Proving for Pensions – UK Supreme Court rules that secondary pensions liability imposed by the Pensions Regulator ranks alongside other unsecured creditors in an administration

The Supreme Court allows the Lehman and Nortel appeals in part declaring that secondary pensions liability imposed on target companies should and does rank as provable debt in an administration

A landmark judgment was handed down by the Supreme Court today, in which Weil represented Lehman Brothers Holdings Inc. and Neuberger Berman Europe Limited. It was decided that any pensions liability imposed on the Lehman and Nortel target companies pursuant to a financial support direction issued after an insolvent event is a provable debt, ranking pari passu with other unsecured debts in an administration or liquidation: “the sensible and fair answer”.

Overturning the decisions of the lower courts that such liability ranks as an expense of the administration, the Court decided that if the liability was not a provable debt, it would still not constitute an expense of the administration. The Justices also fettered the courts’ discretion to re-order the ranking priority declaring that if the liability was not a provable debt, the courts could not order it to be treated as such simply because it considered it to be an unjust outcome as this would be contrary to the intention of the legislation under which the liability is imposed.

The Fair Outcome: Impact of the Decision

  • “Produce[s] fairness and justice” which creates legal certainty and also practical certainty for administrators out of the “legislative mess” as hoped by Mr Justice Briggs at first instance. Previously, the possibility of a pensions liability ranking ahead of the costs of the administrators may have acted as a deterrent for administrators to take on appointments.
  • Enhances companies access to capital markets as previously lenders may not have been willing to lend – had the Court of Appeal been upheld, banks may have been reluctant to advance monies secured by way of a floating charge where such security would rank third behind a fixed charge and a pensions liability deemed to be an expense.
  • Opens up the remit of contingent liability and provable debt for other areas of law and statute which may result in the application of Lord Neuberger’s three-part test to other statutory liabilities to prove they are provable debts in an administration despite his warning that “it would be dangerous to try and suggest a universally applicable formula”.

Test for Provable Debt

Lord Neuberger in the leading Judgment swiftly dismissed the possibility that the liability can fall within rule 13.12(1)(a) and then considered whether the liability arose “by reason of any obligation incurred before” the date of the insolvent event and therefore constitutes a provable debt pursuant to rules 13.12(1)(b) and 12.3 of the Insolvency Rules 1986. He determined “obligation” to have a more imprecise meaning than “liability”, because “the liability is what can be proved for, whereas the obligation is the anterior source of that liability”.

Whilst it would be dangerous to suggest a universally applicable formula, in order for a company to have incurred a relevant “obligation” under rule 13.12(1)(b) the relevant company must have taken or been subjected to some action which:

(i) had some legal effect e.g. creating a legal relationship or a legal duty; and

(ii) resulted in a real prospect of the company being subject to the specific vulnerability.

 If these requirements are satisfied, then it should be considered:

(iii) whether the arising of such an obligation is consistent with the regime under which the liability is imposed.

Liability not an Expense

The Justices held that the liability would not fall within “charges and other expenses incurred in the course of the…administration” of rule 12.2 nor within “any necessary disbursements by the administrator in the course of the administration” within rule 2.67(1)(f). This is because:

(i) the liability is not the result of “any act or decision taken by or on behalf of the administrator” or “any act or decision taken during an administration”; and

(ii) a liability under a contribution notice would be a “debt payable ‘during the period of’ the administration” but it would not be “part of” the administration or a payment which was one of the “natural incidents connected with” the administration, and therefore not incurred during the course of the administration.  Something more would be required before a contribution notice issued after the insolvent event could be held to be an expense.

On this basis, Mr Justice Briggs’ statement of the “general rule” in Toshoku stating that a statutory “financial liability which is not a provable debt…unless it constitutes an expense under any other sub-paragraph…will constitute a necessary disbursement” was held to be an “incorrect statement of the law”.  The test is rather that the liability can only be an expense if the nature of the liability is such that it must reasonably have been intended by the legislature that it should rank ahead of provable debts.

Residual Discretion of the Court

Whilst understanding the attraction of the argument, the Court held that it would be “extraordinary” if a court could order a liability to be treated as a provable debt in the “absence of any specific statutory power to do so”; and this would result in making the law uncertain and give way to the possibility of dissatisfied creditors making applications to the court if they felt the statutory ranking caused them unfair prejudice. The statutory and common law authorities (such as Ex parte James), in this instance, did not “justify the contention that an administrator can be ordered to change the ranking” of a particular debt simply because the “court does not think it fair”.

Widening the Remit of Contingent Liability

Lord Sumption added his observations at the end of the Judgment stating that the “paradigm case of an ‘obligation’” is a contract already in existence before the company goes into liquidation but it should not be the only legal basis for a contingent liability where a “legal relationship between the company and the creditor exists…before the contingency occurs” and statute can also give rise to such a contingent liability. In fact, the discrepancy of treatment of costs orders resulting from litigation proceedings and arbitrations before the insolvent event was wrong under modern insolvency law under which “all liabilities arising from a state of affairs which obtains at the time when the company went into liquidation are in principle provable”.