24th January 2018 Do the GKN trustees really matter to Melrose?
Pension scheme trustees tend to keep quietly in the corner, talking about breach of trust and mortality assumptions, but every now and then they find themselves in the glare of publicity that surrounds the world of M&A.
The latest trustee board to hit the limelight is that of the defined benefit pension scheme for employees of GKN plc and its group. The group is subject to takeover bids, with a hostile bid from Melrose Industries receiving a lot of attention. The trustees of the GKN pension scheme have apparently fired a warning shot at Melrose on 16 January, reportedly saying that they may well need to provide extra funding to the pension scheme, particularly if the group is broken up post-acquisition.
There is no question that the pension funding can be a fundamental issue for acquisitions, particularly in the listed sector. Those with long memories are aware that pension scheme trustees can scupper a bid for a listed company with mere words – in 2004, Permira’s bid for WH Smith notoriously fell away after the trustees of the Smiths pension scheme made it clear that they would demand very significant further funding if the bid succeeded.
How serious are these threats from pension trustees? It is not the job of trustees to try to affect the operation of markets, but they do have to act in the interests of the trust, and that might involve flagging to potential buyers what they risks might be. Of course, they are looking to assess the security of the pension scheme, so simply “fearing change” is not a sufficient motivation – the Smiths trustees were worried about a significant increase in gearing expected from a private equity investor, and the reports of the GKN trustee comments revolved around the need to ensure the pension scheme is secure in a reorganisation.
How effective the threat might be depends on the trustees’ powers and these vary from pension scheme to pension scheme, depending on the wording in the scheme documentation, usually written many decades ago when the scheme was set up. The Smiths scheme reportedly included a power for the trustees to demand funding whenever they wanted, making the threat of an extra payment completely viable. None of the reported information explains how the GKN trustees may demand more funding, and it may be that they are simply flagging that any loss of security may involve the trustees attempting to use the statutory framework to demand more for the scheme.
The statutory framework doesn’t give trustees the same direct power to demand money. Effectively, the valuation of the pension scheme (which must be at least every three years) sets out the contributions that the company must pay into the scheme. That valuation is agreed between the trustees and the company so neither generally has the upper hand. A trustee board worried by an acquisition will inevitably be harder to satisfy in this negotiation, generally leading to higher contributions. If the GKN trustees are ignored, Melrose will find itself with a more challenging negotiation in the next valuation round, so any budgeting based on “business as usual” may need to be revised.
In addition, the trustees can attempt to involve the Pensions Regulator. The Regulator has the power in limited circumstances to demand a payment into the pension scheme where the owner or its group has taken actions which damage the security of the pension scheme. Certainly, the GKN trustees might interest the Regulator in considering its powers if the group is reorganised. In practice, the Regulator rarely uses its powers but often uses the threat of them to obtain concessions, either in changes to the proposals, or extra scheme funding.
How much should Melrose worry about the trustees’ statements? As ever with pension schemes, it depends on the details – if the trustees have a power like that in the WH Smiths scheme, then Melrose need to take this very seriously indeed – it could affect cashflow on day one of the acquisition. If not, then the concern is more nuanced, but that does not make the trustees toothless.
Fundamentally, angry or worried trustees can cost businesses a great deal – from the time taken to deal with negotiations and requests from the trustees and the Pensions Regulator, to actual cash demands into the pension schemes. Melrose, like any other acquirer, would need to be aware of these risks.
A pension scheme can easily be a very significant liability in the valuation of a target for acquisition, and often one of the hardest to value. Not only are the accounting figures on the scheme funding generally a significant understatement of the liabilities, but the cashflow costs depend significantly on the powers and attitudes of the trustees, which are hard to know without significant due diligence. This is always the challenge for a hostile bid, without that ability to meet the trustees in advance, and generally can make a bidder more nervous of the pensions issues.
Melrose should certainly not take the trustees’ comments lightly. Any future planning will need to take into account the need to provide funding and security to the trustees, and cashflow requirements should include a provision for potential rises in contributions. That said, the trustee comments as reported appear to be a shot across the bow rather than a direct attack, and a well-advised and well-funded bidder should not be put off by this level of warning.
If Melrose’s bid is successful, it would be well advised to make an early discussion with the GKN trustees a priority. This will allow the trustees to retire from the limelight to their more comfortable surroundings of discussion and negotiation, in which the more confidential details of Melrose’s future plans can be shared and the issues thrashed out, in a way that keeps the scheme well-supported, letting all the threats and rhetoric recede into distant memory.
Rosalind Connor, Partner
This article was published in Acquisitions Daily
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.