Managing Risk in the LGPS

5 September 2014

Benefits of employer covenant checks

• Reduce the risk of pension liabilities falling on other fund employers

• Improves overall scheme governance & employer monitoring

• Can use to adopt differing valuation strategies based on financial strength of employer (including implementing security)

• Assists in assessing risk on new employer joining the fund

Benefits of employer covenant checks

• Likelihood of employer default remains high

• Provides monitoring system to enable admission agreements to be terminated.

• Enables financial strength of guarantors to be assessed.

• Protecting taxpayers

• Believe employer covenant checks will become the norm in LGPS funds over time.

Mitigating risk

• Costs associated with monitoring covenant low compared to loss to fund in the event of an insolvency

• Recent conference at BDO highlighted that if you attempt to address risk at a late stage unlikely to be successful

Sector wide covenant checks

• Social Housing

• Charities

• Higher Education Sector

• Further Education sector

• Academies/Schools

Engagement with employers

• Explaining benefit of covenant checks/reducing risk of cross subsidy

• Annual provision of information for covenant check

• Developing dialogue so the pension fund are made aware of material events affecting an employer

• Ensuring employers understand key differences between IAS19/ongoing & cessation valuations

• Talks at employer forums/monthly newsletter articles

Engagement with employers

• Cessation valuations provided to all employers at each triennial valuation

• Annual cessation updates for employers at risk or with few active members

• Regularly monitor membership numbers

• Understanding the use of external monitoring systems

• Ensuring admission agreements remain valid

Internal monitoring and processes

• Engagement with Board/Pensions Committee

• Clear process and procedures in place

• Awareness of potential risk

• Regular reporting and monitoring

• Risk register in place

Valuation and inter-valuation

• Funding Strategy Statement

• Clear process and procedures in place

• Risk identified

• Employer Categorisation

• Type of employer

• Open/Closed

• Recovery periods

• Affordability

The Future

• Guidance and Advice

• How can additional security be achieved?

• Examples of best practice

• Consistent Approach

• Employers understand their responsibilities

• Role of National Advisory Board

• Deficits Working Group

• Recommendations to be made to SoS

Managing employer risk in the LGPS

Part I – Types of security

Part II – Risks of invalid admission agreements

Part III – Rights in an insolvency event

Gary Delderfield and

Mandy Kaur-Sadler

Part I – Types of security:

• What is security

• Why take security

• Different types of security that

can be created

What is security?

“Security is a right given to one party in the asset of another party to secure payment or performance by that other party or by a third party”

Goode, Legal Problems of Credit and Security

What is security?

– Different to ‘statutory’ Bond/Indemnity/Guarantee

– These may be required under Regulations for new agreements

– ‘Voluntary’ security

Why take security?

– Better contribution rates

– Priority over other creditors

– Avoid delays and potential uncertainties of formal insolvency process

Payment Priorities Fixed charge

assets

Preferential

Creditors

Prescribed

Part

Floating

Charge

Unsecured

Creditors

Shareholders

Pension Fund Liability

Fees and

expenses

The assets of the company for distribution to the creditors do not include any assets held by the company

on trust for a third party.

Types of security – a simple classification

Charge

• Gives the Fund a right to appropriate an asset to the satisfaction of a debt which will be recognised in insolvency

• Fund has ‘rights’ to the asset, not possession (cf a mortgage)

• Flexible – most assets present or future

• Where other types of security may not be appropriate

Charges over Specific Assets

• Land

• Fixed Plant and Machinery

• Intellectual Property

• Cash/Bank Accounts

• Book Debts

• Shares

Fixed v Floating Charge

• Fixed charge

– asset ascertained and definite

– attaches immediately to charged asset

• Floating charge

– can only be granted by a

company or an LLP

– chargee’s rights attach to a shifting pool of assets

Other Forms of Security

• Pledge

• Mortgage

• Assignment by way of security

• Quasi security

Part II – Risks of invalid admission agreements

What are the risks?

• Administering authorities have a legal obligation to administer the fund and ensure that bodies have valid grounds of participation

• Technically, the employees of that employer are not entitled to participate in the LGPS

• More importantly, does this offer any leeway for a participating employer to evade its ‘liabilities’ in the fund

When should documentation be revised?

Common scenarios:

Scenario 1

• Admission agreement A provides for execution as a deed by admission body (a company).

