The Pensions Regulator (TPR) has released its long-awaited regulatory intervention report following its concerns over the potential abandonment by the Carillion group (Carillion) of its defined benefit pension schemes.

The investigation has received considerable publicity since TPR began its investigations into Carillion in early 2018, with the press reporting how trustee meeting minutes recorded that a previous director considered putting cash towards the pension scheme deficit as a "waste of money". There were also reported concerns of large dividends being paid by Carillion to shareholders, despite the Carillion schemes in aggregate having deficits in excess of £1 billion. However, following its five-year investigation, TPR found no grounds for exercising its powers against Carillon and its officers.

What is a scheme abandonment?

Abandonment of a defined benefit pension scheme happens when a company severs its link with the scheme (for example, through an insolvency process or a restructuring of its business) and leaves it inadequately funded (see TPR guidance on scheme abandonment here). With no employer to support it, providing the eligibility conditions for this are satisfied, the scheme will then fall into the Pension Protection Fund (PPF), the government lifeboat for pension schemes whose employers have become insolvent.

The PPF pays reduced benefits. It will generally continue to pay a pension in full to pensioners whose benefits have already commenced at the date of insolvency but only pays pensions to other members up to 90% of the value of their pension, subject further to a cap (of currently £41,461). The employees therefore get reduced benefits to those they would have accrued had the employer not severed its link with the scheme and funded it properly.

TPR powers

TPR's key statutory objectives are to protect employee pensions and to minimise calls on the PPF. TPR takes a dim view of scheme abandonment. It has two key powers at its disposal when faced with a potential scheme abandonment – its anti-avoidance powers and criminal sanction powers.

Anti-avoidance powers

Contribution Notices

Under these powers and if it considers it reasonable to do so, TPR can require the employers participating in the scheme, as well as other companies in the group (and directors and officers of those companies if it considers them to be responsible), to pay a specified sum of money into the pension scheme (Contribution Notice), if certain grounds are met. TPR can start the procedure for seeking a Contribution Notice up to six years after an act, or failure, took place. The grounds for imposing a Contribution Notice were expanded in October 2021 under the Pension Schemes Act 2021 (2021 Act). A statutory defence is available against the use of this power.

Financial Support Direction

TPR may also impose a Financial Support Direction if it considers that the employer is "insufficiently resourced" (according to a statutory definition) to support the scheme.  Under this power, it may require companies within the wider group to provide financial support to the scheme, such as a guarantee in respect of the pension scheme's liabilities. TPR must consider it reasonable to exercise its powers and it can start the procedure for seeking a Financial Support Direction up to two years after the applicable time.

What kind of corporate activity may be investigated?

When faced with a potential scheme abandonment, TPR will investigate the extent to which any activities in respect of any insolvency or restructuring of the employer, and the events and circumstances leading up to the insolvency, have resulted in the scheme being abandoned. Of concern to TPR would be:

• any activity that materially adversely affected the "employer covenant", being the financial ability of the employer to support the pension scheme;
• payment of a cash dividend or a return of capital, when some of those funds could have been used to improve the funding of the pension scheme;
• early redemption or repayments of other significant creditor balances, before they are contractually due, that favour other creditors of the employer over the scheme;
• other business activity, such as disposals or investments, that materially adversely impacted the scheme; and
• potential acts of dishonesty or concealment on the part of the directors.

Criminal powers

TPR also has criminal powers which it can exercise in the criminal courts. For example, under section 80 of the Pensions Act 2004, any person who knowingly or recklessly provides TPR with false or misleading information can face a fine and a two-year prison sentence. 

TPR's powers were extended significantly under the 2021 Act which made it a criminal offence for anyone to engage in activity that has a material detrimental impact on pension scheme benefits or that prevents the recovery of a Section 75 debt. (A Section 75 debt is equal to the shortfall in the scheme measured on the basis that members' benefits are bought out with an insurance company.) 

A person found guilty could face an unlimited fine and a seven-year custodial sentence. There is also a civil penalty under the 2021 Act, with a fine of up to £1 million. A statutory defence of "reasonable excuse" is available to those facing a criminal charge or investigation. For more on the criminal offences and civil penalties under the 2021 Act, see our previous briefing.

These new criminal powers under the 2021 Act took effect from 1 October 2021 and so do not apply to acts taking place before then, as confirmed by the government. 

More on Carillion

Carillion, a global provider of construction and support services to public and private entities, went into insolvency in January 2018.

