What is it With Pension Liabilities? Sunny Side Up or Sunny Side Down
The latest iteration of the Sun Capital litigation has confirmed once again what many restructuring professionals have known for a long time – that pension liabilities have a nasty habit of kicking investors where it hurts, often when least expected. One of those insights is that the case provides a “road map” for joint investors that want to isolate withdrawal liability in a portfolio company.
But it’s one thing to be able to switch on a force field to protect against exposure to pension liabilities; quite another to deal with pension liabilities once you’ve got them. However, the US Supreme Court’s decision in Jones v. Municipal Employees’ Annuity and Benefit Fund of Chicago affirms that pension liabilities can be legitimately bargained away or waived through a collective bargaining process, “creating a wormhole through the black hole”. There is no underestimating how challenging a negotiation that would be, especially for a city like Chicago, but the possibilities are there – a wormhole has been created in the black hole.
It is easy to kid yourself into thinking that pension liabilities are just a US problem. They’re not. Countries and corporations around the world are grappling with the “problem” of improved healthcare, increased longevity and hence sky-rocketing pension liabilities. But it’s not all doom and gloom. Pension liabilities can represent an opportunity to enhance value, not just hang, like Frodo’s ring, an impossible burden to bear around the neck.
Take the UK for example. Defined benefit pension plans there are generally underfunded and the regulatory regime is very much aimed at getting plans fully funded as soon as practicable, which may represent a drag on a fund’s portfolio company. Specific corporate events during a period of ownership may prove problematic. For instance, the payment of dividends, share buy-backs and corporate restructuring may all attract the interest of the UK’s Pensions Regulator if considered detrimental to the pension plan. The greatest risk is likely to be on exit, especially if the portfolio company is distressed. In these circumstances, it is worth taking advice to minimise the risk of lengthy disputes with the pension plan trustees and the Pensions Regulator.
Although there are certain risks, many UK companies with defined benefit pension plans have yet to deploy some of the recognised liability management and funding techniques that have been developed there such as enhanced transfer-out programmes, trading expensive increasing pension liabilities with pensioners for less costly (but higher) fixed pensions, securing medically underwritten annuities (to name a few). Where these sorts of techniques can be rolled out, a pension plan can instead be seen as an engine to create value.
Investors should consider their portfolio companies, identify where “problem” pension liabilities exist and then try to understand if there are ways of turning that sunny side up!