This information is for employers and trustees of defined benefit (DB) pension schemes who are considering whether to agree to an RAA.
We would only expect RAAs to be considered in circumstances where the scheme employers are facing potential insolvency.
We outline what an RAA is and when it can be considered. We set out the principles we expect to be met in respect of any RAA application made to us. The process for making an application is also described.
In addition, we make clear that in respect of agreements other than RAAs which produce a similar outcome to an RAA, we would expect our RAA principles to also be followed.
At a glance
- An RAA allows an employer facing inevitable insolvency to detach itself from its DB pension scheme so it may continue trading.
- Employers should rule out all other options before applying for an RAA.
- We expect to be involved in discussions when restructuring options for the scheme are being considered by the scheme’s employer.
- The trustees’ view is a crucial part of our consideration of any RAA proposal.
What is an RAA?
An RAA is an arrangement which allows an employer facing inevitable insolvency to detach itself from the liabilities of an under-funded DB scheme, so that the employer may continue to trade.
An RAA is an agreement where a financially distressed employer will apportion most of its liabilities to, typically, a new statutory employer called the FallCo. The FallCo is created specifically for this purpose. Under the agreement, which is entered into in accordance with the scheme’s trust deed and rules, the FallCo will then make an agreed payment to contribute toward its liabilities to the scheme.
The following events will then usually occur:
- FallCo will cease its participation in the scheme, which will then trigger a debt under section 75 of the Pensions Act 1995 (a section 75 debt).
- Since FallCo does not hold sufficient assets to pay the section 75 debt, it will become insolvent which will then cause the scheme to enter a PPF assessment period (where it is not already in one).
- The employer’s section 75 debt that would be triggered goes unpaid.
- The pension scheme enters a PPF assessment period (if not already in one) and, if underfunded on a PPF basis, may be assumed by the PPF.
- The employer survives (in some form) to trade into the future. An RAA generally forms part of a broader corporate rescue plan.
When an RAA is an option
An RAA may only be entered into if certain conditions set out in The Occupational Pension Schemes (Employer Debt) Regulations 2005 (Regulation 7A(1)(a)(i)) are met. This means its use is limited to situations of severe financial distress experienced by a scheme’s employer(s).
An RAA must be approved by us and the PPF must not object to it. The vast majority of pension deficits are affordable to scheme employers. Where they experience material financial pressure with maintaining scheme funding, there are a number of flexibilities within the scheme funding regime which employers and trustees, with help from their advisers, are expected to first explore.
We will not approve an RAA lightly and all other options should be considered and ruled out before an application for an RAA is made.
How we decide: our principles and what we consider when an application is made
Our principles are a reflection of the unfairness that would be caused to members and PPF levy payers if employers were permitted to offload their scheme liabilities without providing appropriate value to the scheme or the PPF.
Provided there is evidence of consideration of our principles, we will consider any RAA proposal. We will take into account the wider circumstances of the employer(s), the scheme and other relevant stakeholders, for example an RAA may be one part of a restructuring of a whole corporate group.
In our experience, it is usual for our principles set out below to be relevant. We expect any application to describe and evidence how those principles are satisfied.
The employer’s insolvency is inevitable within the next 12 months
We would expect the application to describe all other options that have been considered and/or implemented (including funding options for the scheme) to avoid the employer’s insolvency.
We would also look to understand whether the insolvency has been engineered in any way and, if so, we may consider use of our anti-avoidance powers.
Examples of evidence
- Trading and cash flow forecasts, with evidence of when liquidity becomes constrained and what the prospects are for rephasing/renegotiating payments.
- Evidence that the company has sought renewed or alternative sources of financing.
- Details of existing debt arrangements (particularly if a covenant breach is the potential trigger for an insolvency process).
- Confirmation from shareholders that further funding will not be forthcoming.
- Clarification of what the trigger for insolvency would be during the 12 month look-forward period.
The upfront cash consideration proposed is significantly greater than the recovery expected for the scheme in the case of the employer’s insolvency
Examples of evidence
- Estimated outcome statement, entity priority model or equivalent analysis estimating what each creditor of the employer would receive on its insolvency.
- Justification of each assumption used in that analysis.
A better outcome could not be attained for the scheme by other means, including through the use of our powers where relevant
With the assistance of professional advisers, we expect trustees to have analysed the circumstances surrounding the position of the scheme and the employer over the relevant period, to ascertain whether there are other, better, outcomes which are realistically achievable for the scheme.
