Rosalind Connor, partner, at ARC Pensions Law, explains why DB pension schemes can effect mergers and acquisitions
Lawyers and other corporate advisers often make the mistake of thinking that M&A activity is all about ‘the deal’. Once the documents are signed, and the money is paid, it’s assumed that everything is completed.
Those at the coal face of the business know how wrong this is. Buying a business is only the beginning – someone now has to run it, and often more importantly, integrate it with their existing operations.
Integration is a complex matter. As well as the obvious cultural and practical issues, there are a range of financial challenges, from tax treatment to banking constraints.
Amongst these is the effect on any defined benefit pension arrangement and its trustees. The reaction of the pension trustees to the restructuring is not just a HR issue, it is a financial issue, and one that needs careful management.
Pension liabilities are generally significant. They can often dwarf other financial obligations of a group company and pension scheme trustees can have a significant effect on the financial strength of the group.
Valuations and the subsequent contribution payment schedule must be agreed with trustees at least every three years and can sometimes be imposed on the company by the trustees unilaterally.
Trustees hold other powers too. Depending on the scheme rules, they may be able to trigger significant one-off scheme payments and can involve the Pensions Regulator, who can demand these payments not just from the scheme employers, but from group companies, investors and even directors.
The reason that pension trustees care about a restructuring post-deal is that, despite the Pensions Regulator’s powers, the trustees know that their immediate claim is against the employers in the scheme, both current and past, which will rarely be every company in the group.
A restructuring inevitably moves value and the ability to generate returns around a corporate group, so trustees will be watching carefully to see what the effect is on their scheme’s employers.
They are also acutely aware that unless the employers offer them security, the pension liabilities sit as an unsecured creditor.
Restructuring can often involve increased security to lenders from any given company, with the unsecured creditors, such as the pension scheme, feeling increasingly vulnerable.
The question for the finance director who is trying to get the post-deal restructuring finalised is how to deal with pension trustees.
Most obviously, it is generally a false economy to keep them out of the loop. Trustees who feel ignored are much more likely to involve the Regulator and may seek to punish the employer at the next valuation.
In any event, pension trustees are unlikely to stay in the dark for long, given most trustee boards include at least some employees, who will generally be well aware of a post-deal restructure, particularly once employees start being consulted on moving around the group.
It is, therefore, important to involve the trustees and ensure they are aware of what is going on. However, these communications should be mindful of the nature of the trustee boards and their members.
Although pension schemes will increasingly have one or more professional independent trustees with a broader experience of trusteeships, most will also involve people within the business and nearly all are required to include at least some members of the scheme, often with little knowledge of the strategic issues for the business.
In some cases, trustee boards may react to the news in unexpected ways, including the example of a trustee board which wanted to renegotiate contributions to the scheme on the grounds that the uniforms had changed colour. Bizarre as the point is, it represents a reasonable underlying concern – the business had been acquired and the rebranding signified that the previous culture that supported the pension scheme, had been replaced by something unknown.
Trustees of the incoming businesses are particularly vulnerable to these types of concerns. The issue of culture clash and staff change management are usually the remit of the HR team, but the powers of pension trustees can make this a concern for the finance team as well.
Increasingly, a pension scheme and its trustees have the benefit of professional advice on the financial effects of any employer activity. This ‘covenant advice’ is provided by accountancy firms and there is a distinct advantage that these people deal with the cash flows and returns, rather than branding and colour of uniforms.
However, covenant advisers are generally insolvency accountants and their analyses, largely based on the changes in returns available to the scheme as a creditor on an insolvency, will be different from the analysis of the ongoing business that has driven the restructuring.
If the trustees are in the loop, and well advised, it is worth listening to their views. They will generally be well aware that they cannot veto a restructuring, but also acutely aware that, if there are serious concerns for them, they can cause problems in the future.
To some extent, their interests align with that of the business – they wish to have a strong employer with low costs that is able to continue to support the scheme. However, if there is significant extra security to a bank or other lender, or a substantial move of assets from pension scheme employers to non-employers, the pension scheme may be a factor that drives the shape of a post-transaction integration.
Rosalind Connor is a partner, at ARC Pensions Law.