There has been some press comment about Duke Street Capital having made an £8 million contribution to the Focus DIY pension schemes following an intervention by the Pensions Regulator. This has understandably raised concerns about the vulnerability of other private equity houses, particularly as this has happened after Duke Street sold its interest in the Focus DIY group.
This situation appears to have arisen from the threat of the Regulator issuing a “financial support direction” (or “FSD”), a power that the Regulator has had since 6 April 2005. It has nothing to do with the steps currently being taken in Parliament to widen the Regulator’s existing powers to issue FSDs and (more particularly) contribution notices.
The background can briefly be summarised as follows:
- Duke Street had acquired its interest in Focus in 1987. Other companies were subsequently brought into the Focus group too.
- In February 2005, one of these companies, Wickes, was sold out of the group. The remaining companies in the group were then re-financed and part of this process involved a material return of capital to shareholders. At this time, the Focus schemes are understood to have had an FRS 17 deficit in the region of £26 million.
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The Regulator’s published guidance indicates that it normally expects the parties to consider making a “clearance” application in advance of such a return of capital in these circumstances, on the basis that it is an event that might prove materially detrimental to the ability of the pensions schemes to meet their liabilities. (If successful, a “clearance” application can provide a measure of protection from the risk of an FSD subsequently being issued to the applicants.) However, it seems that these events took place shortly before the clearance procedure came into operation.
- The group’s financial position deteriorated after that, as did the schemes’ combined FRS 17 deficit which rose to around £32 million as at April 2007.
- In July 2007, the Focus group was sold to Cerberus Capital for £1. There were a number of vendors, but Duke Street had been involved for longer than most and was the only one whose interest in the group before the sale exceeded one-third.
Because the 2005 refinancing and return of capital appear to have occurred too early for the parties to have made a clearance application, Duke Street would have remained potentially in the Regulator’s “firing line” for the issue of an FSD. The Regulator cannot, however, issue an FSD to someone more than 12 months after that person’s association or connection with the scheme’s employer has come to an end, which means that the 2007 sale triggered the start of a 12-month period within which the Regulator needed to act if it was going to use its FSD powers. This is presumably why the Regulator appears to have moved into action after, rather than before, Duke Street sold its interest in Focus.
The Regulator has not issued an FSD in this case, but appears to have used the threat of doing so to place some pressure on Duke Street which has led to Duke Street agreeing to pay £8 million into the schemes.
This case does not represent a change to the law but it is an example of the Regulator’s use of its existing powers. It should be kept in context, however. Given the scale of the FRS 17 deficit in 2005, it is quite possible that (had Duke Street been able to apply for clearance at that time and chosen to do so) the Regulator would, as a pre-condition to granting clearance, have required Duke Street to give funding commitments that were at least as expensive to it as the £8 million contribution has been some years later.
The main lessons here seems therefore to be of a practical nature:
- This appears to be only the first time that the Regulator has moved directly against a private equity investor, but clearly he is willing to do so.
- The sale of an interest in a company may not itself constitute grounds for the issue of an FSD, but it is an event that may cause the Regulator to take particular interest if grounds for the issue of an FSD already exist.
- The chances of the Regulator taking such an interest are greater if past events have taken place that have weakened the sponsoring employers’ covenant (such as, in this case, the refinancing and reduction of capital) and the parties do not have the benefit of clearance in respect of them.
- It does not necessarily follow from this, however, that the vendor will be placed in a better financial position by seeking clearance before the sale (or indeed for earlier actions while still the owner) as it is usual for the Regulator to require specific funding commitments to the scheme as the “price” of granting clearance.
For further information, please contact:
Claudia Georgiades on (+44) 20 7456 3037 or alternatively claudia.georgiades@linklaters.com