When considering whether a better outcome could be achieved, trustees should check:
- whether our powers could be engaged, including our powers to issue a contribution notice or financial support direction
- whether there are unpaid debts which should be collected. One way to improve the scheme’s outcome could be to collect unpaid section 75 debts from other employers which have previously ceased to participate in the scheme. In such a case, the trustees’ analysis should include the prospects of successful collection of those debts
We would not expect this to be an onerous principle to satisfy, given the trustees must determine whether agreeing to an RAA is an appropriate course of action for them to take.
Examples of evidence
- Legal and/or covenant advice provided to the trustees regarding other possible avenues for improving member outcomes, including the potential use of our powers.
It would not be reasonable for the wider employer group or any entity within it to support the scheme or its employer in the future
This is a wider consideration for us of past events than under principle 3 above in its assessment of the reasonableness of an RAA proposal.
We would expect the application to describe the position of the wider group and provide evidence that it has not disproportionately benefited or derived value from the employer, leading to its current distress.
Examples of evidence
- Relationship of wider group to the employer, evidence of benefit received by wider group including inter-creditor balances, loan notes, shareholder loans.
The scheme is receiving equitable treatment in comparison to the employer’s other creditors, shareholders and other stakeholders
In the same way that a bank would assess this, we would look to ensure that the RAA proposal treats all stakeholders proportionally to the outcome they would expect to receive on insolvency. We go into more detail on equitable treatment in a separate section below.
Examples of evidence
- Details of other creditors and their ranking (secured/preferential/unsecured) and the compromises agreed with the employer concerning their respective debts/liabilities.
- Details of historic dividend payments, bonus arrangements and management incentives.
The scheme receives an appropriate portion of the equity in the employer departing the scheme under the RAA
This is to ensure that in exercising creditor rights the scheme/PPF can share in the benefits the employer enjoys following its release from its pension liabilities.
By agreeing to the RAA, we, together with the scheme and the PPF are facilitating the avoidance of insolvency, which would otherwise be inevitable. In addition, we are assisting the value creation for shareholders, so it is appropriate the scheme shares in this future value.
The appropriate size of the equity to be provided to the scheme/PPF would be a minimum of:
- 33% where the employer continues to be owned or controlled by the same persons who owned or controlled it before the RAA, or
- 10% where the employer is transferred to a new owner previously unconnected in any way to the employer, or any members of a group to which the employer is connected at the time of the RAA
Examples of evidence
- Our expectation is that these arrangements will be documented in accordance with the PPF’s requirements (standard equity documentation is available from the PPF).
Further information related to our principles
The PPF’s role and principles
We work closely with the PPF to ensure our respective factors and principles are satisfied.
In its guidance on employer restructuring, the PPF has identified the principles it expects to be followed in respect of any restructuring or rescue proposal put to it, which would include RAAs. Those principles largely overlap with our principles but, since it has a few additional principles, we would expect the PPF’s guidance to also be considered prior to any RAA proposal being made.
Equitable treatment
When we refer to 'equitable treatment' we mean 'fair treatment' in the specific circumstances of a proposal.
In the context of inevitable insolvency, the critical measure will be assessing what each financial stakeholder would be expected to receive in the event of insolvency. You should consider whether the proposal is treating each party proportionally, relative to that insolvency outcome.
To do this, you should assess what is happening to each party as a result of the transaction.
You should assess the following for each stakeholder, and then compare the proposal with what is being considered for each of the others.
- What are they entitled to (their existing rights) and how those rights arise, for example the circumstances surrounding the build-up of inter-company creditor balances or the taking of security in support of lending.
- What they are obliged to do (their duties and obligations) and what is asked of them.
- What treatment is proposed for them.
How we assess equitable treatment
Our approach to assessing whether the treatment of (a) the employer (and its group) and (b) other creditors and key stakeholders of the employer, is fair when compared with the treatment of the pension scheme is likely to be consistent with the approach that would be taken by banks and restructuring professionals in situations of corporate distress.
Broadly, we would look at:
- the evidence of what would otherwise happen to each key stakeholder, absent the transaction; and
- the expected outcome for each of them under the proposed transaction and the alternative
We would ask ourselves questions such as:
- What is the value of each stakeholder’s interest in the employer and its group in the event of the employer’s insolvency?
- For creditors, what are their estimated recoveries from insolvency?
- For an employer’s wider group, what impact would the employer’s insolvency have on the value of their brand, their assets etc? Are there cross-default clauses in place that may impact debt facilities elsewhere in the group? Does the employer have a key operational/strategy role in the group?
- What will parties receive by way of debt repayment, interest, fees, etc.?
- What is the anticipated increase in value of the employer and its group, if the transaction proceeds? How is this accretion in value to be shared?
- Are lenders putting 'new money' at risk to enable the transaction to proceed and what is the genuine degree of risk they are taking on to recover that 'new money'? Is their reward for doing so commensurate with that risk?
