As is often the case in moral hazard cases, the detailed facts of this case were nuanced and occasionally involved. The background to it was what had happened to the profits from a joint venture business and, later, the sale proceeds from the disposal of that business. The JV had been part-owned by a 100% subsidiary of the scheme's sponsoring employer. Between 2007 and 2011, profits from the JV were distributed as dividends through the subsidiary to the sponsoring employer, but then paid (ultimately) to offshore structures controlled by the Targets. Later, in 2014, the final tranche of sale proceeds (around £3.7m) was treated slightly differently, being paid directly offshore by the employer's subsidiary.
The central issue in the case was whether an agreement entered into in 2012 between the sponsoring employer and its subsidiary, pursuant to which the employer agreed that it had no entitlement to the JV sale proceeds, had the effect of depriving the employer of profits which could have been used to pay creditors (including the Scheme), or whether it recorded a pre-existing agreement purportedly made in 2004 and performed since on behalf of those two companies regarding the sharing of profits from the JV, which meant (the Targets' contended) that the profits from the JV were never for the employer's free use.
tPR's case was that the 2012 agreement removed a valuable asset from the employer, thereby detrimentally affecting its ability to meet its scheme funding obligations. The Contribution Notices sought were in the sum of the last (2014) tranche of sale proceeds.
The employer entered liquidation in 2014, triggering a s75 debt of around £5.85m. The Targets were two individuals connected with the sponsoring employer: a director and his nephew.
By a majority, the Panel concluded that the 2004 arrangements were not legally binding, and determined that CNs should be issued. As an aside, the Determination Notice reveals there had been a lack of transparency on the Targets' part with both HMRC and the Trustee, which clearly went to the merits of the case.
Some points of interest in the case are as follows:
- Financial circumstances and individual targets: The Targets were individuals. While the financial circumstances of a Target are always a relevant issue for the Panel (financial circumstances being one of the non-exhaustive "reasonableness" factors listed in section 38(7)), where the Targets are individuals, the question of financial circumstances and the impact on the Target of a CN can naturally be a significant issue. In the case of one of the Targets in this case, the Determination Notice suggests affordability was not seriously contested. In the case of the other Target, his position was that he had no material assets, but the Panel considered that his limited financial means "ought not to prevent a CN being issued to him if the other matters listed in section 38(7) and the circumstances of the case supported that outcome."
- The need for a counterfactual: The case was advanced on both the "material detriment" test and the "main purpose" test, but the Panel addressed the case under only the first of these (paragraph 226). An issue that tPR has struggled with in previous material detriment cases has been the need to make out its case by reference to a counterfactual. That is to say, in order to establish (on the balance of probabilities) that the alleged act or failure on the part of the Target caused the Scheme material detriment, it has been necessary for tPR to establish what would have happened but for the act or failure. In other words, tPR needs to show that, in the relevant counterfactual scenario, no material detriment would have been suffered. This can be challenging, and can result in cases becoming a battle of expert evidence opining as to how things would have been different but for the Targets' acts or failure to act. In this case, the case team argued that the Panel did not need (although it would be permissible) to look at the counterfactual scenario to determine the case. The Panel did assess the counterfactual in this case, and also remarked (paragraph 221) that while it may be possible that some material detriment cases could be decided without considering what would have happened but for the act or failure "we suspect such cases will be a minority". The new "employer resources test" introduced by the Pension Schemes Act 2021 was intended, in policy terms, in part to overcome these difficulties by providing for an assessment of the impact of an act on an employer on a snapshot, rather than long term, basis.
- The claim for investment return: The Panel concluded that tPR's case team had failed to establish that it was reasonable to impose liability for lost investment returns on the principal sums claimed, because it had not adduced evidence in relation to changes in the Scheme’s investments, nor evidence explaining why proceedings were not commenced sooner (paragraph 253). Investment return, when claimed, can comprise a material part of the overall CN sought by the case team. Here it was worth over £2m, or 45% of the sum sought. One would expect tPR to seek to ensure it has evidence to assert such a claim in future cases, and there may be a trend of tPR commencing regulatory action sooner (in any given case) than has sometimes been the case in the past.
- The Panel's decision was not unanimous, and in a significant respect went against the Regulator: one Panel member dissented as to the outcome and would not have issued CNs at all, and the Panel as a whole, in rejecting the claim for investment return, disallowed almost half of the total amount sought. As far as we are aware, this is the first time the Panel has reached a decision on a moral hazard case on anything other than a unanimous basis. While it is difficult to draw firm conclusions from this case as to what may happen in other cases, this episode demonstrates how finely balanced moral hazard cases can be.
- Bonas: the Panel (naturally, given that they were effectively bound by it) referred, in paragraph 240, approvingly to Warren J's 2011 decision in Bonas (which continues to be the only judicial (as opposed to Panel) authority addressing the principles governing the quantification of CNs, albeit this was addressed in the context of a strike-out application). In that case, in commenting on the quantification principles, Mr Justice Warren considered that the function of a CN was to compensate a scheme, rather than to impose a penalty on the targets for their behaviour. tPR has been keen to downplay the significance of Warren J's remarks and has made known that it does not accept that tPR's power to issue a CN in a "main purpose" case is limited to compensation for detriment caused. It remains to be seen how these issues will be addressed by the Upper Tribunal in the future. The Panel's Determination in this case has been referred to the Upper Tribunal, so it may be that judicial guidance will be given in due course.
- The role of the Trustee: Punter Southall Governance Services became sole independent Trustee of the Scheme in 2006. Given the Panel's remarks as to the lack of transparency the Targets exhibited in their communications with the Trustee as to the true value of the employer's subsidiary's interest in the JV, PSGS clearly performed an important role in challenging the Targets on relevant points at an early stage and alerting tPR to the possibility of morally hazardous activity.
Next steps
Our pensions litigation team has extensive experience of moral hazard cases, including: Silentnight, Nortel, Box Clever, Bernard Matthews and BHS.
Authored by Matthew Bullen.
