As more and more sponsors of defined benefit schemes are preparing to terminate contributions to their schemes or are going into receivership, examinership or liquidation, a question which keeps arising for trustees is whether or not they are under a duty to demand payment of the scheme’s deficit.
When trustees either know or have a justifiable belief that the sponsor of their defined benefit scheme is about to terminate its contribution liability or suffer an event of insolvency, our view is that the trustees need to take immediate action. The first thing they need to do is to look at the scheme’s employer contribution rule and the winding-up provisions and see what powers they have. Only then can they decide what to do.
Termination of contribution liability by sponsor
Many schemes require an employer to give advance notice to terminate its contribution liability and provide that the trustees or actuary (or both) set the rate of contributions. The trustees of such schemes may well have good grounds for making a deficit demand. In other schemes, the employer is able to terminate its contribution liability on immediate notice and / or the employer must agree the rate of employer contributions. In such schemes, the power of the trustees to demand payment of the deficit may be less clear.
Sponsor is subject to an insolvency process
The wind-up provision of a scheme will often provide that if the sponsor goes into liquidation, the trustees may wind-up the scheme; the liquidation of the company on its own is unlikely to terminate the company’s contribution liability. It is extremely rare to see a scheme provision which deals with what happens on the appointment of a receiver or examiner to the sponsor.
In the event of any of these processes happening, the trustees must quickly look at the employer contribution provisions of the scheme to see if they have the power to make a deficit demand. If they do, and they make a demand while the sponsor is still liable under the terms of the scheme, they will be creditors of the company to the tune of the amount demanded. In a receivership and a liquidation, the trustees’ claim will usually have preferential status. In an examinership, the position of the trustees on liquidation of the company will be taken into account in assessing if the examiner’s scheme is appropriate.
Is there a duty to make a contribution demand?
The answer to this question is probably ‘no’, but as the power to make a demand is discretionary, the trustees must at least consider whether or not to make a demand and, in reaching a decision, take into account all of the relevant factors. These will include:
- the level of scheme funding,
- the asset position and structure of the balance sheet of the company,
- the interests of active members in keeping their jobs (which may conflict with the interests of the deferreds and pensioners),
- whether the is a reasonable prospect of getting any deficit funding,
- what alternative arrangements the company is proposing.
One thing is certain, if the trustees issue a contribution demand, it has to be dealt with by the sponsor and the trustees will have taken a clear step to protect the position of members of the scheme.
A demand can always be compromised (so long as there are justifiable reasons for doing so). Not making a demand is a brave move which must be founded upon clear reasons, given that some or all members are likely to be prejudiced by a shortfall in scheme funding.
We would usually suggest to trustees to make a demand and then talk to the sponsor, especially if the company is going through an insolvency process. This appears to us to be the safer route for trustees. Whatever the trustees decide to do, their actions may well be challenged and they will need to be able to show a paper trail documenting what they did and the reasons for it.