Lehman and Nortel : balancing the interests of the pension scheme and the unsecured creditors

In Bloom & Ors v The Pensions Regulator (Nortel, Re) [2010] in the High Court recently, Briggs J had to decide whether financial support directions (FSDs) and contribution notices (CNs) issued by the Pensions Regulator (the Regulator) to companies in administration or liquidation would rank as ‘expenses’ having super priority in the insolvency proceedings, or merely as provable debts ranking pari passu with other unsecured creditors of each company. Alternatively, if neither of these outcomes could be derived from the interaction between pensions legislation on the one hand and insolvency legislation on the other, the question was whether these pension liabilities would simply fall down a ‘black hole’. Bloom concerned the occupational pension schemes of Lehman Brothers Holding Inc and Nortel Networks, which were heard together in view of the common issues raised in both. There were applications before the court for directions by the administrators of 20 companies in the two groups.

Unfortunately, the Pensions Act 2004 (the 2004 Act) is silent on the issue of how FSDs and CNs rank in the insolvency of a target company. It was therefore left to the court to decide this matter, which it did, taking into account the principle established by the House of Lords in Re Toshoku Finance UK plc [2002]. Broadly, the Toshoku principle states that a liability imposed by Parliament that does not constitute a provable debt in the insolvency proceedings is an administration or liquidation expense.


The FSD regime was instituted to counter the perceived risk of moral hazard, that is, that employers would seek to take advantage of the Pension Protection Fund (PPF), introduced as a key protection measure for employees by the 2004 Act. The PPF is financed by levies from occupational pension schemes and was set up to provide some compensation to scheme members in the event of a shortfall in the assets of their scheme in relation to its liabilities. In particular the FSD regime was intended to guard against the inherent vulnerability of the pension scheme in groups of companies using one employer company to provide employees for the whole group, a structure that was perceived to create a greater risk of burdening the PPF with its own scheme deficiencies.

The Regulator is a corporate body set up by the 2004 Act consisting of a chairperson, chief executive and at least five other persons appointed by the Secretary of State. The Regulator has power to issue FSDs and CNs under the 2004 Act.

A shortfall in an occupational pension scheme is a debt under s75 of the Pensions Act 1995 (section 75 debt). It was accepted by all parties that a section 75 debt was a provable debt, rankingpari passu with other unsecured creditors in the event of insolvency of the employer. The concept of the section 75 debt is relevant to the FSD regime under the 2004 Act, but it is the priority status of the FSD that was crucial as regards the target companies.


Under s43 of the 2004 Act the Regulator has power to issue an FSD where an employer is either a ‘service company’ or is ‘insufficiently resourced’ during a period starting with a date specified by the Regulator and ending with the issue of the FSD. A service company is defined in s44(2) of the 2004 Act as a company that principally provides the services of its employees to companies in its group. In essence, a company is insufficiently resourced if its resources are less than 50% of any shortfall in the assets of an occupational pension scheme according to the complex definition contained in s44(3) to (5) of the 2004 Act.

By s43(6) 2004 Act the Regulator has the power to issue an FSD to associated or connected companies of the employer and may also issue to the employer company itself. A company to which an FSD is issued is known as a ‘target’. Under s43(3) of the 2004 Act an FSD can require that financial support for the pension scheme is put in place within a specified period, that the financial support will remain in place while the scheme exists and that the Regulator is kept notified of insolvency-related events in relation to the target.

By s45 of the 2004 Act financial support can include the following arrangements: if the employer is a member of a group, all the group members, including the group’s holding company, are jointly and severally liable for the whole or part of the employer’s pension liabilities.

Briggs J noted in his judgment that the most important condition for the issue of an FSD to a particular target is that the Regulator must consider it reasonable to impose the FSD on that person. The Regulator must also have regard to the interests of the members of the scheme and the interests of such persons as will be affected by the exercise of its powers under the 2004 Act.

The contribution notice provisions are part of the FSD regime and referred to in ss47 to 50 of the 2004 Act. A CN can be served where there is non-compliance with an FSD. The issue of CNs must also be exercised reasonably, having regard to similar interests to those that must be considered when an FSD is issued. The issue of both FSDs and CNs are to be subjected, separately, to a procedure that includes a right of referral to the Upper Tribunal (Tax and Chancery Chamber) (the Tribunal). The result of referral is that the FSD process is stayed.


