Transaction targets with no defined benefit scheme? Can corporate lawyers stop worrying about pensions? Unfortunately, not.
Some corporate lawyers are tempted to let out a sigh of relief when told that the target company on an acquisition does not operate a defined benefit pension scheme. The assumption is that all the risk and complexity surrounding pensions can, happily, be avoided?
Experienced lawyers know that to ensure the client, and their insurers, don’t end up picking up the bill for unexpected pension liabilities, there are key questions that need to be asked during due diligence and then answered through a robust warranty and disclosure process. This process will ensure that hidden defined benefit liabilities do not attach to the target company and other significant pension liabilities are not overlooked.
Defined benefits liabilities can arise without a company ever operating a defined benefit scheme. There are several ways that this may be possible, and it could turn a sweet deal into a sour one.
Inherited rights via TUPE
Where employees will be TUPE transferred from the target company their existing rights to early retirement pension benefits and enhanced pension rights on redundancy come with them. The client could well be liable to fund these rights, even if it does not have a defined benefit scheme itself.
Liabilities imposed by the Pensions Regulator for previous group pension debts
If the target company is, or was, associated or connected to another company (for example a holding company, subsidiary company or even an associated company) that operates a defined benefit scheme then in certain circumstances the Pensions Regulator may hold the target company liable for the other company’s defined benefit deficit.
This deficit is calculated as the cost of buying out the benefits by way of annuities less the scheme assets. In large pension schemes, the deficit could be billions of pounds and even in a small scheme, tens of millions of pounds.
A shortfall in funding the employer pension promise
If the target company has given any defined benefit promises to its employees, or ex-employees, which cannot be funded, liability could land at the feet of the client.
An example could be where the employment contract promises a guaranteed pension benefit, say 1/60th of the final pensionable salary for each year of service but a defined contribution plan set up by the target company has inadequate funds to pay for the guaranteed pension.
Multi-employer pension scheme participation
If the target company has ever participated in another employer’s pension scheme, even if only for a temporary period for one employee, liability could be with your client.
This can happen where there has been historic participation in a previous seller’s multi-employer defined benefit scheme, even though that scheme was closed years ago.
Other sources of unwanted pensions liability
The experienced corporate lawyer also needs to ensure that other pension liabilities which may be attached to a target company are identified and/or provided for. These could include the following:
The money purchase scheme isn’t a money purchase scheme. Many hybrid pension schemes exist. They may look like defined benefit/money purchase schemes because they have that mechanic as their main feature but, hidden within are defined benefit promises.
Often such schemes are discovered late in a transaction process because they have been mis-categorised. However, better late than never because missing these schemes can be costly.
It could also be a simple case of mistaken identity, which happens more than one would like to imagine. Sometimes a pension scheme has been operated as a defined contribution scheme when in fact it is a defined benefit scheme and has been all along. Where this happens liability often follows.
Often overlooked are the substantial fines (up to £10,000 per day) for breaches of auto-enrolment legislation which can be imposed on target companies. The breaches are hard to detect during due diligence reviews.
Failure to comply with eligibility requirements
Failure to offer a contractually defined contribution pension scheme when the employees were first eligible to join can result in the target company having to make significant back contributions and lost investment returns.
Litigation against the target company’s pension scheme
Whether the scheme is an occupational defined contribution scheme or a defined benefit scheme, pensions litigation can be extremely costly. These costs may not be picked up by some standard warranties and indemnities because a distinction could be drawn between litigation against the target company and litigation against the trustees of an occupational scheme – even though the target company is ultimately on the hook to indemnify the trustees/fund the scheme costs.
So, what is the upshot?
Pensions complexity does not end with identifying a defined contribution scheme during due diligence.
You need to ensure that:
- A pension plan is what it says it is – the target company has not inherited any defined benefit liabilities from other companies in the same group, or whose staff it acquired.
- The target company has (a) complied with the terms of any pension scheme rules, including the eligibility and benefits criteria; and, (b) the company has complied with pensions legislation (including auto-enrolment);
- The target and its pension scheme, is free from pensions-related litigation.
Thankfully a well-run acquisition process, from due diligence to drafting warranties, indemnities and disclosure, can be used to identify and avoid unwanted risks for clients.
How can Abbiss Cadres help?
We help you during due diligence and by ensuring a robust warranty and disclosure process -neither your client (or you) need pick up the bill for unexpected pension liabilities.
We support your transactions team to ensure that hidden defined benefit liabilities do not attach to the target company and other significant pension liabilities are not overlooked.
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