The regulatory intervention report published by the Pensions Regulator following its investigation in relation to the Bernard Matthews Ltd Pension Scheme (Scheme), will be welcomed by private equity firms, at a time when many businesses may be in need of fresh capital injections, as it indicates that the Regulator does not object in principle to private equity firms making substantial profits, even where their efforts to turn around a business are ultimately unsuccessful and result in a DB scheme entering the PPF.
This outcome may surprise some given the scale of the profit made by the private equity investor in circumstances where the Scheme has ultimately received nothing on the insolvency of Bernard Matthews Ltd and has ended up in the PPF.
Back in March 2013, BML (a food products business specialising in turkey meat) was in severe financial difficulty and was required by the bank to refinance a proportion of its existing secured debt. This resulted in an offer of financing of £25 million from Rutland Partners LLP (Rutland), a private equity fund, which in turn entitled Rutland to 20% per year ‘payment-in-kind’ (i.e. accumulating non-cash) interest. Rutland’s financing was secured by a charge over assets which ranked behind the bank debt but ahead of the Scheme. Up to this point, the pension scheme had held a second ranking charge behind the bank’s security. Rutland also took a controlling stake in BML’s parent company. This led to their being able to control the decisions taken at board level due to the percentage weighting that their vote would carry.
Rutland’s investment was considered to be high risk, with little or no assurance that they would get any return. BML’s board approved the investment after concluding that the alternative would have been the insolvency of the business. The parties did not seek clearance from the Regulator.
As well as approval for the transaction by the board of BML, the trustees of the Scheme had to give their agreement in view of the change to the Scheme’s security. At no stage did Rutland itself assume any formal responsibility for the Scheme, whose sole statutory employer remained BML.
Efforts to turn BML around in the subsequent years were undermined by a decline in poultry prices in late 2015. Boparan Private Office (BPO) made an offer to purchase the share capital of BML which, if successful, would have meant that BML would continue to sponsor the pension scheme. However, exercising its rights as secured creditor, Rutland refused this as the offer would have involved Rutland writing off the majority of its original investment. Then in 2016, BPO subsequently made an offer of £87.5 million to acquire the business and assets of BML but not its debts, including the pension scheme liabilities. The BML board took the view, having taken professional advice, that a sale of the business via a pre-pack insolvency was the most appropriate option at the time, taking into account the interests of all of the group’s creditors.
BML entered administration on 20 September 2016 and, via the relevant court procedure, appointed administrators who sold the company’s business and assets to BPO on the same day. Rutland made a profit of £13.9 million on its investment, while the pension scheme received nothing under its third ranking charge and entered an assessment period with the PPF on BML’s insolvency.
The Regulator reviewed several thousand documents to assess whether there were grounds for issuing a contribution notice, taking account of the actions of the relevant parties in:
- the lead up to Rutland’s initial investment in 2013
- the period when BML was under Rutland’s ownership between 2013 and 2016, and
- Rutland’s rejection of BPO’s initial offer and the pre-pack leading up to the insolvency.
Regarding the initial investment, the Regulator found Rutland negotiated the terms of its investment on an arm’s length commercial basis, the financing provided by Rutland was high-risk given BML’s financial position and the payment in kind interest rate of 20% was in line with what was on offer in the private equity market at the time.
While the pension scheme trustees were aware that the future accrual of the interest could be detrimental to the Scheme if BML did not perform in line with the business plan, there appeared to be a high likelihood that BML would go insolvent in the absence of Rutland’s financing, as the banking lenders at the time were looking to exit their relationship with BML. In the circumstances, the trustees decided that it was preferable to allow the company an opportunity to turn around its performance in the hope that the Scheme’s members would ultimately receive their accrued benefits in full.
For the period between 2013 and 2016, the Regulator found the further decline in the business’ financials was not attributable to Rutland’s performance as an investor during this time, so it could not be said that their actions were materially detrimental to the position of the Scheme. Under Rutland’s control, efforts were made to restructure the company by reducing the business’ cost base, and BML’s losses before tax were successfully reduced from £18 million in 2013 to £3.7 million in 2015. However, this progress was derailed when the business was hit by an unforeseen decline in poultry prices in 2015.
In relation to the events leading up to the insolvency and pre-pack administration, the Regulator found no evidence to suggest that the sales process and pre-pack were carried out inappropriately or that Rutland sought to unduly influence or control either process. Rutland sought to maximise the return on their investment, and they did so in line with the terms agreed back in 2013 by the BML board. The Regulator concluded that Rutland’s profit was a legitimate consequence of the terms of its high-risk investment in BML which had been negotiated and agreed on an arm’s length commercial basis with the board of BML and the trustees.
The Regulator did not seek to conduct a full Financial Support Direction investigation as the initial analysis suggested that the insufficiently resourced test could not be satisfied.
The Regulator found that there were no reasonable grounds to use its Contribution Notice power in this case.
The key factors which appear to have led the Regulator to decide that it was not appropriate to exercise its anti-avoidance powers in this case seem to be that:
- Rutland had no links or obligation to the Scheme before its investment in Bernard Matthews.
- It negotiated the terms of its investment on an arm’s length commercial basis with an independent BML board and there was no evidence of bad faith or unreasonable behaviour by any party involved in the process.
- Rutland’s terms (including the 20% interest rate) were in line with what was on offer in the private equity market at the time.
- Rutland took active steps to restructure the business and the fact that the business continued to suffer losses was not due to the actions (or inaction) of Rutland.
- There was no evidence to suggest that the sales process and the pre-pack were carried out inappropriately or that Rutland sought to unduly influence or control either process.
In short, in the Regulator’s view, Rutland’s profit was a legitimate consequence of the terms of its high-risk investment in BML which had been negotiated and agreed on an arm’s length commercial basis with the board of BML and the scheme’s trustees. In addition, the Regulator had found no evidence of unreasonable conduct on Rutland’s part at any stage of its association with BML and the scheme or in respect of the sales and insolvency processes.
The outcome of this investigation may surprise some given the scale of the profit made by Rutland in circumstances where the Scheme has ultimately received nothing on the insolvency of BML and ended up in the PPF. The fact that the Regulator has reached the conclusion that it would not be reasonable for it to issue a Contribution Notice where all Rutland had done was to prefer its own interests over those of the pension scheme is unlikely to receive universal approval.
However, the outcome indicates that the Regulator does not object in principle to private equity firms making substantial profits, even where their efforts to turn around a business are ultimately unsuccessful where it can be shown that the firm has acted reasonably, demonstrated its commitment to restructure a business and where it has negotiated the terms of its investment on an arm’s length commercial basis and those terms are in line with industry practice at the relevant time. This will be welcomed by private equity firms, particularly at a time when many businesses may be in need of fresh capital injections.
Having said that, it is interesting to consider whether the new grounds for issuing CNs contained in the Pension Schemes Bill would have been applicable in these circumstances or, perhaps more importantly in the current economic environment, whether the 2013 rescue would have even gone ahead if the new criminal offences contained in the Pension Schemes Bill’s had already been introduced.