Criminal risks of loans to defined benefit pension employers

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The Pension Schemes Act 2021 (the 2021 Act) introduced additional powers for the Pensions Regulator (the Regulator) to intervene in corporate activity where wrongdoing risks the savings of members of defined benefit pension schemes (a DB scheme).

The majority of these new powers were brought into force on 1 October 2021 (see our Pension Insights here and here for further details.

Under the 2021 Act, lenders (and thereby their employees, officers and advisors (other than insolvency practitioners)) are now potentially exposed to criminal liability and financial penalties when engaged with a borrower where there is a DB scheme involved. This article seeks to distil down the changes that lenders need to be aware of and give some practical guidance and tips, for lenders, on how to pro-actively navigate these new risks.

The headline changes of the 2021 Act.

Criminal Offences

There are new criminal offences that attract unlimited fines and custodial sentences. The offences are:

  • avoidance of employer debt; and
  • conduct risking accrued scheme benefits.

Contribution Notices

The existing contribution notice regime has been amended, and two new grounds upon which a contribution notice can be issued have been introduced:

  • the employer insolvency test; and
  • the employer resources test.

There is also the potential for criminal liability and an unlimited fine for failure to comply with a contribution notice.

Notifiable Events

The criminal offence of knowingly or recklessly providing false or misleading information to the Regulator has been extended to the notifiable events regime. This offence is punishable by a Custodial sentence of up to 2 years and/or an unlimited fine.

Two new employer-related notifiable events, a decision in principle to sell a material proportion of the business or assets of the employer and a decision in principle to grant or extend security that ranks ahead of the scheme together with certain other changes are also being introduced by regulations, currently still in draft form, which are expected to come into force on 6 April 2022 (see our Pensions Insight).

Information Gathering by the Regulator

The Regulator's information-gathering powers are extended, there are new penalties for non-compliance.

Financial Penalties

The Regulator can also impose a civil fine of up to £1 million for certain offences including the offences of avoidance of an employer debt and conduct risking accrued scheme benefits (which are similar to the criminal offences), failure to comply with a contribution notice, non-compliance with the notifiable events regime and knowingly or recklessly providing false or misleading information to the Regulator or trustees.


What are the new criminal offences and why should lenders care?

The two new criminal offences introduced into the Pensions Act 2004 (the 2004 Act) by the 2021 Act are:

  • Avoidance of Employer Debt (the s58A Offence): a person preventing, compromising or reducing, without a reasonable excuse, a debt (which the employer owes to the trustees of an underfunded DB scheme in specified circumstances) where that person intended such act or conduct to have that effect;
  • Conduct Risking Accrued Scheme Benefits (the s58B Offence): a person doing an act or engaging in conduct, without a reasonable excuse, that detrimentally affects in a material way the chance of accrued pension benefits being received, where that person knew or ought to have known such act or conduct would have that effect together being the Offences. 

What types of transactions should lenders be mindful of?

The s58B Offence will cover not only the original lend but any proposed refinancing or restructuring of existing debt or any amendment that would have the potential to detrimentally impact upon any linked DB schemes. Some non-exhaustive examples of situations to assist with anticipating where the Offences may be relevant include:

  • Taking security: where security is being granted, there is clearly a possible impact on the DB scheme as secured creditors will rank ahead of the trustees on an insolvency;
  • Increasing or extending debt: where prior ranking debt is increased or existing financing extended this could reduce the chances of an employer being able to meet its obligations under a DB scheme;
  • Loans to distressed borrowers: injecting funds to a distressed business that involves a DB scheme will require more consideration.

What are the punishments and how can lenders avoid them?

The punishment

Any person convicted of either of the Offences, may face an unlimited fine and/or a custodial sentence of up to 7 years. The 'reasonable defence' excuse is key to a successful defence – the Offences cannot apply if the person has a reasonable excuse for acting how they did, the onus being on the prosecution to prove there was no such excuse. 

Reasonable excuse is not defined in the 2021 Act which means that lenders will need to refer to the Regulator's Criminal Offences Policy (the Policy) to assist in identifying what may constitute 'reasonable excuse'.

The 'reasonable excuse' defence

As noted by the Regulator in its Policy, what amounts to a reasonable excuse will depend upon the particular facts and circumstances of the case and ultimately will be determined by the criminal courts.

Having said that, the Policy does set out the Regulator's approach – there are three principal factors which the Regulator will generally consider when deciding whether a reasonable excuse exists:

  • the extent to which the detriment to the scheme was an incidental consequence of the act or omission, the more incidental the detriment the more likely it will point to reasonable excuse;
  • was any mitigation provided to offset the detrimental impact and how adequate was it? The more adequate the mitigation, the increased likelihood of there being a reasonable excuse;
  • where no, or inadequate, mitigation was provided, was there a viable alternative which would have avoided or reduced the detrimental impact?