In his judgment, Briggs J referred to the fact that the only previous occasion on which the FSD regime had run its course was that in relation to the Sea Containers group, of which Sea Containers Ltd, registered in Bermuda, was the holding company. Sea Containers Services Ltd was a UK subsidiary that was both a service company and an employer that sponsored two UK pension schemes. Following the issue of a warning notice to the parent company in October 2006 by the Regulator, the parent applied for protection under Chapter 11 of the US Bankruptcy Code in Delaware. It had a total section 75 debt of £91m. Subsequently, the Regulator issued a determination notice identifying the parent as a target for an FSD. In turn, this was initially referred to the Pensions Regulator Tribunal and automatically stayed. Finally, the FSD was issued against the holding company (the appeal was later withdrawn).

The Regulator, the trustees of the pension schemes and the holding company entered into negotiations and eventually agreed that the trustees should be issued with 25% of the shares in the company that inherited the business of the holding company under a business rescue plan approved by the Delaware court in the Chapter 11 proceedings. The value of the shareholding in the parent was less than the section 75 debt, but the Regulator considered this level of financial support to be reasonable in the circumstances.

Briggs J observed towards the end of his judgment (at paragraph 206) that the Sea Containers case demonstrated an alternative approach to satisfying the requirements of the FSD regime and suggested the office-holders of Nortel and Lehman might consider a similar solution.


Lehman Brothers collapsed on 15 September 2008. Shortly afterwards, the Regulator began investigations and the process of obtaining information from the Lehman administrators. Warning notices were issued by the Regulator to several group companies from 24 May 2010 and, following an oral hearing in September 2010, a determination was issued that an FSD should be issued against six group companies. The FSD process was stayed by reason of the reference of that determination to the Tribunal.


The Nortel group collapsed on 14 January 2009. There were approximately 42,000 members of the Nortel Scheme, of whom about 20,000 were already receiving pension benefits at the date of the hearing. Nortel Networks UK Ltd, the group’s principal operating company in the UK, had a shortfall of assets in its occupational pension scheme that crystallised in the amount of approximately £2.1bn. The administrators of the Nortel companies were in the process of selling the Europe, Middle East and Africa businesses of the group, and had made realisations of approximately $3.1bn.

The Regulator began investigations in early 2009 and a warning notice was issued on 11 January 2010 to targets, including all Nortel companies involved in the proceedings. There was an oral hearing on 2 June 2010, following which a determination notice was issued on 25 June deciding that an FSD should be issued. Following a reference to the Tribunal the FSD process was stayed, meaning that no FSD had been issued prior to the hearing before Briggs J.


Briggs J’s decision on the provable debt point turned on some very technical analysis of case law concerning the meaning of Rule 13.12(1)(a) and (b) of the Insolvency Rules 1986 (the Rules). He decided that, on the proper interpretation of this Rule, an FSD issued after the insolvency cut-off date (the commencement of the applicant companies’ administrations) could not give rise to a provable debt in those administrations for the following two reasons.

First, pending the issue of the FSD, the only obligations, contractual or statutory owed to the scheme trustees were owed not by the insolvent target, but by the employer. It was precisely because of the absence of any contractual or statutory obligations of the target companies that the FSD regime was created. The second reason turned on the fact that since the Regulator had discretion as to whether or not to issue an FSD or a CN against the target, there was no legal obligation in relation to the target on the insolvency cut-off date.

The judgment went on to identify (paragraph 106) an exception to that general position based on a quirk of the Rules as amended by the Insolvency (Amendment) Rules 2010 (SI 2010/686), which is, if an FSD is issued to a target company while in administration and a CN is issued to the same target after the administration had been immediately followed by a liquidation, then the CN would create a provable debt in that target’s liquidation.


Put at its simplest, the Toshoku principle is the rule that where statute creates a monetary liability that applies to a company, including a company in liquidation or administration, then if that obligation is not a provable debt, it must be an expense in the administration (under Rule 2.67 of the Rules) or in the liquidation (under Rule 4.218).

Applying this principle to the issues, Briggs J stated that the outcome of Bloom turned on the answers to two questions:

  1. Did the FSD regime apply to target companies in an insolvency process, so as to make its financial consequences liabilities of the insolvent target?
  2. Did the 2004 Act provide for the priority of any financial obligations imposed on an insolvent target or leave this to be decided by the technical provisions of the Insolvency Act 1986 and the Rules.

