and time, potentially, probably want a cap in terms of amount and time potentially. So I mean, I think that with a funding issue, you, they will probably want to see at least that it couldn't, it couldn't extend beyond the winding up of a pension scheme, for example. So, yes, so you'd be, you'd be looking at those types of things, and I think that if the buyer, though, was concerned about the potential solvency of the seller and its recovery, that it could get under warranties or indemnities, then you'd probably go straight in for a price reduction. 

Natalie Wood : 21:46 

So in an asset purchase transaction things are a bit more complicated, as, generally, rights and employee occupational schemes do not transfer under TUPE subject to certain exceptions, of course, which we'll come on to Can you explain what a buyer needs to do in respect of employee pensions post transfer? 

Maria Riccio: 22:10 

Yeah, that that's broadly right. As a general rule, pension rights under an occupational pension scheme do not transfer. That's really important is to make the point. It's occupational pension schemes, but there is this statutory level of protection. That was that came about because of the pensions that 2004. 

Maria Riccio: 22:26 

So if you've got people that are in an occupational pension scheme and they transfer under TUPE so if they were active members or if they're eligible to be an active member or they're in a waiting period to join an occupational scheme, then they have to be provided with the statutory minimum. Now it would be possible for a buyer to provide them. If, for example, they were currently in a DB scheme, it would be possible for the buyer to provide them with DB. But, like I said earlier, nobody wants to go anywhere near it, so that is highly unlikely. So if you were in a DB scheme, if the people are coming from a DB scheme, then the purchaser could provide either a DC occupational scheme or a stakeholder scheme. Now we haven't talked about stakeholder, let's just. 

Maria Riccio: 23:34 

I think it's best to probably gloss over them because whilst there are still a few hanging around, they are pretty much dead in the water, so it's not really something that's worth talking about in too much detail. 

Maria Riccio: 23:48 

So let's just talk DC. They can give them a DC scheme where they would match the employee contribution up to 5%, so up to 6% of remuneration. So that's what they can do. But if the transfer rule pays solely to a DC scheme before the transfer, then membership has to be given to another DC scheme where you contribute, where the buyer would contribute exactly the same that the transfer all was paying. So this is quite interesting because it means that whilst the first type of level you could pay is 6%, if under this DC scheme the employer was paying 4%, then the buyer only needs to pay 4%. So I think people get in their heads that they always have to pay six percent, but it's not necessarily the case. Conversely to that, if the seller's paying 10, then you would also have to pay 10. Wow, so you could end up paying less than the six, but you could end up paying more. So it really depends on what the pension provision actually is. 

Natalie Wood : 25:23 

And is it different then for schemes that are not occupational pension schemes? 

Maria Riccio: 25:32 

Yes, personal pensions. They fall outside of the pensions exceptions under TUPE because they are not occupational pension schemes, so the contractual terms just carry on. So, for example, if if you've got a GBP where you're paying 10, some are paying 12, some pay 15 or you know you, then you would end up having to pay that as the transferee. Um, there's also life assurance. So, for example, if there is a death benefit only life assurance scheme and you see that quite regularly paying four times salary or sometimes six or even more, that will also pass automatically. 

Natalie Wood : 26:17 

So in an asset purchase, we know that some benefits, such as early retirement, redundancy benefits, for example, can transfer, and these are referred to as the Beckman Martin liabilities. Would you be able to just explain this in a bit more detail? 

Maria Riccio: 26:32 

Yeah, that's right. As a result of the TUPE exception that relates to occupational schemes, old age, invalidity or survivor's benefits, they do not transfer. So when they're looking about what do they mean by retirement benefits here they mean those that are paid at the end of an employee's normal working life. Often you'll see that referred to as normal the normal retirement date. So that's what they mean by old age benefits. And then, obviously, anything paid as a result of ill health, because usually if somebody is in ill health some benefits get paid earlier, and contingent benefits which are paid to survivors if the member were to die whilst still in the pension scheme. But there are occupational pension rights that do not relate to old age, invalidity and survivors and these are what we now known as Beckman and Martin rights and these are the ones that do transfer. Now when we look at what a Beckman and Martin right is, we get as a throwback to the two cases that came from the European Court of Justice still binding on us in the UK. 