- What power does each of the stakeholders have to permit or frustrate the transaction? Are they behaving fairly and reasonably in exercising those powers?
- Are there any creditors or other stakeholders in a similar position to the scheme (for example, equal-ranking creditors, putting/not putting new money at risk in an equivalent way to the scheme) and is the scheme’s proposed treatment consistent with the proposed treatment of them?
- Transactions of this kind are nearly always proposed because they are expected to create value compared to the alternative of the employer’s insolvency – perhaps for both the employer and its group. We would look to understand:
- Who gains from the transaction? for example, lenders, management, the scheme.
- Is that gain fair compared to what they are putting at risk or giving up, enabling it to happen?
- How is that restructuring surplus distributed between stakeholders and is that division fair?
- When will that share of the restructuring surplus be received by each stakeholder? Are some having to wait longer to receive it and therefore running more risk?
Determining equitable treatment is an examination of relevant factors (such as those above) and weighing up the relative treatment of key stakeholders. This will be a fact-specific exercise.
Other situations where we apply our RAA principles
We will also apply our RAA principles to arrangements which produce a similar outcome to an RAA.
One instance in which we would expect adherence to our RAA principles is where a clearance application is made in respect of an agreement to compromise the employer’s section 75 debt. This would be in return for a cash contribution to the scheme to enable it to secure a portion of member benefits (by way of an insurance policy) exceeding the level of benefits provided for members if the scheme were to enter the PPF.
These so-called 'PPF+ compromises' usually form part of a wider employer or employer group restructuring proposal and trustees may consider it appropriate to agree to this where they consider the compromise will deliver a higher proportion of the benefits promised to members than that which would be provided in the alternative.
As stated in our clearance guidance, scheme compromises will always be Type A events, which engage our anti-avoidance powers. In these situations, we will apply the same principles as those we apply in an RAA scenario. There would be an additional requirement that it will need to be clearly demonstrated to us that the level of mitigation offered will be more than sufficient to allow the scheme to buy out members’ benefits in excess of PPF compensation levels.
We will engage with the PPF where it is appropriate to do so.
Making an application: Our expectations
Engage with us early
We expect to be involved in discussions when restructuring options for the scheme are being considered by the scheme’s employer.
If a decision is made to proceed with an RAA application, relevant information should be submitted to us in a draft application, which includes the level of mitigation proposed.
Employers: seek the views of trustees
The trustees’ view is a crucial part of our consideration of any RAA proposal.
You should discuss any proposal in detail with the trustees before approaching us about making an application.
Your RAA application must include the trustees’ view on the proposal. An RAA involving a scheme not yet in a PPF assessment period can only be affected with the agreement of the trustees.
What trustees and advisers need to do
Trustees and their advisers should have considered and be able to evidence their view on:
- whether the proposal satisfies the RAA principles above and
- if it does, whether it would be in the best interests of scheme members for the trustees to agree the RAA
Trustees should:
- effectively manage conflicts of interest on the trustee board
- take appropriate professional advice, including covenant, actuarial and legal advice. The advice the trustees have received from independent advisers will be a fundamental and integral part of our considerations
- robustly negotiate mitigation for the scheme. It is not our role to negotiate on behalf of the trustees
- consider all other options to the RAA and reach an informed view on the viability of those options, including funding options
Apply for clearance
We expect any RAA application to be made by the scheme’s employer(s). As an RAA is a 'Type A event' for the purposes of our clearance guidance (please see Part II ) we expect any RAA application to be accompanied by a clearance application. Our template clearance application has been designed so that both clearance and RAA approval can be applied for in the one form.
Deadlines
Applicants/employers should notify us and the trustees, if there is a commercial deadline, to ensure there is a reasonable period given to process the application. An approval notice cannot be issued until 28 days after we issue the Determination Notice to approve the RAA.
We will need sufficient information from the applicants and trustees to consider an application. We will undertake a certain level of due diligence to decide whether an RAA may be appropriate. This due diligence may take some time to complete, as the facts and the legal issues may be complex. We will conclude this due diligence and form an initial view about whether an RAA might be appropriate and reasonable in the circumstances and will take into account the PPF’s view in the process.
Avoid providing unnecessary information
All information provided with the draft application form should be targeted and relevant. You should avoid including excessive or irrelevant documentation as this will extend the time it takes for us to review the application.
We may publish a report
If we consider it appropriate to do so, we may decide to publish a report on the consideration given to approve or reject an RAA and grant or refuse clearance. In advance of any publication, we would provide the directly affected parties with a copy of the report we intend to publish.
Our approach to publication is set out in more detail in our essential guide to how we publish information about cases.
In a few cases, we have published regulatory intervention reports regarding our use of powers to approve RAAs. You may wish to review these to understand our process more fully.