Regulatory intervention report issued under section 89 of the Pensions Act 2004 in relation to the Silentnight Group DB Scheme.
Published: 2 March 2021
Case summary
This report sets out how we pursued the use of our anti-avoidance powers after the Silentnight Group’s defined benefit (DB) pension scheme was severed from its sponsoring employers’ business by a pre-pack administration.
Our case was that the targets acquired the employers’ bank debt and used their position as lender to bring about the unnecessary insolvency of the employers. We alleged that they then took steps to buy the employers’ business at an undervalue as part of the administration process that followed.
This was a long-running case that began in 2011. We issued two warning notices in 2014 and 2016, seeking contribution notices (CNs) against targets in the UK and overseas and successfully defended a judicial review application by them in 2016.
The case was settled in February 2021, meaning that our Determinations Panel did not make any decisions in relation to the events described in this report. The targets disputed our case and settled this matter with no admission of liability. We expect that the scheme will transfer to the Pension Protection Fund (PPF).
Background
In early 2011 the Silentnight Group was the largest bed manufacturer in the UK, with a market share of 23% of the UK bedding market. Its nearest rival had a third of Silentnight’s market share, at only 7%. Silentnight employed around 1,250 staff across a number of sites. It was ultimately owned by various individuals and family trusts for members of the family of its founders, Tom and Joan Clarke.
Silentnight set up the Silentnight Group D B Scheme in March 1956, which closed to new entrants in March 2010. The scheme had two sponsoring employers at that time, and approximately 1,200 members at the end of 2020.
In the early 2000s, Silentnight made a series of decisions that led to a substantial debt burden in the business, but that debt had been serviced and reduced by the end of 2010 (with its term loan having reduced from £26m in 2006 to £3.7m by that point).
Silentnight had a good relationship with Clydesdale, with whom it had banked since 2003. Silentnight’s main banking facilities were due to expire in November 2011. Clydesdale’s preference by 2011 was to exit the relationship but, before selling the debt to HIG, it had taken no decision as to whether or not to refinance the Silentnight debt. Clydesdale would be entitled to a fee if certain events occurred, including a refinance.
The Silentnight management team had identified the spring/summer 2011 as the refinancing window for the business.
Shortly before the events described below, the pension scheme’s trustees and the sponsoring employers had agreed a recovery plan for the scheme valuation as at December 2008, which showed an ongoing deficit of £39.5m and a buyout deficit of £99.8m. The recovery plan spanned 29 years, with low contributions in the initial years, increasing substantially from 2018 onwards. The trustees agreed to such a long recovery plan because they considered that this would enable Silentnight to save funds towards a potential refinancing.
The targets - HIG
The targets of our action were certain members and executives (or former members and executives) of the HIG Group, a US private equity group, and various entities in the HIG Group.
In November 2009, Clydesdale received an unsolicited approach from an introducer for investment and debt acquisitions in relation to Clydesdale’s lending to Silentnight. The introducer proposed that a third party would buy Clydesdale’s debt and envisaged that this third party would then place Silentnight into administration. After this, a new entity owned by the third party would buy Silentnight’s business and assets without the scheme.
Clydesdale rejected offers from the first potential buyer that was introduced, including an offer at ‘par’, the face value of the debt, as there was no payment in respect of the bank fee. When that deal collapsed, the introducer approached HIG. After reviewing financial information in relation to Silentnight, HIG estimated that it might make a £47m capital gain on the deal and decided to proceed on the assumption that the pension scheme would be left behind as part of the administration.
HIG attempted to secure the support of the Silentnight management team to favour its acquisition. An offer was made to certain Silentnight executives setting out a substantial equity stake which would be provided to them if HIG successfully acquired the Silentnight business. The offer also required that those members of the management team must not solicit or encourage any bids or discussions with other bidders for Silentnight, its assets or its debt. While Silentnight’s management did not expressly accept the offer, HIG believed that it had “management in [its] back pocket”.
Having again rejected a par offer, Clydesdale accepted HIG’s revised offer of par, plus £1.25m in respect of the bank fee.
HIG acquired the Silentnight debt on 12 January 2011. It knew that Clydesdale would not provide an ongoing overdraft facility to Silentnight if the sale went ahead, so in its place HIG chose to offer a revolving credit facility[1], which it could terminate at its discretion. Silentnight had no choice but to accept – there wasn’t time to arrange an alternative source of funding, and so it would enter an insolvency process if it did not accept HIG’s terms.