Maria Riccio: 27:59 

Beckman related to a transfer from the NHS to the private sector and Martin was from the NHS to another part of the public sector. The benefits that they had under the NHS were defined benefits. They looked closely at what do they mean by old age and they decided that certain early retirement rights which so benefits that were in a pension scheme to enhance early retirement in a pension scheme to enhance early retirement, specifically if you were retiring early due to redundancy were not old age benefits. They were being paid earlier than, if you like, what they meant by old age, which was at the end of your working life. So when we do due diligence and we know that there may have been benefits in a DB scheme, we have to look very carefully as to whether or not any of those that have transferred relates to Beckman and Martin, because quite often it's missed and it only arises when a transaction is happening now where somebody is eagle-eyed and has spotted oh crumbs. 

Maria Riccio: 29:28 

Actually there could have been Bettman and Martin problems here and of course, if there are, they really cannot be replicated. So the only way you can deal with it is basically by giving those individuals an enhancement of some sort, usually a lump sum. And then of course, there are tax consequences relating to that. Well, we'll go over those a bit, but but broadly it's a liability that that a buyer is going to want to have, it's going to have to deal with, but needs the money in order to deal with it. So that's when we'll be starting to ask for reductions in price. Maybe might get indemnities combination. 

Natalie Wood : 30:19 

In an asset purchase transaction, then would it be fair to say that Beckman liabilities are one of, or the main sort of areas of liability? 

Maria Riccio: 30:28 

Completely. It is one of the main. Obviously, there's also the issue about the level of contributions, to make sure that they've all been paid properly as well, and what we're going to be paying going. Oh, I buy what they would be paying going forward, but there is one little fly in the ointment as well, because whilst we've talked about the moral hazard issues relating to a share sale. It can actually arise with asset purchases as well because you can get it in a situation where the target TUPE or the assets have been come out of a particular company, leaving that as a, in effect a shell back in the original group. But of course, if that company and those assets had supported that pension scheme and those assets have now been taken out, then you're at risk to moral hazard, so you could end up having the same sorts of issues even on a TUPE. So an asset purchase. 

Natalie Wood : 31:49 

And so lots for a potential buyer to think about, and indeed a seller too, absolutely potential buyer to to think about, and indeed a seller too, absolutely so. Just as a final question, then there are certain nuance um with employees who are employed in the public sector, who are then compulsorily transferred into the private sector. So appreciate, this is a complex area, as sort of much of pensions is. Would you be able to just explain what these nuances are? 

Maria Riccio: 32:17 

Yeah, this, actually this all comes about because of Beckman and Martin, because obviously they were those cases related to transfers out of the NHS. So, and basically what happens now is that if you've been transferred into the private sector, then what's known as the fair deal guidance comes into play. Fair deal emerged because of Beckman and Martin, and it ensures protection of pension rights above the minimum protection which we mentioned earlier. So these are the quirks in terms of minimum protection which we mentioned earlier. So these are the quirks in terms of minimum protection. Originally, it came about in 1999. And if a private contractor came along, they would have had to provide what was called a broadly comparable scheme. So, for example, if it was the NHS that the transfer was coming out of, then you would have had to produce a broadly comparable scheme to the NHS pension scheme. Now that became very, very difficult, because it was very hard for anyone to be able to provide something that was broadly comparable. It didn't have to match it, but it had to be very similar, and so that actually paid quite a lot of outsourcing contracts. 

Maria Riccio: 33:45 

So the government then introduced a new fair deal, which was in 2013. And under this version, the individuals that transfer now have the right to retain the rights to carry on participating as members in the relevant scheme. So let's take, for example, the NHS scheme. But it's only for so long as they continue to be in the outsourced service function. So that's what happens with the main public sector. But Fair Deal doesn't relate to what we call best value authorities, for example, the local and district councils, county councils, etc. They're covered by something called the best value direction. 

Maria Riccio: 34:38 

Now, you'll see this cropping up more often, probably in deals than others, because you tend to find that it just it. It's more often that you're going to get an outsourcing from local government and to to the private sector. Um. Now, under these you can still have broadly comparable but um. In most cases you wouldn't do that. You would enter into what's called an admission agreement, um, which um allows you to be uh, participating in the local government pension scheme, so, and you would become what's known as an admitted body. That basically sums up the differences that you have when you're dealing with a compulsory transferred person into the private sector out of the public sector. 

Natalie Wood : 35:33 

Well, that's all really interesting. So thank you very much for explaining that and also for all of your insights in this podcast. I've enjoyed it, actually. Thank you. That was Maria Riccio, a specialist pensions lawyer. In our next episode, we'll be speaking with Chris Harber, who is head of our immigration team, to discuss key immigration issues that arise on corporate transactions. Just subscribe or follow the podcast and you'll be able to listen to the episode as soon as it is available. Thanks and goodbye.