• Admission agreement B provides for execution as a deed by a governing body of a voluntary aided school.

• Agreement A is signed by one director.

• Agreement B is signed by two governors of the school.

• Are A and B valid?

Scenario 2

• Admission Agreement in name of “AB Limited”

• Certificate of incorporation of change of name to “AC Limited”

• Is new agreement required?

Scenario 3

• Admission Agreement for “AB” in place

• AB is unincorporated institution

• AB incorporates as a company limited by guarantee

• Is new agreement required?

Scenario 4

• AB is an admission body.

• AB ceases to have any active members – only liabilities are deferred and pensioners.

• Is admission agreement still valid?

Scenario 5

• AB is a housing association.

• AB amalgamates with CD, also an admission body.

• Are AB and CD’s admission agreements still valid?

Part III – Rights in an insolvency event

What are the rights of an administering authority as a creditor in an insolvency event?

Employer Risk

• A company can be placed into a formal insolvency procedures by its directors, shareholders, creditors or the court.

• The main UK corporate insolvency procedures, each run under the control of an appointed insolvency practitioner, are:

Administration

Company Voluntary Arrangement

Liquidation

Corporate Insolvency

Administration

• A procedure where a company may be rescued or reorganised or where its assets may be realised under the protection of a statutory moratorium.

• Statutory defined purpose(s) – a sliding scale:

– To rescue company as a going concern;

– To achieve a better result, for creditors as a whole, than on a winding up; and

– To realise property to make a distribution to one or more secured or preferential creditors.

• Administrator appointed to take custody and control of the company’s business and assets. Appointment automatically ends after one year.

• Administrator carries out his functions in the interests of creditors as a whole.

The basics

• Initial creditors’ meeting to vote on administrator’s proposals.

• Creditors vote – one vote per £1 of unsecured debt.

• Proposals may be approved with or without modifications or otherwise rejected.

• Proposals approved if >50% (in value) of all creditors vote in favour but invalid if >50% (in value) of unconnected creditors vote against.

• If approved, the proposals will set out how the administrator intends to manage the affairs of the company and his entitlement to draw fees and expenses.

• Creditors then receive updates by way of biannual progress reports.

• Influencing the administrator’s actions

• Taking action against the administrator

Administration Creditors’ rights

• A procedure where the company and its creditors come to an agreement which is implemented and supervised by an insolvency practitioner.

• Purpose – to allow the company to settle its debts by only paying a proportion of the debts due.

• Requires creditor approval of 75% (in value).

• Once approved binds all creditors who were entitled to receive notice of the proposal – whether known or unknown and even those who voted against the proposal.

• Not binding on secured or preferential creditors.

• No statutory moratorium.

Company Voluntary Arrangements The basics

• Depending on the value of a creditor’s debt they may have an influencing or blocking vote (if they hold more than 25% (in value) of the debt) affecting whether the proposals are passed.

• A CVA can be challenged in court on the grounds of unfair prejudice or material irregularity.

CVAs Creditors’ rights

• An alternative to rescue mechanisms.

• Purpose – to realise assets and distribute to creditors.

• A terminal process – the liquidator takes control of the company’s assets and all employees are automatically dismissed.

• Either compulsory (via a winding-up petition) or voluntary (creditors voluntary liquidation if company insolvent or members voluntary liquidation if solvent).

• Liquidator appointed to collect in assets and distribute them in a prescribed order.

Liquidation The basics

• CVL - both the creditors and the members can nominate a person to be liquidator at their respective meetings. Creditors’ choice prevails.

• CVL – creditors may raise questions of the directors and the proposed liquidator at the creditors meeting.

• Compulsory liquidation - Official Receiver (the “OR”) acts as the liquidator in the first instance. Creditors can influence the appointment and identity of an external liquidator to replace the OR.

• Request the liquidator to summon further meetings at which they could (with a 50% majority):

– remove the liquidator from office; and/or

– form a liquidation committee.

• Challenge a liquidator’s excessive remuneration.

• Apply to court if they suspect there has been a breach by the liquidator of his duties.

Liquidation Creditors’ rights

Eversheds Contact Details

Gary Delderfield Partner E: garydelderfield@eversheds.com D: 0845 497 1786 M: 07826 918 202

Mandy Kaur-Sadler Senior Associate E: Mandykaur-sadler@eversheds.com D: 0845 497 1438 M: 07717 516 203

Q&A