Regulatory intervention report issued under section 12 of the Pensions Act 2004 in relation to Arcadia Group Limited (AGL).
Published: January 2020
Summary
The purpose of this regulatory intervention report is to highlight to the industry what we expect of employers in company voluntary arrangement (CVA) scenarios, and to educate them on the principles we assess CVAs against[1].
We are publishing this report under section 12 of the Pensions Act 2004, which allows us to provide information, education and assistance to, among others, employers in relation to work-based pension schemes.
Background
In autumn 2018, AGL realised that, in the absence of taking initiatives, it would face liquidity issues in 2019 resulting from the widely reported challenges in the high street retail sector.
It also needed to invest in its business to reflect structural changes in the market in which it operates, in particular the increase in online sales. With a view to addressing its cash flow issues in the long term, AGL explored restructuring options.
AGL is the sole statutory employer of two defined benefit (DB) pension schemes:
- Arcadia Group Pension Scheme
- Arcadia Group Senior Executives Pension Scheme
AGL’s directors, along with the directors of six of its subsidiaries, decided to propose a CVA (so there were seven CVAs proposed in total) with creditors of those companies.
The main objective of the CVA proposals was to reduce the rents on some of the group’s commercial properties.
CVAs
A CVA is a process led by an insolvency practitioner to seek a statutory agreement between a company and its creditors[2] to amend the agreed terms for repayments of debts.
For a CVA to be successful, it needs to be supported by 75% of the creditors who vote on it (with the percentage being based on relative debt value). If passed, a CVA can forcibly compromise unsecured creditors, meaning they would be bound by the CVA terms even if they voted against it, including if the CVA terms provide for their debts to be reduced.
Where the pension scheme is eligible for Pension Protection Fund (PPF) entry, the PPF acquires voting rights in the CVA.
The schemes were creditors only in the proposed AGL CVA, and their aggregate claims accounted for around 35% in value of AGL’s creditors[3]. This meant that together, the schemes potentially had a “blocking” vote in the AGL CVA.
While there was no proposal to compromise the schemes’ section 75 liabilities by the CVAs, the trustees were asked to agree to a reduction in the deficit reduction contributions (DRCs) being made to the schemes from circa £50 million per annum to circa £25 million per annum in aggregate for the two schemes.
Section 75 liabilities
This is the amount of money estimated by the scheme actuary to be required to secure the scheme’s liabilities by purchasing an annuity for each scheme member to pay their benefits in full.Our approach
We expect to be told at an early stage when a CVA is being considered that impacts a DB scheme. We have statutory objectives to protect member benefits and the PPF, and where a restructuring is happening in a company or group that sponsors DB schemes, we will want to understand the impact on those schemes.
Employers and their advisers should engage with us early in the process and provide us with full information so we can work with the PPF to assess the impact of the CVA.
This may help inform the PPF’s vote in the CVA. Seeking to agree a proposal with other creditors before approaching us and the PPF may leave the employer in a position where it does not have sufficient room to manoeuvre to get the PPF’s support. In this case, AGL and its advisers engaged with us from an early stage.
We also expect trustee boards and their advisers to be fully engaged and willing to work collaboratively with us and the PPF. On this occasion, a constructive working relationship resulted in a significant improvement in the mitigation offered to the schemes during the course of negotiations.
We take a principled approach to considering the merits or otherwise of a CVA proposal.
The circumstances in which CVAs are proposed may be similar to those where a regulated apportionment arrangement (RAA) may otherwise be sought. In such a case, we will assess the CVA proposal in line with the principles listed in our 2010 statement on RAAs.
Although no RAA was proposed in this case, we viewed the situation as one where application of our RAA principles was appropriate.
RAA criteria
The criteria we consider before determining whether or not to approve an RAA are:
- whether insolvency of the employer would be otherwise inevitable or whether there could be other solutions which would avoid insolvency
- whether the scheme might receive more from an insolvency
- whether a better outcome might be attained for the scheme by other means, including the use of our powers
- the position of the remainder of the employer group, where there is a group
- the outcome of the proposals for other creditors (equitable treatment)
Our application of those principles in this case are explained in the points below. We work closely with the PPF, as it has the vote on whether a CVA is approved in respect of a scheme’s claims.
Whether the insolvency of the employer would be otherwise inevitable
We considered whether there could be other solutions (including funding options for the schemes) which would avoid the insolvency of AGL. We expected the parties (employer and trustees) to each seek their own independent advice in relation to this. In this case, we were satisfied that the proposed restructure was necessary for the business to stand a chance of being viable in the long term and avoid any future insolvency. We were also aware that the majority shareholder was providing liquidity to AGL and the wider group, and we understood that this comprised funding and commitments of funding totalling approximately £158 million to support the restructuring.
Whether the scheme might receive more from an insolvency
We, along with the trustees and the PPF, were keen to ensure that the schemes’ estimated outcomes on insolvency before the CVA proposal were protected by the terms agreed with AGL and/or the majority shareholder. The schemes were given security over group assets to a value that exceeded their estimated insolvency outcome. Additionally, cash injection from the majority shareholder to the schemes remains payable even if there is an insolvency of the employer in the future. As a general point, if mitigation cannot be provided in cash (either immediately upfront, or adequately secured or guaranteed), then alternative mitigation needs to be made available. The value of non-cash or future cash mitigation should allow for both the inherent risk of a promise of future mitigation, and the value of the time delay to the scheme in receiving that mitigation.
