Hearn & Anor v Bell

1. This is an application by the Trustees of the Champion Pension Scheme (“the Champion Scheme”) for directions in relation to what is properly described as the Third Amended Joint Plan of Reorganisation (“the Plan”) filed in the US Bankruptcy Court in respect of the Federal-Mogul Group of Companies (“FMG”) as part of Chapter 11 proceedings under the US Bankruptcy Code. The sponsoring employer of the Champion Scheme is Federal-Mogul Ignition (UK) Limited (“FMI”), which is a subsidiary within FMG. Unlike other companies within FMG (most notably T&N Limited) FMI is not subject to any asbestos-related liabilities, which have been the cause of the group’s insolvency. Its liabilities to creditors (including the Trustees of the Champion Scheme) require, however, to be dealt with as part of the restructuring arrangements under the Plan, if it is to allow FMG to emerge from insolvency free of all the claims of its existing creditors.

2. On 2 nd November this year ( [2004] EWHC 2448 ) I gave directions to the Trustees of the T&N Retirement Benefits Scheme (1989) in relation to the Plan. As explained in paragraphs 1-9 of my earlier judgment, the purpose of the Plan is to compromise the claims of the creditors of FMG, the bulk of which claims are in respect of asbestos-related conditions alleged to have been caused by the products manufactured by T&N Limited and various subsidiary or associated companies. As already indicated, however, the creditors also include the Trustees of the T&N Scheme and the Trustees of the Champion Scheme.

3. In my earlier judgment I have set out the background to the Plan and have analysed its essential features. It is therefore unnecessary to repeat that here and I shall treat that material as incorporated by reference into this judgment. References to paragraph numbers are references, unless otherwise stated, to the paragraphs of that judgment.

4. Under the Plan as it stood on 2 nd November (and as it still stands in relation to the T&N Trustees) both sets of pension trustees were offered compensation for their claims in the form of a choice between what is described as the Let it Run option and the Alternative Treatment (see paragraphs 23-32). Let it Run envisages the continuation of the pension schemes until 30 th April 2012, but with the annual liability of the employer being limited to the annual maintenance cost attributable to active service by current employees within the scheme. There is to be no liability to top up the scheme in respect of past service benefits, so that the statutory liability arising under ss.56 -61 of the Pensions Act 1995 (or any successor provisions) is restricted. The employer is given the right to terminate the scheme on or after 30 th April 2012, and in that event the Trustees of the T&N Scheme will receive a cash payment equal to what is defined as the Allowed Amount of their claims against T&N and the other participating employers as of 1 st October 2001 multiplied by the T&N Distribution Ratio 1 plus interest. This is estimated to amount to 7.2% of the buy-out shortfall.

5. As explained in paragraph 32, Let it Run only applies if the Trustees of the T&N Scheme vote in favour of the Plan, give an irrevocable undertaking prior to the confirmation hearing to vote to approve any voluntary arrangement for T&N and the other participating employers, and such a voluntary arrangement is put into effect in England by the Administrators of those companies in order to implement the Plan. The last of these three conditions also has to be fulfilled for the Trustees to become entitled to an immediate dividend calculated on the basis of T&N Distribution Ratio 1. If the Administrators do not promote the Plan by seeking approval for the necessary voluntary arrangements, then the dividend payable to the Trustees will fall to be calculated by the application of T&N Distribution Ratio 2. This is estimated in the Disclosure Statement to be likely to yield a dividend equal to between 3.8% and 6% of the claims: see paragraph 29.

6. There are a number of objections raised by the Trustees of the T&N Scheme both to Let it Run and to the Alternative Treatment, and I examined these in paragraphs 33-54 of my earlier judgment. I have nothing to add to what I said there. At that time the treatment offered to the Trustees of the Champion Scheme, as set out in section 3.7 of the Plan, was broadly similar in many (but not all) respects to that available for the Trustees of the T&N Scheme. Section 3.7.3 set out the terms of Treatment A and Treatment B. Treatment A consisted of a choice between Let it Run and what is termed the Alternate Payout treatment, rather than simply Let it Run. Let it Run (as in the case of the T&N Scheme) envisaged the continuation of the Champion Scheme, with FMI’s annual contribution liability being limited to the cost of maintaining current service benefits. No contributions were to be made to amortise the underfunding relating to prior service benefits. FMI was given the right to terminate the Scheme on and after 30 th April 2012, in which case the Trustees would be entitled to a cash payment equal to the Allowed Amount of their claim multiplied by the greater of T&N Distribution Ratio 1 and the Company Specific Distribution Ratio plus interest, in full satisfaction of all claims. If the Alternate Payout treatment was chosen, then the Trustees would receive, on the implementation of the Plan, a payment (capped at a maximum of £9m) to purchase annuities to secure the benefits of all retired members currently in receipt of a pension and to provide specified transfer values for deferred and active members.

