The Carillion Group – Regulatory intervention report | The Pensions Regulator

The Pensions Regulator (TPR) has published its regulatory intervention report into the compulsory liquidation of Carillion PLC on 15 January 2018, confirming that it is satisfied there is no basis for using its anti-avoidance and criminal powers and has closed its investigation. The collapse of Carillion, alongside other high profile cases such as BHS and the Silentnight Group ultimately led to the enactment of Pension Schemes Act 2021 which gave TPR new regulatory powers in relation to corporate events and provided for the introduction of a new DB funding regime, which is currently the subject of ongoing consultation.

“Reasonable alternative uses” of employer cash by distressed employers

This report gives us an interesting insight into how TPR may assess the new concept of “reasonable alternative uses” introduced in the draft DB Funding Code in the context of a distressed employer. In its drive for low-dependency, the new funding regime and any recovery plan requires that any deficit “must be recovered as soon as the employer can reasonably afford”. In determining what contributions an employer can reasonably afford, trustees must assess the employer’s available cash, the reliability of that available cash and whether any of it could reasonably be used by the employer other than to make contributions to the scheme (a new concept of “reasonable alternative uses”).

The draft Code states that trustees will typically have to consider the following types of alternative uses for an employer’s available cash:

Investment in sustainable growth - referred to as the growth a business could realistically achieve and maintain without creating a heightened risk of running into difficulty – unlikely to apply in the case of distressed employers;

Covenant leakage (including distributions to shareholders and the granting of an intercompany loan that is unlikely to be paid back) and discretionary payments to other creditors e.g. the early repayment of a loan. The draft Code states that where a scheme has a low funding level and is running risks that are not supportable, it expects schemes to receive more of the available cash by way of deficit contributions and would not expect any discretionary payments or covenant leakage.

Making contributions to other DB schemes sponsored by the employer - allocation of available cash between schemes should be fair, considering the respective funding levels and level of maturity of each scheme.

Within the Carillion Group, there were 13 DB schemes, with a combined estimated s 75 deficit on of around £1.8 billion at the end of 2016. During 2016 and 2017, TPR reports that deficit contributions totalling £76 million were paid into the schemes and scheduled payments continued to be paid up until 3 months before the Group’s liquidation. Based on the assumed financial strength of the Group prior to the July 2017 profit warning, TPR concluded that the schemes had acceptable recovery plans in place and given the continuation of deficit contribution payments the schemes were not detrimentally affected.

During 2015 and 2016, Carillion declared dividends of nearly £235 million. However, TPR concluded that had that covenant leakage not occurred, given the extent of the Group’s bank debt and other creditors (listed in the interim 2017 Group accounts as trade creditors of approximately £2 billion, and bank debt of just below £1 billion), it is reasonable to assume that the directors’ priority, acting reasonably, would have been to use the cash to pay down debt rather than to increase payments to the schemes.

So, will the new DB funding regime help prevent a second Carillion? 

The answer potentially lies in the increased focus on an employer’s financial ability to support the scheme not just now but into the future, requiring employers to provide trustees with greater visibility over cash flow, profit and loss and balance sheet forecasts, typically over one to three years. This represents a real change for employers and trustees, who will be required to form their own assessment of the employer’s prospects (including its capital structure and overall resilience, and the market in which it operates) and how long the employer will remain in existence to support the scheme. In the context of distressed employers and poorly funded schemes, expert independent advice should be obtained.

As the Parliamentary report into the collapse of Carillion stated “Although the July 2017 profit warning marks the beginning of the end for Carillion, it is poor decisions in the years leading up to it that caused the company serious trouble”. In particular:

Over the eight years from December 2009 to January 2018, the total owed by Carillion in loans increased from £242 million to an estimated £1.3 billion;

While Carillion’s debts rose by 297%, the value of its long-term assets grew by just 14% between 2009 and 2017;

Nor did Carillion manage to grow its revenue. The group’s revenue actually fell by 2% between 2009 and 2016.

However, will a greater forward-looking assessment of an employer’s financial ability to support a scheme help trustees with an employer like Carillion who has been heavily criticised for adopting aggressive accounting practices, declaring revenue and profits based on optimistic forecasts, before the money has actually been made? The solution may yet lie in the outcome of the Financial Reporting Council’s ongoing investigation into the audit, preparation and approval of the financial statements of Carillion PLC.

This blog was written by Catrin Young.