Pitfalls of transferring undertakings between pension scheme employers

A consequence of the ever-increasing legislation on pensions (and the no doubt well-meaning attempts by legislators to prevent unscrupulous employers from avoiding their obligations to scheme members) is that even innocent corporate activities can be fraught with danger for the unwary.

There may be many reasons for transferring an undertaking from one group entity to another. There may be a corporate reorganisation where the business of one company is transferred to one or more other group companies. Some groups may just feel that it is preferable for all their employees to be employed by a single company. Many unincorporated charities are now taking the opportunity to incorporate and this inevitably involves the transfer of the undertaking from unincorporated association to a new company.

All assets and liabilities, including employees' contracts of employment, can be transferred from one entity to another with little difficulty. However, the sting in the tail lies where the employer participates in a defined benefit scheme which has a deficit.

An employer is liable to pay its share of a scheme deficit "if he ceases to be an employer employing persons in the description of employment to which the scheme relates when at least one other person continues to employ such persons". So, if there is only one employer participating in the scheme and the whole undertaking passes to a successor, no debt is triggered because there are no other employers continuing to employ the employees at the precise moment the transfer takes effect.

However, where there are a number of employers in the scheme, the transfer of all the business from one to another will trigger a debt on the first. Furthermore, the share of the debt payable relates not just to the employees transferring, but also all the former employees of the old entity and the deficit is calculated on a buy-out basis. So the size of the sum involved may be such as to make the transfer unfeasible.

However, it is not inevitable that a buy-out debt has to be paid in these circumstances.

One option is that a withdrawal arrangement can be entered into between the trustees and employer which is then approved by the Pensions Regulator. However, even then the exiting employer has to pay a deficit to at least the minimum funding requirement level (and in the future the scheme's specific funding level) and then another entity has to be found to guarantee the full buy-out cost if the scheme should enter winding up. The guarantor is supposed to have resources which make it more likely that it will be able to meet the deficit than the old employer. Where there is a transfer of the whole undertaking from one entity to a successor, it is unlikely that the new company would be in any different position to the old one and so no better able to meet the deficit.

A more acceptable alternative may be to apportion a debt amongst other employers, which is permitted under the Pensions Act 1995. This can result in no actual payment having to be made at the time of exit, regardless of the deficit. No withdrawal arrangement needs to be entered into with a guarantor and approved by the Regulator. However, this requires the scheme rules to have an appropriate apportionment power and if one doesn't currently exist the rules will need to be amended to introduce one.

Technically, the apportionment needs to be made to other employers which are participating at the time of exit by the old employer. That will be a problem if there is a transfer to an entirely different successor company because at the precise moment that all the employees transfer with the undertaking, the new company will not be a participating employer. This can be overcome by the device of transferring one employee in advance and letting the new employer participate in respect of that employee. The complete transfer of the undertaking can then follow. This arrangement does require the consent of a willing employee as his/her employment will not be transferred under TUPE. However, even that process may leave exposure to a further payment by an employer. The Pensions Regulator has power under the Pensions Act 2004 to impose a contribution notice against an employer, or any person associated or connected to it. This applies where one of the main purposes of an act is to prevent the recovery of all or part of a debt due under section 75 of the Pensions Act 1995, or otherwise than in good faith, to prevent such a debt becoming due. The above arrangement would seem to fall squarely within that power. Therefore, before attempting this, it may be that a relevant employer would be wise to seek clearance from the Pensions Regulator to the whole transaction.

So, it is not impossible to arrange the transfer of a business from one undertaking to another in these circumstances. However, it is certainly not something to be undertaken lightly.

This article first appeared in our Pensions update bulletin, December 2006. To view this publication, please click here to view the pdf in a new window.