HIG's strategy
HIG’s commercial strategy was to acquire Silentnight’s valuable business without the pension scheme. HIG’s own assessment in September 2010 was that Silentnight was “not a distressed business facing a burning platform”. HIG intended, in its own words, to “buy the debt at par, restrict available facilities which would put pressure on the directors to restructure, and facilitate a discussion with the pension scheme and other secured creditors.”
That pressure was applied by the revolving credit facility being ‘on demand’. Once that was in place, the window in which Silentnight could refinance was, in practice, controlled by HIG. They could, in their words “pull it at any time”, thus controlling the solvency of Silentnight.
There was therefore little opportunity for Silentnight to avoid some form of restructuring once the revolving credit facility had replaced the overdraft. To the extent that there was any window to refinance, HIG had sought to incentivise the Silentnight management team not to explore it – HIG had promised them a substantial equity stake if it acquired the business, which they were unlikely to obtain if Silentnight refinanced and continued to trade.
In late February 2011, HIG indicated that it was willing to provide a short window to 31 March for a regulated apportionment arrangement (RAA) to be agreed in principle with the trustees, the PPF and TPR. HIG engaged with us and the PPF but declined to offer the necessary level of equity for the proposal to be accepted by the PPF.
In any event, HIG’s own analysis was that a RAA would give it a lower return than its preferred mechanism of a company voluntary arrangement (CVA)[2]. A CVA would compromise Silentnight’s liability to the scheme, which would require the consent of the PPF (who would have the carrying vote in a CVA). If a CVA was not possible, HIG intended to acquire Silentnight’s business and assets from administration, leaving the employers’ liabilities to the scheme behind. Each of these options involved savers not receiving their full benefits.
By early April 2011, HIG had settled on its approach: Silentnight’s business would be marketed for a pre-pack administration sale at the same time as the employers put forward CVA proposals for discussion to TPR and the PPF. If the CVA wasn’t approved by creditors, the pre-pack administration would go ahead. While these were decisions for Silentnight’s management, our case was that HIG instigated and influenced that decision-making.
In order to increase its influence over the CVA process, HIG agreed to buy shares in the sponsoring employers’ parent company, with some terms of that agreement being conditional. Under this share sale agreement, the shareholders would be obliged to sell the shares on completion of the CVA and they undertook to provide their full support to ensure approval of any CVA in relation to the employers. This meant, in HIG’s words, that “shareholders must support us in all decisions relating to the CVA and/or any other restructuring inc. admin”. In fact, the obligation to sell and purchase shares never became unconditional, but the restrictions in the share sale agreement were in force until 6 May 2011.
HIG did all it could to ensure that it would be the highest bidder for Silentnight’s business and assets in any pre-pack administration, including:
- Claiming the full contractual £5m bank fee in Silentnight’s administration, even though HIG had agreed to pay only £1.25m for the rights to it, with payment due in September 2012
- Seeking to impose a combined CVA and pre-pack marketing process thereby compressing the timeframe for competing bidders when compared with a post-administration sale process. In HIG’s words “reducing [the] risk of a third party coming in”
- Entering into an exclusivity agreement with a party with whom Silentnight had a lucrative licence and attempting to use this exclusivity agreement to put off other bidders and thereby reduce open market competition
The PPF indicated that it would not vote in favour of the CVA proposals as the equity element of the proposal did not reflect the PPF’s requirements given HIG’s existing involvement as lender (having acquired the Silentnight debt). The PPF required a minimum of 33% of the equity of the surviving employer to be provided to the scheme, rather than the 10% offered.
Offers to buy the business and assets had to be made by 28 April 2011 and Silentnight’s administrators, KPMG, took two of the three highest bidders forward, including HIG. KPMG informed HIG that it was not the highest bidder and revealed by how much its bid fell below the leading bid. KPMG invited HIG to provide its best and final offer on the evening of 6 May 2011 and confirmed that it (KPMG) could do the deal the following day if HIG bettered the rival offer. On the same evening the rival bidder was asked to provide its best and final offer and did not change its position.
HIG provided an improved offer. KPMG’s assessment of the two bids concluded that HIG’s offer provided a greater return for unsecured creditors than the rival bid by £2.7m. However, HIG had claimed £5m in respect of its rights to the bank fee, despite it having acquired the right to that fee from Clydesdale for only £1.25m. By claiming the contractual £5m HIG ensured that a substantial part of any successful bid would be paid to it, rather than to unsecured creditors.
HIG withdrew the revolving credit facility on 6 May 2011. Administrators were appointed the next day, and promptly sold Silentnight’s business and assets to HIG without the pension scheme.
