What is the impact of the Court of Appeal's judgment on 14 October 2011 in Nortel and Lehmans v The Pensions Regulator on lending decisions?

Nortel & Lehman Brothers v The Pensions Regulator [2011] EWCA Civ 1124

Summary of the case:

• A Contribution Notice can be issued against any company that is or was associated with the employer of a "defined benefit" pension scheme and which has failed to make arrangements satisfactory to the Regulator to deal with the pension scheme’s funding situation.  The Contribution Notice creates a debt owed by the company receiving it to the relevant pension scheme's trustees.
• The first instance judge reluctantly decided (because he considered he had no choice due to there being a "legislative mess") that the debt created by a Contribution Notice issued after the target company enters an administration or liquidation ranks as an expense of the administration.  He recognised this result is "likely to prove unfair to the creditors of an insolvent target".
• The Court of Appeal upheld the first decision, adding "The legislation has a valuable and realistic purpose if it enables some redistribution of assets".

What is its significance to lending decisions?

• Any liability which ranks as an "expense" of an administration, such as the administrator’s fees and liabilities incurred by the administrator in trading the business, rank ahead of the floating charge realisations.
• A Contribution Notice issued after a company enters administration will, on the current state of the law, rank ahead of the floating charge.
• Therefore, the value of a floating charge granted by a borrower can be affected by the existence of an underfunded pension scheme of which the employer is in the same group as the borrower (or was in the same group in the previous two years). 
• The potential liability is unlikely to be identified unless due diligence extends to pension scheme obligations of all members of the borrower’s group going back two years.
• The Financial Support Direction (a precursor to a Contribution Notice) and the Contribution Notice regimes have the potential to impose a liability owed by an unrelated corporate entity on a borrower in a way which could, if the pension shortfall is sufficient (in Nortel it is estimated at £2.1bn), wipe out the value of the floating charge.

What next?

• We await the Court of Appeal's ruling on whether the administrators of Lehmans and Nortel can appeal to the Supreme Court.  If the Supreme Court option is available then it could be many months before there is a final ruling.
• In the meantime, lenders with floating charges continue to face uncertainty.

Lawyers Nick Moser