Whether a better outcome might be attained for the scheme by other means, including the use of our powers
Based on the circumstances and the information made available to us, we concluded that a better outcome could not be attained for the scheme by other means, including the use of our powers.
The position of the remainder of the employer group, where there is a group, and the outcome of the proposals for other creditors (equitable treatment)
The schemes’ status as long-term involuntary creditors (and a scheme is often the most significant creditor) should be reflected in any proposal. We will compare the treatment of the scheme with that of other equivalently ranked creditors (including those within the group) and would not generally expect other creditors to receive better treatment than the pension scheme.
A CVA is often the start of a restructuring process. As a matter of principle, we expect a scheme’s position to be recognised not only in the terms of the CVA but also, where applicable, its continuing interest in the ability of the business to effect a turnaround in the future[4]. This may mean it is appropriate for trustees to have corporate monitoring and company board observer rights, as well as for there to be restrictions on value leakage from the covenant supporting the scheme.
The challenges faced by the employer here highlight the importance of regular monitoring by trustee boards as well as ensuring they have adequate communication channels and information-sharing procedures.
Good forward-looking visibility of a scheme’s employer, along with an understanding of the implications of refinancing and the position of other creditors and financial stakeholders, is key if trustee boards are to react swiftly and effectively. Trustee boards will likely require restructuring expertise within their skills set in these scenarios. If necessary this may involve appointing an additional, suitably qualified trustee and/or seeking appropriate independent advice. It may be necessary for additional trustees/ advisers to be retained beyond the CVA challenge period.
We also considered the impact of the CVA proposal on the PPF funding position. Here, the mitigation for the reduction to the previously agreed DRCs to the schemes protected the members and the PPF’s funding position in the event of a potential future insolvency.
We do not generally expect schemes to be asked to defer or postpone any DRCs, and it is rare in our experience that an employer proposes doing so in connection with a CVA. In this case, it was clear that the existing DRCs were not affordable by the employer. However, we expected the proposed reduction to be mitigated in a material way in return for the trustees agreeing to reduce DRCs, therefore helping to support the turnaround plan of the business with a view to protecting member benefits.
Outcome
- Security over group assets to the value of £185 million for the benefit of the schemes. This secured what the schemes were projected to receive from an insolvency of AGL if it had happened before the CVA proposals were made.
- £100 million cash from the majority shareholder, payable in three instalments over the next two years, backed by a guarantee arrangement, plus a further £25 million security (bringing the total value of assets secured for the schemes to £210 million). This represented mitigation for the reduction in the DRCs being paid by AGL for the first few years of the CVA.
- The new level of DRCs (£25 million per annum in aggregate) will start to increase by pre-agreed amounts after three years.
Timeline
September 2018
We engaged with the trustee boards following media reports that the group’s credit insurance cover was being reduced.
November 2018
We met with the trustee boards. Discussion items included credit insurance reduction, decline in covenant, and the upcoming triennial valuation (as at 31 March 2019).
December 2018
The trustees provided us with a timetable in respect of the upcoming triennial valuation.
January 2019
We continued engaging with the trustees to focus on Christmas trading results and media coverage of Deloitte being engaged by the company to advise on restructuring options.
February 2019
The company explored the feasibility of a CVA with advice from Deloitte. The company presented a business turnaround plan (including the CVA proposal) to the trustees, us and the PPF. This included proposing the reduction in DRCs from circa £50 million per annum to circa £25 million per annum.
February 2019 to May 2019
With the PPF, we engaged with the trustee boards and company to:
- seek information from the company
- set out what mitigation would be appropriate (from either the company/shareholder or both) in exchange for DRCs being reduced, and
- understand what contingency plans were being worked on in the event the CVAs did not succeed
We also engaged with the trustees throughout their negotiations with the company, along with representatives for the majority shareholder.
June 2019
CVA votes took place and the PPF voted in favour.
15 July 2019
28-day period within which the CVAs could be challenged ended.
6 October 2019
Scheme rescue became binding.
Footnotes
- [1] The PPF’s role and approach to CVAs is explained in its Guidance Note 5.
- [2] The CVA does not bind secured or preferential creditors without their consent.
- [3] The schemes’ claims in the AGL CVA were valued on the basis of their respective estimated deficits on a section 75 basis.
- [4] Where a CVA is used to sever the scheme from the employer, we would expect anti-embarrassment protection to be provided.
The Pensions Regulator's (TPR) consideration and approach to individual cases is informed by the specific circumstances presented by a case, not all of which are referred to or set out in this summary report.
This summary report must be read in conjunction with the relevant legislation. It does not provide a definitive interpretation of the law. The exercise of TPR’s powers in any particular case will depend upon the relevant facts and the outcome set out in this report may not be appropriate in other cases. This statement should not be read as limiting TPR’s discretion in any particular case to take such action as is appropriate. Employers and other parties should, where appropriate, seek legal advice on the facts of their particular case.