Thinking about pensions is unlikely to be top of any law student’s list.
Retirement probably seems far off and even the word “pension” hardly conjures up a glamorous picture.
However in the legal sector, pensions are a hot topic and an endless source of work.
Over the past two decades, starting with the Pensions Act 1995, the legislative regime governing pensions has become ever more complex, meaning a much increased need from law firm clients for specialist advice. This in turn has meant the role of a pensions lawyer has evolved, becoming more integral and sometimes pivotal to a deal getting off the ground.
Defined benefit schemes used to be extremely common in the UK. As the name suggests, the benefit the member is “promised” is defined by the scheme’s trust deed and rules. Typically this would be a fraction of your salary at retirement (e.g. 1/60th) multiplied by your years of service. So an employee with 40 years’ of service could retire with a pension of two-thirds of their salary per year.
As employees typically move up through the ranks, the salary at retirement would generally be the highest salary of their career. This is contrasted with a defined contribution scheme, where the employee and employer contribute set amounts into pension “pot” over the term of employment, but the ultimate benefit is whatever your pot can buy you on retirement.
It will be immediately obvious to most people that there is a problem with a defined benefit scheme. What if the scheme does not have enough funds to pay the pensions that have been promised to members? That, in a nutshell, combined with a number of high profile examples where unscrupulous employers raided their pension schemes for cash or abandoned them altogether, led to successive UK governments putting in place numerous protective measures.
Pension scheme deficits now have to be measured on the “scheme specific” basis to give an accurate reflection of the liabilities, and a plan put in place for removing any such deficit. If the company wishes to wind-up the pension plan, a debt to the pension plan of the amount required to buy out all the benefits in full will become due.
The accounting standard governing pensions now requires companies to report pension scheme deficits on their balance sheets – meaning even the most cursory diligence on a potential take-over target will reveal if there is a pensions debt.
In addition, the Pensions Regulator has been given powers to “pierce the corporate veil” meaning in essence that other group companies, even if based abroad, or significant shareholders can be required in certain circumstances to fund pension deficits or put in place other support arrangements.
In many cases, the pension deficit is the largest debt the company has, and it may even dwarf the company’s market capitalisation. Advising clients on the pensions concerns, whether as a buyer taking on these liabilities or as a seller hoping to achieve a “clean break” from the pensions liabilities when the UK company is sold, can often be one of the most important work streams on a corporate transaction.
Gone are the days where your diligence report could just refer to the pension scheme and comment on whether it was defined benefit or defined contribution. Instead, quite often we find ourselves in critical negotiations with the pension scheme trustees and the Pensions Regulator with resolution of the pensions issues being the gating item to get a deal done.
Anyone who went into pensions law in the early 1990s for an easy life compared with their corporate or finance peers has certainly had a rude awakening.
Catherine Drinnan is a pensions partner at Latham & Watkins