The recent takeover of Silentnight by private equity firm H.I.G in the UK, has led to concerns from the Pensions Regulator and Pension Protection Fund that firms may have found a way to buy and restructure profitable companies without having to take on their pension liabilities. Pension Funds Insider looks at the implications of 'the Silentnight case'

The story is one of many. Silentnight, the UK's largest bed manufacturer, got itself into trouble with a huge deficit. The Clydesdale Bank held a majority share of the debt and decided to rid itself of it. It was taken over by Bayside Capital, a subsidiary of American owned private equity firm H.I.G., and they then had the power to put the business into receivership.

A large share of the debt, however, was created by the pension scheme liabilities. Silentnight had a DB scheme with roughly 1500 members (mostly deferred) and liabilities were high.

As Bob Woods, executive chairman at pension consultancy firm Mattioli Woods explains, in order for Bayside to make itself a profitable deal through the rescue package, it offered the Pension Protection Fund (PPF) 6p in every pound to back the Creditors Voluntary Agreement (CVA) - a deal between the insolvent company and its creditors which protects a firm from predatory creditors - and also promised the PPF a 10% stake in the restructured business. "However, it offered other creditors 65p in the pound," says Woods.

Presenting a deal which would come down to a mere £5m, the PPF declined the offer. The company then went into administration via a quick 'pre-pack' arrangement, leaving a chance for H.I.G. to buy the company out. H.I.G. suddenly had control of a strong brand, without any liabilities. On top of that, 1,250 jobs were kept in place, leaving the private equity firm in a good light. However, the big loser was the pensions scheme which was left behind and entered into the PPF's assessment period.

In a press release dated 10 May 2011, the firm said that the takeover took place "after Silentnight was forced to file for administration following unsuccessful negotiations with the Pension Protection Fund over the company's unserviceable pension deficit".

Right or wrong?

Was the PPF right to reject the offer?

"Yes", thinks Jonathan Hazlett, partner at UK law firm Osborne Clarke and head of pensions law. "It is by far an ideal situation but going into administration leaves Silentnight with more than they would have received. Now they will receive roughly £7.6m."

"They received a lousy deal, also in terms of the 10% stake that was offered. The PPF's standard is 33% so that when the company makes a restart and does well the pension scheme will also profit from it."

Woods says that it is a difficult position to be in for the Pensions Regulator and the PPF, especially since there were jobs that could be lost. "But it is only fair that creditors are being treated equally. This was a bad deal, though not enough is known about the company's other liabilities to make a firm judgement."

Kevin Legrand, principal and head of technical services at Buck Consultants, says: "This is such an important area with wide consequences and needs to be looked at to see whether the balance between the competing financial interests on company insolvency is currently right.

"There are detailed insolvency rules, and accrued pension rights for former employees of the failed business have to fit into the picture," he says. "The rules have to ensure that pensioners get a fair share, but that potential investors in a business are not put off from investing through fear of losing an unfairly large amount of their invested funds."

On top of all this is can be argued that for a company to go bust will also have other consequences for their potential and it can by no means mean that this is the preferred option for other companies who will get into trouble in the future. The Regulator should have mechanisms in place for this situation and in that respect there can be talk of a 'loophole'.

"There is no simple answer," says Legrand. "It may be preferable to stick with a flexible system, with a mixture of set rules and regulatory discretion rather as we have now, but with perhaps a little more certainty or clarity over how the regulatory powers are likely to be used."

Now not all is lost for the members of the Silentnight pension scheme. The regulator can undertake two steps. Although the process might be lengthy the future looks not too bleak.

The role of the regulator

The Pensions Regulator says that a clearance processis available in the event of a corporate restructuring, albeit there is no obligation to do so. In this case, it says, no approach was received by the regulator.

"As a result of not receiving any detailed information, the regulator is now looking into the circumstances of the deal which enabled H.I.G. group to purchase Silentnight following a brief insolvency which was triggered by H.I.G. group as an existing creditor. This has placed the scheme into the PPF assessment period, which does not guarantee PPF entry," it said in a statement.

"The regulator is currently investigating the matter from an avoidance perspective. We of course can not predict what, if any, action may be appropriate."

This action, Hazlett says, can mean one of two things. One is to issue a contribution notice. Then there is the option of a financial support direction, regular cash or a cash guarantee. These issues have been handed out once and three times, respectively, but it is expected that the regulator will make a stance in this case.

Ordinarily clearance will only be granted if the regulator is satisfied that an offer has been made which presents the best possible outcome for the pension scheme in all the specific circumstances, and insolvency would be otherwise inevitable.

Also first it will have to be established that the regulator has a case in looking further than Silentnight. Although Bayside Capital was not a shareholder, it did have a degree of control, as did H.I.G. effectively, so it can be said that they were shadow directors. The regulator will have to show that what happened was detrimental to the pension scheme now not being able to fulfil all its liabilities.

But, warns Hazlett, it can take a funny turn. "H.I.G is American and it will be interesting to see if the Pension Regulator will have jurisdiction to follow up with the claims it will in all likelihood make."

Putting things straight

The regulator and the PPF say they are certainly not opposed to company 'rescue' bids, and are willing to have constructive discussions that lead to a fair outcome. In the right circumstances, the regulator and the PPF will agree to a controlled PPF entry.

"There have been reports that Neil Mernock, chief executive of Silentnight, had effectively blamed the PPF for the failure of attempts to win agreement among creditors to support a CVA. There have also been reports that The Pensions Regulator has rejected a deficit-for-equity swap. These statements are misleading", says the regulator.

"In this case, discussions with the PPF never resulted in a realistic offer which treated the pension scheme fairly with regards to the position of other creditors."

The PPF says it considered the offer "insufficient" in light of the debt owed to the pension scheme, the outcome which other creditors would have received, and the potential for Silentnight to generate profits. The next move will have to come from the regulator.

Pension Funds Insider contacted H.I.G., but the firm has not responded to our requests for comment to date.


First published 01.06.2011

azeevalkink@wilmington.co.uk