The recent furore over the collapse of high street retailer BHS has caused fierce debate over whether companies, or their ultimate owners, are responsible for the upkeep of a pension plan. For private equity, the debate has important implications.
In the US, pensions have also been hitting the headlines. In March, two funds of American private equity firm Sun Capital were found to be liable for bankrupt portfolio company Scott Brass’ pension deficit. A court ruled that Sun’s funds were jointly responsible for Scott Brass’ pension plan, as they had been directly involved in managing the company.
The ruling considered the fact Sun Capital employees had been appointed in the majority of the director positions at Scott Brass. The ruling also considered the purpose of Sun’s funds, to sell on Scott Brass for a profit.
Sun’s ownership of Scott Brass had been structured over two funds, one with 70% ownership and the other with 30%, to avoid the 80% threshold. However, the court found the two Sun funds collectively liable.
Although it has no direct impact on UK defined benefit pension plans, the controversial Sun Capital ruling shows just how far authorities can go in determining who is responsible for fund deficits.
The Sun Capital ruling comes as UK deficits have increased in the past decade. Statistics from the UK Pension Protection Fund show that, as at April 2016, UK defined benefit pension plans had an aggregate deficit of £309.4 billion, increased from £273.5 billion in April 2015.
The UK Pensions Regulator has similar powers to those the American court exercised, meaning private equity firms must tread carefully when investing in UK companies with a defined benefit pension plan. The UK regulator can require entities that own more than 33% of a company to provide financial support or guarantees for that company’s pension plan (up to the amount of the plan’s total outstanding liabilities). Shareholdings can be aggregated to meet this 33% threshold, as in the Scott Brass case.
The UK regulator is likely to take action against private equity firms when the regulator believes a fund has weakened a company’s ability to meet its pension obligations. Therefore, buyout funds should be cautious when considering dividends and refinancings.
Private equity funds are not off the hook once they have sold a portfolio company. The regulator’s scope lasts for up to six years after a business is sold.
Although the UK regulator has not formally exercised its powers against private equity firms, the regulator is looking closely at the recent BHS case to determine who is liable for BHS’s pension liabilities. In a publicised action in 2008, the regulator agreed with Duke Street Capital that Duke Street would pay £8 million into the Focus DIY pension plan, a portfolio company which Duke Street sold in 2007. We understand that the regulator used the threat of its powers to obtain this settlement with Duke Street. The regulator formally exercising its powers in the BHS case could mark a turning point. Private equity will need to look closely at the health of pension funds when considering new investments.
There are potential remedies including agreeing a deal with a pension plan’s trustees when making an investment. However, these cases provide yet more evidence of regulators seeking ways to impose responsibility on “parent” private equity funds for their portfolio companies’ activities.