Carillion contained 360 entities and 19 of those were participating employers in 13 defined benefit pension schemes. By the end of 2016, the combined estimated deficits of the pension scheme was around £1.8 billion. 

Carillion was brought down by the unsustainable level of its debt and an £845 million write-down in the value of several major long-term construction contracts, leaving thousands of its pension scheme members facing cuts to their pensions.

TPR opened an investigation to establish the circumstances that had led to the insolvency and the impact on the pension savers. TPR also had discussions with the Financial Conduct Authority, the Financial Reporting Council and the Insolvency Service which were also opening their own regulatory investigations into Carillion. TPR investigated whether a series of disposals caused material detriment to the pension schemes or were carried out to avoid scheme liabilities. It also looked into whether the publication of misleading information about Carillion's financial position from July 2015 to July 2017, and the resultant payment of dividends during this period, caused material detriment. 

TPR found that the substantial proceeds generated from the disposals, which included the sale of a real estate business, far from being detrimental to the pension schemes, provided essential liquidity, enabling Carillion to support the schemes for a longer period under its recovery plans.

TPR also found that the publication of misleading information did not detrimentally affect the likelihood of accrued scheme benefits being received (for the purposes of a potential imposition of a Contribution Notice), citing the following reasons:

• had the true position of Carillion's financial position been revealed earlier, the collapse would most likely have happened sooner; 
• it was an unsustainable level of debt that ultimately brought Carillion down; and 
• to the extent Carillion continued trading whilst directors knew of its true financially distressed state, the continued payment of contributions to the pension schemes meant the schemes were not detrimentally affected.

TPR also considered whether there was any scope to use its criminal powers under the Pensions Act 2004 relating to the provision of false and/or misleading information (as referred to above).  However, it concluded that the offence was not made out on the facts of this case. Although TPR did not exercise its powers in this case, the Financial Conduct Authority and the Insolvency Service did exercise their powers against Carillion in relation to wrongful reporting.

Food for thought

In the Carillion case, TPR only considered its criminal powers in respect of the publication of misleading information and not the other grounds on which its criminal powers may be engaged (albeit the new criminal powers under the 2021 Act were not yet in force). It remains to be seen if and how TPR will exercise its new powers to impose criminal sanctions under the 2021 Act in future investigations.

Without any further funds or support into the pension schemes that might have been provided, had TPR found grounds for exercising its anti-avoidance powers, we understand that around 28,000 members of Carillion's 13 pension schemes would face cuts to their pensions as the schemes fell into the PPF. It is reported that the PPF has estimated that the cost of taking on all of Carillion's schemes could be as high as £900 million, its largest on record. 

Since its investigations into Carillion first began, TPR has come under considerable criticism for not having tackled what has been described as the Carillion "time-bomb" earlier. The Work and Pensions select committee and the former Business, Energy and Industry Strategy select committee published a joint report criticising TPR for allowing years of underfunding of the scheme by Carillion and for threatening to use its powers but never actually exercising them. The criticism here was however, in relation to different powers of TPR, being its scheme funding powers under section 231 of the Pensions Act 2004, which it could have sought to use, but did not (rather than its anti-avoidance powers). Under these section 231 powers, TPR can engage early in the scheme valuation process and, for instance, give directions as to how a scheme's technical provisions (essentially its liabilities) are to be determined, or to impose a schedule of contributions specifying the rates and the dates by which an employer must pay them. TPR has sought to exercise these powers only on a handful of occasions to date. In its regulatory report in relation to its investigations into the Southern Water Pension Scheme of December 2018, TPR stated that it issued a warning notice exercising its section 231 powers seeking to impose a schedule of contributions in relation to the scheme; however, TPR did not actually go as far as exercising those powers and bolstered its action by seeking to exercise its anti-avoidance powers; it also stated in its report that "it would welcome judicial scrutiny of its section 231 powers in the future", confirming concerns of many in the industry that TPR is reluctant to use its section 231 powers. It may be that the new TPR defined benefit funding code will make it easier for TPR to use these powers in the future to enable earlier and more effective intervention.

In light of TPR's extensive powers, it is important that directors and officers consider whether any action to be taken will have an adverse impact on any of its defined benefit pension schemes, whether in the ordinary course or in a distressed situation. Although TPR did not exercise its powers in the case of Carillion, there may be situations where it is appropriate and reasonable for TPR to use its powers as a result of action taken in the period leading up to an insolvency. Early advice will be important to manage any risk.

Please contact Eleanor Hart for any advice in relation to this article or pensions more generally.