7. The availability of Treatment A under section 3.7.3 was subject to the same three conditions as applied to Let it Run in relation to the T&N Scheme. If these were not fulfilled, then the claims of the Champion Scheme would fall into Class 7H under section 3.7.2 of the Plan and were to be satisfied by a payment equal to the greater of: i) a proportion of the Allowed Amount calculated either by reference to the T&N Distribution Ratio 1 (if Consensual Marketing Procedures are not performed) or by reference to T&N Distribution Ratio 2 (if they are performed); or ii) the Allowed Amount of the claims multiplied by the Company Specific Distribution Ratio applicable to FMI.

8. In her second witness statement of 12 th October 2004 Mrs Hearn, the First Claimant, who is the independent Trustee and as such is entitled to exercise all the discretionary powers of the Trustees under the Scheme alone, explained why she had found it impossible to calculate which of the then existing options (if any) was most favourable to the members of the Champion Scheme, and it was envisaged that the Trustees would apply for directions immediately after the parallel application by the Trustees of the T&N Scheme, but in their case surrendering their discretion to the Court. In the event the application was adjourned to allow the Trustees to consider some revised proposals from the Plan Proponents, and as a result of that they now seek the Court’s approval to their voting in favour of the Plan in its amended form and to their giving the undertaking to support proposals for, and to vote in favour of, whatever scheme of arrangement or CVA in respect of FMI is necessary to implement the Plan in England. They also seek approval for their acceptance of the Alternate Payout (under section 3.7.3(b) of the Plan) in preference to Let it Run. At a hearing on 23 rd November I made the directions sought and I now give my reasons for doing so. The Revised Proposals

9. The relevant provisions of the Plan as recast are set out in an appendix to this judgment. One of the principal changes to the treatment offered is that the provisions applicable to Class 7H no longer apply in default. The Trustees of the Champion Scheme remain the only creditors in Class 7I under section 3.7.3 of the Plan and have available to them the series of alternatives specified in that section, which do not in any way depend upon the T&N Distribution Ratios. The problems of calculation outlined in my earlier judgment are therefore avoided. If the Trustees vote in favour of the Plan and give the required undertaking to support an appropriate scheme of arrangement or CVA, they are given the choice between Let it Run and the Alternate Payout treatment, provided that in each case a scheme or CVA is sanctioned for the UK debtor companies (or at the option of FMG), at least in relation to FMI.

10. In order to qualify for Let it Run, the Trustees must elect for it. The default position is the Alternate Payout treatment. Let it Run involves the continuation of the Scheme with no termination by FMI or the Trustees prior to 30 th April 2012. If the Scheme continues under Let it Run, the Trustees are required to implement rule changes reducing the accrual rate (in rule 6(A)) from 1/60 to 1/80 and the contribution rate (in rule 4(A)) from 5% to 4.5%. Rule 5 has also to be amended to limit FMI’s annual contributions to the lower of either the amounts which the Trustees consider (on advice from the actuary) to be necessary to enable benefits accruing after the date of election for members in active pensionable service to be maintained or the sum of £574,216. As in the original section 3.7.3, no contributions are to be payable to correct underfunding. If FMI elects after 30 th April 2012, under rule 52, to terminate its contributions to the Scheme, or the Trustees resolve to terminate the Scheme, then FMI will pay the sum of £8.4m plus interest in satisfaction of all claims. If the Trustees decide to accept the Alternate Payout treatment, they will receive £11m on the implementation of the Plan plus interest from the Election Date as defined. The Scheme will be treated as terminated upon payment of this sum.

11. The next possible alternative is that the Trustees do not vote in favour of the Plan or give the undertaking to support a scheme or CVA, but the necessary scheme or arrangement is nonetheless approved. In this event Treatment B applies and the Trustees will receive a cash payment of £8.4m. The difference between this sum and the £11m available from the Alternate Payout under Treatment A is only explicable as an inducement to the Trustees to support the Plan and its implementation.