Regulatory action
We began an investigation into the possible use of our CN anti-avoidance power following the pre-pack administration. After investigation, based on the evidence obtained, we concluded that HIG had bought the business and assets at an undervalue, thereby reducing the sum paid to the scheme in Silentnight’s insolvency to the material detriment of member benefits. We issued our first warning notice (WN1) in December 2014 to a number of individuals and entities within the HIG group. The notice was based on the allegation that the price paid by HIG for the business and assets of Silentnight in the pre-pack administration was less than the value which would have been achieved in a well-managed arm’s-length sale.
The amount we sought in WN1 was £17.2m, a sum that reflected the impact of the undervalue on the scheme’s recovery and the investment returns the scheme would have benefited from on that amount. We also stated that this amount would increase if the evidence showed that additional investment returns would have been achieved between the issuing of WN1 and any determination to issue a CN. Our evidence indicated a total sum of up to £32.1m as at August 2020.
In their representations, the trustees of the scheme supported our case, but also submitted that there was no need for a sale (whether well-managed or not) in 2011. The trustees considered that, but for HIG’s actions, Silentnight could have refinanced and supported the scheme into the future and provided savers with their full benefits. We carefully considered the evidence put forward by the trustees and came to the view that this warranted further investigation.
We concluded that the trustees’ argument had merit, and that it was appropriate to issue a second warning notice against the same targets, also seeking a CN but of a higher value, £96.4m, which was the deficit of the scheme on a buy-out basis at the time of the employers’ administration (WN2). WN2 argued that, without HIG’s involvement, Silentnight would have been able to refinance, would have traded successfully as it had done for many years, and would therefore have been able to fully fund the scheme over time.
We had therefore issued two warning notices, with WN2 as our primary case.
It is unusual for us to issue two warning notices proposing the use of the same power. In September 2016, when HIG received WN2, it applied to judicially review the issuing of WN2. Its arguments included that WN2 was unlawful as (a) we may only issue a single notice against a target arising from the same facts and seeking the same regulatory action, and (b) even if the issuing of a second warning notice was generally permitted, it would be unfair in this instance because (amongst other things) we worked with the trustees to explore the argument they had put forward before issuing WN2.
The Court refused to grant permission for judicial review, as HIG had an alternative remedy. This was because HIG would be able to pursue its arguments before the Determinations Panel, which could adjudicate accordingly. The Court did not express any view on the merits of the unlawfulness arguments referred to above claims. Shortly before the planned Determinations Panel hearing in December 2020, HIG confirmed that it would not pursue those allegations.
We remain of the view that we can lawfully issue multiple warning notices in relation to the same power and the same background facts. We also reject the allegation that our interaction with the trustees was in any way unfair. Engaging with trustees is an essential part of our oversight of our regulatory community, particularly when we are investigating concerns regarding detriment to schemes. Here, we worked closely with the trustees, relying on their factual evidence and some of the expert evidence that they provided in support of the case set out in WN2.
TPR's case
Our main case (as set out in WN2) was that, without HIG’s involvement, Silentnight could have refinanced, traded successfully and supported the scheme into the future. This involved a significant amount of factual and expert evidence to set out the counter-factual position of Silentnight if HIG had not pursued its strategy to discard the scheme, ie what would have happened but for HIG’s actions.
In 2010, the Silentnight business was struggling to generate substantial free cash, which necessitated the long, and back-end loaded, recovery plan agreed with the trustees. However, our case, supported by our expert opinion evidence, indicated that it would have survived, prospered over time, and made meaningful deficit reduction contributions in the future, which would have enabled the scheme to reach full funding. Our case was that the cash constraints on the business in 2010/11 did not mean that the employers or the scheme would fail.
This case involved projections into the future, forecasting what would have happened over the lifetime of employer support for the scheme. We maintained that the Determinations Panel did not need to be certain of exactly what would have happened, and we contended that we did not have to quantify the detriment caused to member benefits by the targets’ actions. The material detriment test in the legislation does not require certainty of detrimental effect, only likelihood.
We considered the HIG entities and individuals to be “connected with” or “associates of” the sponsoring employers for the purposes of the Pensions Act 2004. While none of the targets were shareholders of the employers (the most common route to establish association in our previous CN cases), our case was that they met the technical test of association or connection, as described by the Upper Tribunal and the Court of Appeal in the Boxclever case[3].
The routes used in this case to establish association were:
- The “control” we considered HIG was given by the terms of the share sale agreement and revolving credit facility agreement. Both prohibited the passing of shareholder resolutions in the employers without HIG consent
- Shadow directorship. We viewed the employers’ directors as having acted in accordance with HIG’s directions, in particular in relation to the CVA proposals
- De facto directorship. Some directors of the sponsoring employers acted as if they were directors of the entity used by HIG to acquire the employers’ business and assets before they were formally appointed.
