The High Court had to choose whether the proposed FSD costs amounted to one of the following:

It ruled in favour of the second option (see News brief "FSDs in insolvency: the Lehman/Nortel ruling", www.practicallaw.com/5-504-5699).

The court found, on the first option, that an FSD imposed post-administration cannot be a provable debt because it does not satisfy the statutory requirements that the debt must arise from a pre-existing legal obligation. In particular, at the time the companies went into administration, they were not yet under an obligation to the Regulator, so the Regulator taking action was merely a possibility.

The court eliminated the third option as being unlikely to have been intended by Parliament.

The Court of Appeal agreed with the High Court's reasoning. In relation to the first option, it held that the fact that the moral hazard regime involves the exercise of numerous discretions means that the possible future issue of an FSD is not a pre-existing legal obligation.

The Court of Appeal therefore had to undergo a balancing act between categorising the liability as either a prioritised expense or destined for a black hole. Given that Parliament envisaged that FSDs could apply in insolvency situations, the Court of Appeal held that Parliament cannot have intended for any resulting liability not to be paid. It therefore had to be classified as a "necessary disbursement" of the administrator, which is one of the categories of insolvency expenses set out in the Insolvency Rules 1986 (SI 1986/1925).

The Court of Appeal acknowledged that this conclusion produces odd results and highlights the conflict between pension scheme members and creditors, but concluded that there would be an "equal or greater anomaly...[if]...these liabilities...[were treated]...as not payable as an expense in cases where they are not provable debts, so that they disappear into the black hole".

There was one subtlety that the Court of Appeal mentioned, which was not focused on in the High Court judgment: the Court of Appeal expressly leaves open the question of the date at which the liability of an FSD comes into existence. The Court of Appeal argued that it is possible for the liability of an FSD to be created as early as the Regulator's Determination Panel's decision to issue the FSD, rather than at the date on which the FSD is actually issued. It remains to be seen whether this point will be considered in any appeal (it is not yet known whether permission to appeal to the Supreme Court will be sought).

This decision is, on the face of it, good for pension scheme trustees and the Regulator as it prioritises a company's pension deficit and gives them a stronger position in restructuring negotiations. In practice, however, it may cause difficulties and could mean that there are few winners.

An unhappy and unintended consequence is that, as a result of these costs being prioritised, more employers could be pushed into insolvency (leaving pension schemes without a healthy employer to fund them). Banks are already more resistant to lend/renew finance to companies with a pension deficit where there is the looming possibility that the Regulator could take most of the available assets and leave none for the creditors.

Such concerns are mitigated by the Regulator's obligation to use reasonableness during the FSD process; in particular, the support required to be put in place and/or any sum demanded in a contribution notice should be reasonable, and should take account of the assets of the company in administration and the number of creditors.

However, there remains a considerable level of uncertainty about what assets may be available to fund administrations and meet claims of creditors where the possibility of Regulator action hangs over a distressed group. This uncertainty, coupled with the already limited financing available to companies, may make it difficult to persuade potential administrators and stakeholders to seek to rescue businesses.