12. The final scenario is that no scheme or CVA is approved for FMI in England. This could occur whether or not the Trustees of the Champion Scheme support the Plan. One possibility which exercised the Trustees (and on which they obtained legal advice) was that they might support the Plan by voting in favour of it and giving the undertaking, yet be deprived of Treatment A by factors beyond their control, such as a refusal by the Administrators of FMI to promote or support a scheme. In that event they would almost certainly have submitted to the jurisdiction of the US Court and might find themselves disabled from pursuing their claims against FMI in English proceedings, notwithstanding the failure of the English Court to approve a scheme. To avoid these difficulties section 3.7.3(e) expressly provides that if no scheme of arrangement or CVA is approved, then the Class 7I regime has no application and the Trustees are free to pursue their remedies against FMI under English law. There is therefore no disadvantage for the Trustees in positively supporting the Plan in the US proceedings if it is otherwise appropriate to do so. Under section 3.7.3, as now qualified, they will either get £11m (if they support the Plan and opt for the Alternate Payout) or they will be left where they started, with their legal rights against FMI intact. The Choice to be Made

13. The form of the revised section 3.7.3 narrows the decision to be made quite considerably, and this explains why the Trustees no longer intend to surrender their discretion to the Court. There are essentially two choices to be made: the first between Let it Run and the Alternate Payout of £11m; the second between Treatment A in one of these two forms and the pursuit of remedies against FMI outside the Plan, in all probability in the context of a liquidation. It is only if the second of these two options is clearly balanced in favour of a dividend under a controlled realisation or liquidation that the Trustees will be justified in risking the application to them of Treatment B, were the Plan to be approved through a scheme or voluntary arrangement notwithstanding their opposition to it. The Claims

14. It is necessary to begin a consideration of the Trustees’ position by outlining briefly the nature of the claims against FMI. The Champion Scheme is an exempt approved retirement benefits scheme. Pensions are payable at the age of 65 for members of both sexes at a rate of 1/60 of Final Pensionable Earnings, as defined, multiplied by the relevant period of pensionable service. Members who joined before September 1984 have the benefit of what is described as a “no worse off” guarantee. There is also provision for early and late retirement. Contributions by active members are paid at the rate of 5% of pensionable earnings under rule 4 of the Scheme. As at 30 th September 2004, there were 286 active members, 443 deferred pensioners and 424 pensioners. The Scheme has been closed to new members since 30 th April 1997.

15. The actuary of the Scheme (Mr Andrew Staddon of Hewitt Bacon and Woodrow Limited) has estimated its assets (again as at 30 th September 2004) in the sum of £45.5m. FMI has paid the monthly contributions provided for by the actuary for the purposes of meeting its statutory liability for MFR purposes under ss.56 -61 of the 1995 Pensions Act, but notwithstanding this, the actuary calculated that as of 1 st May 2001 there was a past service deficit of some £7.8m and that funding was only 90% of the cost of benefits, even on an MFR basis. This deficit was reduced to only £300,000 by the payment of a special contribution of £7.5m from FMG immediately prior to FMI being placed in administration, but the Scheme is in deficit again, largely due to the downturn in the equities market. On 24 th September 2004 the independent trustee resolved to adopt a gilts-matching policy in place of a mix of gilts and equities, which resulted in a recalculation of FMI’s liabilities under the Scheme. As of 30 th September 2004 the MFR deficit stood at £1m, but based on Mr Staddon’s actuarial advice, the Trustees served a demand on FMI on 30 th September in the sum of £43.9m, which is what is calculated to be necessary to fund benefits on a buy-out basis. As explained in my earlier judgment, this will be the scale of the statutory liability under s.75 of the 1995 Act , if the Champion Scheme is terminated prior to a liquidation of FMI, but if the liquidation of the company precedes any winding up of the Scheme, the sum payable on an MFR discontinuance basis will be £5.4m. The Administrators of FMI dispute the current demand for £43.9m, but it is that figure which has formed the basis of the negotiations with the Plan Proponents in devising the new Class 7I treatment. The Exercise of the Discretion

16. Since I am no longer called upon to exercise the Trustees’ discretion myself, I am only concerned on this application to satisfy myself that the proposed exercise of the discretion by Mrs Hearn is one which she, as a reasonable trustee properly directed on the material before her, could reasonably make. I explained the limits of the Court’s function in this regard in paragraphs 10-12 of my earlier judgment.

17. Mrs Hearn wishes to support the Plan by voting in favour of it and giving the undertaking referred to section 3.7.3(b)(i). She has taken advice from Messrs Baker Tilly on what she might expect to receive from a sale of FMI’s business and core assets outside the Plan, most likely on a liquidation. They have estimated that the likely dividend (on a buy-out basis of claim of £44m) would range from £5.06m to £9.46m. They point out, however, that FMI currently continues to be loss-making and that the only likely buyer for the business would be FMG. In the absence of competition the assets are likely, in their opinion, to realise a sum closer to the lower end of the dividend range and therefore significantly less than £9m.