Each of these routes to “association” was disputed by HIG on the facts, and some of them involved novel arguments which we maintained validly establish the targets’ association, although had not previously been tested in court.
We concluded that it was reasonable to seek CNs for £96.4m (the buy-out deficit at the time of the employers’ administration), on a joint and several basis, because in our view:
- But for the actions of HIG, Silentnight would have refinanced and continued to trade profitably, supporting the scheme to pay or secure all of the benefits which had accrued to members
- HIG acquired the profitable Silentnight business and extracted benefit. This was the result of a wholly unreasonable process contrived by them to further their own interests to the material detriment of the scheme. That business is highly likely to generate a very significant return for HIG when it is sold
- The targets had a relationship of control over the employers by means of the debt acquisition and the other restrictions they placed on the Silentnight management team and shareholders.
Outcome
Shortly before the scheduled Determinations Panel hearing, the targets made an offer to settle. We considered various factors in taking this decision, including:
- the value of the financial sum being made immediately available to the scheme
- the risk of litigating complex regulatory actions with the potential for prolonged periods of legal challenge
- the resulting significant costs
- continued uncertainty for the saver
We decided to accept the offer of settlement and agreed to withdraw the case if HIG paid £25m to the scheme. Together with the liquidation proceeds from the insolvency process, the scheme will receive a total of approximately £35m.
While this is a substantial sum, it is insufficient to eradicate the deficit on a PPF basis, so we expect the scheme to transfer to the PPF.
Our approach
This was a long-running and complex enforcement case, involving the successful defence of a judicial review application and the investigation and pursuit of two alternative arguments, each of which relied on expert evidence, against well-resourced targets in the UK and overseas. We continued to pursue our case despite those challenges.
Our case was that HIG used the control that was available under the lending facilities to bring about the unnecessary insolvency of otherwise viable companies that were supporting a DB pension scheme. We challenged those actions and achieved a good outcome by settlement.
This case demonstrates that we are prepared to pursue regulatory proceedings where we see conduct that we consider to be unacceptable. That said, meaningful settlement discussions can take place in parallel where an appropriate outcome can be achieved without the need to formally use our powers.
We would not expect lenders to bring about unnecessary insolvencies, and so we would not ordinarily anticipate targeting them with our powers. However, we will be alert to any instance where we believe an unnecessary insolvency is brought about to sever a scheme from its employer and will pursue those cases to appropriate outcomes in accordance with our statutory objectives.
Timeline of key events
- June 2010: HIG makes an offer of equity to members of Silentnight management in the event that HIG acquires Silentnight in return for exclusivity. Silentnight and the trustees agree a recovery plan.
- January 2011: HIG agrees to buy the Silentnight debt. In accordance with the terms of the debt sale agreement, Clydesdale informs Silentnight it will not renew the overdraft facility after 14 February 2011.
- February 2011: Conditional Share Sale Agreement between HIG and the shareholders in Silentnight. £10m on-demand revolving credit facility entered into with Silentnight.
- April 2011: KPMG markets the Silentnight business to potential buyers. Offers are made by interested parties, including HIG. HIG enters into an exclusivity agreement with a key Silentnight licensor.
- May 2011: The PPF rejects a CVA offer. Notices appointing administrators filed, triggering a s75 debt. HIG acquires Silentnight’s business and assets.
- December 2011: The Silentnight employers enter Creditors’ Voluntary Liquidation. TPR opens investigation.
- December 2014: WN1 issued.
- October – December 2015: Representations to WN1 received from the trustees and HIG.
- June 2016: WN2 issued.
- July 2016: Letter before action sent from HIG to TPR regarding judicial review claim.
- September 2016: Judicial review claim issued.
- January 2017: Administrative Court refuses permission for HIG’s judicial review claim.
- June 2017: Representations to WN2 received from the trustees and HIG.
- November 2018: TPR responds to representations on both warning notices.
- August 2019: TPR receives replies from the trustees and HIG.
- March 2020: Matter referred to Determinations Panel by TPR.
- February 2021: TPR withdraws proceedings from the Determinations Panel following settlement.
Footnotes
[1] A revolving credit facility gives the borrower the flexibility to access money up to the credit limit. When money is paid back, the money becomes available for use again.
[2] A CVA is an insolvency process where a company can compromise or reschedule some or all of its unsecured debts. It is generally used to allow companies an opportunity to trade out of their financial difficulties.
[3] Granada UK Rental & Retail Limited v The Pensions Regulator [2018] UKUT 0164 (TCC); Granada UK Rental & Retail Limited v The Pensions Regulator [2019] EWCA Civ 1032.