What was the situation?

• Pension Scheme A was sponsored by a UK retail business with a parent guarantee providing access to more limited international operations
• The covenant was Tending to Weak, reflecting poor recent trading and material secured debt in the capital structure which subordinated the Scheme
• The covenant then deteriorated further due to the impact of COVID-19 and store closures, requiring material additional liquidity to prevent possible insolvency
• There was no appetite from existing shareholders to recapitalise and existing lenders (secured with an estimated full recovery on insolvency and therefore indifferent to the outcome) were reluctant to extend further credit so a process was initiated to find new investors
• After an extensive search, two possible offers emerged, one debt financed, and one equity financed 
• The Pensions Regulator became increasingly involved as well as the Pension Protection Fund as insolvency was a risk
• The Scheme had a strong power, the use of which it had to continually assess against the likely outcome of the refinancing – was it better to trigger insolvency now and recover what it could or allow the refinancing and run the risk of a worse outcome over the longer term?

What were the key risks?

Status quo

• The cash flow impact of COVID-19 related lockdowns was severe, with the sponsor forecast to run out of financing which would leave Pension Scheme A without a sponsor

Debt financed offer

• Subordination of Pension Scheme A to lenders, resulting in minimal, if any, recovery on insolvency
• Aggressive repayment terms risked covenant strength in the future

Equity financed offer

• The equity investment was structured such that it ranked behind the scheme

Other

• Existing secured lenders needed to agree to waive and amend covenants to prevent default; sought to agree accelerated debt repayment which could have placed sponsor under undue pressure in downside trading scenarios
• Cross-party agreement would be required between the investor, the secured lenders, Pension Scheme A and shareholders

What action did we take?

• Supported Trustee in engagement with the sponsor, the bidders, existing lenders and tPR / PPF 
• Actively encouraged tPR engagement with the sponsor
• Employed forward-looking profit and cash flow analysis and assessed insolvency outcomes to determine any detriment or heightened covenant risk resulting from the proposals and identify mitigation requirements; secured same information flow as lenders (common information sharing platform) 
• As a result, Trustee was then able to constructively engage in negotiations with robust rationale for its concerns / requirements
• Concluded that Pension Scheme A’s interests would not have been adequately protected under the terms of the debt finance offer; bidder could not form a financeable solution
• Trustee expressed strong preference for the equity bidder (eventual preferred bidder)
• Based on robust analysis and integrated approach with other scheme advisers, Trustee was able to negotiate a package of new protections including:
  • Security
  • A new valuation agreement and suitable recovery plan
  • Extension of parental guarantee 
  • Information provisions to enable enhanced monitoring
• Financing was secured and the sponsor continued as a going concern with Pension Scheme A’s interests protected

What are the key takeaways?

• Security in favour of another stakeholder can appear harmless when a business is doing well but its effects when it bites (i.e. when a business is doing badly) can be fundamental to the survival of a scheme - schemes should avoid such structural subordination
• A scheme’s covenant could be rapidly undermined by the impact of a material corporate downside event and any resultant financial restructuring
• A forward-looking approach can aid assessment of the finance ability of the sponsor in a range of scenarios, to determine what financial restructuring can be supported 
• Robust financial analysis allowed the Trustee to highlight the risks and merits of possible outcomes and provided a rationale for negotiated mitigation
• Equality of information flow is key
• A constructive and collaborative approach between sponsor and Trustee (including equality of information between key stakeholders) is fundamental to securing a mutually beneficial outcome