18. Mr Staddon has calculated the likely benefit coverage which would be achieved from the various sums on offer under the Plan (again on a buy-out basis). He has advised that a payment of £11m would provide 100% cover for pensioners and 75% cover for non-pensioners (excluding increases in payment in both cases). £8.4m would also produce 100% cover for pensioners, but only 69% for non-pensioners. A dividend on a liquidation of £9.46m would produce 73% cover for non-pensioners, but the likelihood is that the dividend will be significantly less than the £8.4m default figure available under Treatment B. Mrs Hearn has therefore concluded that the cash options available under the Plan are preferable to seeking a dividend on a liquidation, and this therefore rules out Treatment B as a sensible or proper option. The real choice faced by her is between the Alternate Payout and Let it Run.

19. Mrs Hearn has decided to opt for the Alternate Payout. That decision is based on the expert advice of Mr Staddon, who has calculated the comparative benefits of the two possible treatments. This is not a choice which has to be made immediately, but all parties to the application are agreed that in the interests of saving both time and costs it is convenient for the issue to be raised and decided now.

20. As already mentioned, the receipt of £11m following the implementation of the Plan will secure 100% of the benefits payable to pensioners and 75% of the benefits of non-pensioners. Let it Run is only preferable if it is likely to produce over time significantly enhanced benefits for the members of the Scheme as a whole over what can be secured for them now by accepting the Alternate Payout. Mr Staddon has calculated that Let it Run will only achieve this if the Trustees change their investment policy from gilts-matching, restore a 57%/43% mix of equities and bonds, and equities out-perform gilts over the next eight years by 2% or more per annum. Historically, over eight-year rolling periods, this has occurred in about 50% of such periods. Any substantially better performance by equities is considerably less likely. There is therefore some prospect that enhanced performance by equities could increase the benefits coverage for non-pensioners to as much as 90%, but also a 20% chance that under-performance would occur. This would lead to a significant reduction in benefits coverage for non-pensioners, compared to what is currently available under the Alternate Payout treatment.

21. Mrs Hearn has opted for certainty against a background of unpredictable equities markets. She has also taken into account the possible legal difficulties involved in Let it Run, which are referred to in paragraph 36 of my earlier judgment, and the possibility that FMI might fail before 2012, thereby leaving the Trustees with a termination in funding and no certainty about obtaining the £8.4m due on termination in 2012. It is of course the case (as she accepts) that some beneficiaries will be better or worse off than others, depending upon the treatment chosen. By opting for the Alternate Payout rather than Let it Run, in order to produce a certain return of 75% for non-pensioners, one excludes the ability of active and deferred members to achieve 100% of cover by attaining pensionable age during the continuation of the Scheme prior to April 2012. But to allow that would risk the cover available to non-pensioners at that date, if there was a return to investment in equities by the Trustees followed by a downturn in the equities market. There is a balancing exercise to perform, and Mr Burroughs for the representative Defendant, who is one of those who would become pensioners before April 2012, rightly accepts that Mrs Hearn was entitled to opt for the Alternate Payout in the circumstances which exist at this time. She has obviously had regard to interests of the members as a whole in deciding how to exercise her discretion.

22. The other matter to which some consideration has been given in relation to Let it Run, and more generally, is the Pensions Act 2004 , which has now received the Royal Assent. Sections 44 -52 of the Act enable financial support directions to be given by the new Pensions Regulator, requiring arrangements for the financial support of a scheme to be put in place by a person associated or connected with the employer. However, the regulations which will determine the type of arrangements contemplated are yet to be published, and it is not clear whether any such directions could be given to FMG.

23. The Champion Scheme as an occupational defined benefits scheme is also eligible for protection under the pension protection provisions set out in Chapter 3 of Part 2 of the Act , provided that the Scheme is not being wound up before the appointed day, which is likely to be in April 2005. Again the details of PPF cover will be contained in regulations yet to be published. The statutory duty to provide protection will not apply unless the value of scheme assets is less than the amount of the protected liabilities, which in the case of non-pensioners will be 90% of benefits cover. The availability of PPF cover will also depend upon a qualifying insolvency event occurring in relation to FMI prior to the Scheme going into winding up. This is unlikely if the Alternate Payout option is chosen, but also far from certain under Let it Run.

24. The Act also makes provision for what is called the Financial Assistance Scheme. This was introduced into the Bill at a late stage and appears to be intended to offer assistance to a scheme which is wound up before the PPF provisions come into force. Again there is a complete absence of detail in the Act , which makes the evaluation of its potential benefits uncertain.

25. Mrs Hearn has considered the possible effects of the new Act upon the Scheme, but has concluded that its provisions are unlikely to offer sufficient assurance to outweigh the benefits to be gained from the Alternate Payout treatment under the Plan. It seems to me that this is a view which she is clearly entitled to take. She has, in my judgment, had regard to all relevant factors which bear on the decision she has to make, and the exercise of her discretion is not open to challenge. The Trustees are therefore entitled to the directions which they seek.