On 10 December 2010, Mr Justice Briggs ruled in the High Court that any Financial Support Direction (FSD) or Contribution Notice (CN) from The Pensions Regulator (TPR) issued against an insolvent company will rank as an administration expense, and therefore take priority over other liabilities such as bank loans. This was a winning result for TPR in its case against the estates of Nortel Networks and Lehman Brothers.

Nortel Networks UK Limited and 18 other related companies in the Nortel group entered administration in the UK in January 2009. TPR decreed that 25 Nortel companies were liable to meet the £2.1bn shortfall in pension funding, nine of which were still solvent companies. The same issue was affecting the administration procedure of Lehman Brothers, with TPR demanding £130m to meet the liabilities of its underfunded pension scheme, so they issued joint proceedings challenging TPR's demands.

The High Court’s decision prioritises the pension deficit payment onus of an insolvent company on remaining group companies throughout the world over and above most, if not all, other creditors, including unsecured claims, preferential debts, floating charges and the fees of the administrators. Once pension deficits of insolvent companies have been paid off there may well be very little left for banks.

This has considerable implications for both current and future lenders and companies with defined benefit pension schemes seeking finance: lenders will have to assess their risk in not getting a return in the event of default; companies with deficits may struggle to raise finance. Reducing pension deficits is likely, therefore, to be even more of a priority for companies in 2011.

Lawyers lie at the heart of a solution to this problem for clients with defined benefit pension schemes, especially if they are in deficit. Last year, pension deficits rose to all-time high, fuelled by low-asset values and increases in liabilities. A number of innovative solutions were presented to reduce companies’ exposure to this liability, most in the way of asset-backed schemes. A fifth of the FTSE 100 now uses non-cash assets as a means of funding their pension schemes, with £8bn of the total £20bn (40%) pension fund contributions made from such assets.

A number of assets are suitable for asset-backed pension funding, with a growing trend for intellectual property such as brands, patents, trademarks, contracts, databases and copyright. Intellectual property is an attractive asset class because it is often an unleveraged asset, unencumbered by existing loan obligations. It can be valued reliably, separated relatively easily, and is often the most valuable asset the company owns.

Property has been a popular asset class to use to contribute to underfunded pension funds. Sainsbury’s has contributed £750m, Marks & Spencer £300m and John Lewis £95m. Intellectual property is an increasingly popular asset class with Interserve contributing 13 private finance initiative contracts worth £62m, John Lewis providing its 29% shareholding in Ocado, and engineering firm GKN contributing a collection of assets valued at £331m, including its trademark. Other assets have also been used such as ITV contributing part of its digital channel operator SDN, and Diageo contributing £500m of maturing whisky stocks to its scheme.

Legal involvement is central to these schemes, alongside valuation, tax and accounting advice, as they are governed by arrangements such as the transfer of assets, establishment of special purpose vehicles (SPVs), ‘bond-like’ agreements, licences, and operating agreements. There are a number of variations but the simple premise of the arrangement is that the corporate agrees to secure rights to an asset for the pension fund in event of defined default under specified circumstances, with the income based on the discounted cashflows generated from the asset transferred to the SPV. The pension deficit is reduced by a value related to the security provided and the operating company continues to use the asset under licence from the newly established SPV owning the asset.

This should be a win-win situation. Pension fund trustees gain security over an asset it can sell or operate if the company goes into default, and it places the corporate in a healthier position so it is more able to meet its ongoing obligations. The corporate wins as cashflow improves, the deficit reduces, there is an accelerated corporation tax relief benefit, Pension Protection Fund contributions are lowered as well as potential commercial benefits.

The reduced pension deficit and consequent improvement in liquidity could make the corporate a more attractive investment option for the banks. While secured finance may be harder to obtain, as another asset would be unavailable, clients with or seeking unsecured bank loans may find this an effective aid to obtaining more attractive terms.

This issue is far from over as the administrators have been given leave to appeal to the Court of Appeal, due for the first half of this year. What is certain, however, is that the implications of having a pension deficit are not going to go away and whether it is this judgment or another, clients will be increasingly receptive to innovative solutions such as this which resolve their pension deficits.

Thayne Forbes is joint managing director of Intangible Business, specialist IP valuation consultants and expert witnesses