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By Kris Weber, Legal Director Arc Pensions Law

It is a long-established pillar of UK insolvency law that in every corporate failure, some creditors can and will recover more of what is owed to them than others.  This is achieved through a precise, status-driven order set out in legislation.

But recent legal changes have adjusted that order, reinstating HMRC as a preferential creditor on corporate failures, in respect of unpaid income tax, National Insurance Contributions (NICs) and VAT.  This ‘new normal’ arises from regulations made under the Finance Act 2020, which restored HMRC’s status in respect of any insolvency-related process commencing on or after 1 December 2020.

Although beneficial for Treasury receipts going forward, there will be potentially negative consequences elsewhere.  For example, as a result of HMRC’s revised position further up the creditor list, both the corporate and financial sectors are also genuinely concerned that lenders will be far less-inclined to lend, thanks to the increased risk of lower recoveries in the event of corporate failure.

Consequences will also arise in the pensions arena, most notably in respect of ‘defined benefit’ (DB) pension schemes.  Because HMRC’s claims now rank ahead of the unsecured ‘statutory debts’ owed by failed corporates to their DB schemes, pence-in-the-pound recovery of the latter will be commensurately smaller: those DB schemes and their members are set to lose out.

The legislative changes are also set to create a further potential drain on the resources of the Pension Protection Fund (PPF), which could again impact not only DB schemes but ultimately scheme members as well.  Established in 2005, the PPF acts as a statutory ‘lifeboat’ for underfunded DB pension schemes of failed corporates, which would otherwise have to wind up with whatever assets they (and they alone) have available to them.

First, the new legislation has the potential, dependent on the sums involved in any given situation, to cause schemes which might be too well-funded for the PPF (and able to continue, or wind-up, outside it) to instead fall into it.

The PPF provides ‘compensation’ to scheme members equal to between 90% and 100% of what their pension benefits from their employer’s scheme would have been, had the company and the scheme survived long enough for those benefits to be paid directly.

In essence, existing pensioners are paid in full whilst deferred members – those who have yet to draw their benefits – take some form of financial hit.  PPF compensation for deferred members is essentially limited to 90% of their benefits, with a lower level of inflation-proofing then applied than schemes’ own rules would require.

(Further constraints also apply, most notably an upper limit on the amount of compensation that the PPF can pay to any given individual.)

The net result is that HMRC’s gain could come at the expense of member outcomes being adversely impacted.  Even when the PPF intervenes to make good the benefits due to DB pension scheme members of failed corporate entities, those members may – if the scheme that goes into the PPF would not have done, absent the change in insolvency priority order – still lose out because of the legislative change.

Alternatively, if the scheme would have entered the PPF anyway, its own recovery will be smaller.  Any funding shortfall is likely to flow through to the ultimate backers of the PPF, namely existing levy payers.  Those levy payers are the remaining corporate entities with DB pension schemes, who must pay the levy in order to fund the PPF and thereby maintain their own schemes’ eligibility for it.

It is self-evident that any creditor’s gain must always come at the expense of another – and HMRC’s in this case will be to the chagrin of DB pension schemes, the corporate entities which sponsor them, and potentially those schemes’ members too.  For the PPF, this represents another potential drain on its stretched resources.  It is already having to deal with the financial implications of its compensation cap having been declared contrary to both the EU Insolvency Directive and age discrimination legislation in recent years.

And the fact that it, the PPF, is (currently) in surplus is neither here nor there – surplus is transient, being nothing more than temporary over-funding; and whether an investment fund (being in reality what the PPF is) is in surplus or deficit, a drain on resource is a drain on resource which means money that wouldn’t otherwise have to be found from somewhere, does now need to be.

If the PPF now receives less than it would have done previously, because HMRC is once again a preferential creditor, the shortfall will have to be restored: levies will increase and pension schemes and their members will ultimately bear the cost.  Treasury will gain whereas DB pension schemes, employers that sponsor them, and those schemes’ members, all stand to lose.

Whether that was the intention of those who drafted the legislation, or an unintended consequence, is unclear.  But it doesn’t seem entirely right – as well as somewhat ironic now that our newest piece of pensions legislation, the Pension Schemes Act 2021, introduces criminal penalties for those corporate entities (and/or their individual directors) whose acts or omissions cause DB scheme members not to receive their benefits in full…

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