The Policy provides examples including ones in a lending context which detail how these factors may come into play.

It should also be noted generally that both the Government and the Regulator have issued several statements confirming that legitimate business activity conducted in good faith is not intended to be caught. As the Policy states, the Regulator's intent is to "investigate and prosecute the most serious…intentional or reckless conduct".

Clearance under the 2004 Act

Under the 2004 Act, a voluntary clearance process was introduced to provide comfort to employers and parties connected or associated with the employer that the Regulator would not issue a contribution notice or financial support direction in connection with a particular corporate transaction.

No such regime exists in relation to the Offences. However, although clearance is not available, we do know from the Policy that the Regulator's approach to the Offences will be 'closely linked' to its existing contribution notice power. Furthermore, it will 'take the same approach' when considering material detriment under the s58B Offence and a material detriment contribution notice meaning that having a defence to a material detriment contribution notice could constitute a reasonable excuse under s58B.

Therefore, we expect the introduction of the Offences will lead to an increase in clearance applications under the contribution notice regime on the basis that it is likely to be difficult to show that a party had no reasonable excuse where it sought and obtained clearance from the Regulator in respect of its contribution notice powers.

Practical tips for lenders

Be diligent, and document

Lenders should pro-actively consider their general processes and look to ensure that they are able to meet the available defences when dealing with DB schemes. The Offences have no limitation period, so practical steps should be built into processes emphasising hindsight and foresight in equal measure to anticipate any potential proceedings. It’s always good practice, and doubly so under the 2021 Act, to prioritise diligence and documentation:

Diligence, be alert to any relevant DB schemes relating to a borrower or its group, so that attention can be paid at the start of a transaction to the Offences and navigating them;

  • Documenting, in the sense of maintaining an audit trail and records of all relevant decisions so that, if need be, a lender can establish a reasonable excuse defence. The Regulator expects those investigated to be able to explain why they acted and for this to be 'well documented'. Therefore, it is important to keep contemporaneous records of meetings, correspondence, key decisions, and written advice and to be able to actively demonstrate the key factors that were considered in the context of a given transaction.

The factors above should be subject to constant review, not just considered at a transaction’s inception. If, following a loan, there is then amendment to the terms, or waivers and consents are granted, or any security or guarantee is enforced, this could potentially have a detrimental effect on a DB scheme. Initial diligence and compliance with the reasonable excuse defence will not necessarily justify subsequent decisions that then affect the scheme. As a result, it is therefore prudent for the same considerations to be taken on board and carried out whenever any lending-related activity is undertaken in proximity to a DB scheme.

Heightened awareness where lending in distressed scenarios

Whilst enforcement of security where a DB scheme is involved needs careful consideration in light of the 2021 Act’s provisions, any actual financing or lending in a distressed situation should also be carefully considered. Notwithstanding that the intention of the financing or lending will be to rescue a company, if this also has a detrimental effect on a DB scheme it could now, in the absence of a reasonable excuse, expose a lender to criminal liability through the Offences.

For example, if a lender injects rescue funding into a borrower (who sponsors a DB scheme) and supports the liabilities due to it by taking security from that borrower that security would (if enforced) rank ahead of any claim from the DB scheme's trustees. Such enforcement could potentially fall within the remit of the s58B Offence, being conduct materially affecting the likelihood of accrued scheme benefits being received.

If such an intervention isn’t successful, then the Regulator may look at the intervention as having exposed the pension creditors to losses when compared to alternative actions, such as pursuing insolvency sooner. Logically this may mean lenders take a far more cautious approach to financing in some circumstances, particularly where there is rescue funding being put in place. As clearance is not available in respect of the Offences, a far greater reliance will be placed on diligence and lenders ensuring they can satisfy the reasonable excuse defence.

Concluding Remarks

Serious concerns have been raised about the scope of the Offences, particularly the s58B Offence which is much wider in terms of both the types of behaviour it could apply to and who could be caught by it.

Lenders are likely to take a more cautious approach given the wide scope of the Offences. However, they may derive some comfort from the common theme running through the Policy lender examples where 'ordinary commercial' lender activity conducted reasonably and in good faith on commercial terms was not caught, with the lenders in the examples being entitled to act in the best interests of shareholders and not expected to take decisions materially opposed to their commercial interests, albeit doing so impacted the DB scheme.

At present there are still unknowns and until the Offences and other extended Regulator powers 'bed in' uncertainty will remain. As noted above, it is essential that lenders have suitable due diligence and documentation procedures in place to identify when lender activity may come within the remit of the extended Regulator powers.

This article was co authored by Rebecca Jones

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