On the first question, the FSD regime was judged to be a paradigm example of legislation that imposes matters without distinguishing between companies that are, and that are not, in an insolvency process. He noted that the only factor sensitive to insolvency employed in the criteria that identified particular companies as the targets of an FSD was the requirement to consider the financial circumstances of the target as part of the reasonableness of conditions in ss43(5)(b) and (7)(d) of the 2004 Act. On the second question, Briggs J said that he felt compelled to rule that Parliament had chosen to leave the question of priority to be resolved purely by the technical provisions of the insolvency legislation.


The effect of this is that FSDs constitute expenses of the administration or liquidation because they do not constitute provable debts and therefore, under the Toshoku principle, they will rank as expenses in the administration with super priority over the office-holders’ own remuneration and expenses, and over the unsecured creditors as a whole.

The applicant administrators of Nortel and Lehman had opposed this conclusion on the basis that it would be extremely detrimental to the rescue culture. The administrator of Nortel had submitted detailed evidence explaining that the restructuring, with its preservation of businesses and numerous jobs, would be completely undermined by the massive debt to the pension fund, payable ahead of all but the secured creditors.

While acknowledging that, Briggs J suggested that this would be mitigated by the fact that the court could make a prospective order altering expense priorities under Rule 2.67(3) of the Rules, which would alleviate the effect of super priority given to FSDs and CNs. He also noted that the obligation imposed on a target by an FSD or CN is only to provide that level of financial support to the scheme as is reasonable in all the circumstances, including insolvency. He further noted that s100 of the 2004 Act required the Regulator to have regard to the interests of the insolvent target’s creditors and thought that the Regulator would be unlikely to impose financial obligations that might prevent a beneficial business rescue, while incidentally killing the goose that might still lay the golden egg.

In summary, Briggs J considered that he was driven to the conclusion that Parliament had legislated to create financial obligations applicable to and payable by a company in an insolvency process, which could be triggered in such a way that they created administration or liquidation expenses. This was probably by inadvertence (as pointed out by Briggs J) as it would have been possible for Parliament to prescribe FSDs’ status as provable debts. In fact, the evidence indicated the latter appears to have been the legislators’ true intention. Briggs J acknowledged that this conclusion would be a less fair result than the provable debt outcome and an impediment to the rescue culture. He observed that he felt acutely uncomfortable with his decision for that reason and expressed the hope that a higher court would find a way through the existing authorities to produce a different result.


It is understood that there will be an appeal against the judgment to the Court of Appeal in the summer. The law, as it stands on this issue, is unfortunately in a mess, and in his lengthy and detailed judgment Briggs J has thoroughly identified the problems, but he clearly felt his hands were tied in terms of an effective solution. Some of the palliatives offered in the judgment are unlikely to be acceptable to insolvency office-holders or indeed to legislators if the rescue culture is indeed regarded as something worth having. One suggestion that emerged during the hearing was that in determining the amount due from the target under the FSD regime the Regulator could have regard to the pari passu principle. As regards the Regulator’s duty to impose reasonable requirements in FSDs, many will have sympathy with administrators, whose counsel pointed out that the Regulator is not the person to make the judgment as to reasonableness, given its overriding statutory duty to protect the PPF and the underfunded pension scheme.

The inconsistencies of the result are unhelpful, not least to those involved in planning and leading the restructuring. An FSD issued prior to the insolvency cut-off date ranks as an ordinary unsecured claim. On the other hand, if the Regulator delays the issue of an FSD until after the insolvency cut-off date, it then has super priority. Even more illogical is the fact that the FSD can have super priority over the insolvent target but the pension scheme’s claim has ordinary unsecured status in relation to the employer.

Many involved in business rescue and restructuring have made it known that the decision as it stands will be extremely detrimental to the rescue culture at the core of UK insolvency legislation, as the judge himself acknowledged. While the Court of Appeal’s decision will be awaited with interest, the most effective way of remedying the current uncertain position is for the government to introduce clarifying legislation. Clearly, in such important twin areas as occupational pension schemes and insolvency it is unsatisfactory to have such uncertainty, especially when all sides recognised that the most equitable solution (and the one that it appears that Parliament itself intended) is that the pension scheme’s claim should rank as unsecured and not have the super priority of administration or liquidation expenses.