Dr Marco Wilhelm, Partner and Head of Restructuring Germany Mayer Brown LLP
1. We often hear that there are specific legal, tax and economic issues or even risks associated with a pension buy-out - what is your actual experience?
The German Transformation Act (Umwandlungsgesetz) allows companies to spin off their pension liabilities and related assets. Although the transferring company is jointly liable for a pensioner company's financial liabilities for the first ten years, a pension buy-out significantly and immediately reduces the company's balance sheet. The joint liability is limited in time and therefore represents a better position, as the alternative without such a measure would generally be unlimited full liability. In addition, this secondary liability is very unlikely to arise in the case of a pension buy-out, partly due to the level of funding required by BAG (Federal Labor Court) jurisprudence.
However, companies need to be aware of a few things:
Initial funding (BAG jurisprudence), corporate governance, insolvency protection, reputational risks, etc.
2. If you had to describe the key points on the way to a pensioner company in the context of insolvency provision, what parameters need to be checked?
Firstly, there are the commercial and financial mathematical aspects. The decisive factors are the earliest date on which the pension liabilities will fall due and how long and in what amount these liabilities are expected to continue to exist. The following "risks" from the company's point of view must therefore be taken into account and assessed accordingly: the age of the retired employees, the granularity or structure of the retired employees' portfolio and liabilities, the development of interest rates and capital market scenarios, mortality tables and inflation adjustments.. Depending on the results of this calculation/assessment, the company will need more or less capital for the funding of the pensioner company in order to cover these risks in the event of a transfer of liabilities. A tailor-made investment strategy for the assets to be transferred must also be drawn up as part of the calculation/assessment.
The liabilities and the corresponding assets can be transferred from a company to a pensioner company thanks to the aforementioned right of conversion (Transformation Act). Companies do not need the consent of creditors to do this.
It is therefore crucial that the pensioner company has sufficient and legally compliant (BAG jurisprudence) assets to cover the pension claims. Otherwise, there is a risk of significant subsequent liability risks and the failure to achieve the desired balance sheet effects.
In many cases, pension entitlements are secured through contractual trust arrangements (CTAs). In a CTA structure, the assets and liabilities are segregated in an insolvency-proof manner and thus 'removed' from the company's balance sheet, i.e. netted. Dual-purpose trust structures are usually used for this purpose.
3. Why is it worth considering a pensioner company, especially in the context of M&A transactions?
Pension liabilities are always accounted for as provisions. These liabilities often remain on the balance sheet for decades and have a negative impact on the company and its value. In addition, the annual adjustment of provisions required by actuarial reports can have a negative impact on distributable profits. Such long-term obligations continue to deter potential buyers in day-to-day transactions or depress the purchase price.
Even if the economic logic of a merger or transaction is convincing, pension liabilities can stand in the way of a company sale because they cannot be calculated in absolute terms as they are subject to many external parameters. In addition, they are quite complex due to their different treatment under tax law, HGB and IFRS regulations.
4. Can a buy-out be a viable option when restructuring the balance sheet?
A buy-out can relieve the company's risk balance sheet, depending on the circumstances. Inflation and longevity risks are transferred, making the balance sheet less vulnerable to interest rate fluctuations. Depending on how the transaction is structured, the financial ratios of the transferring company can also improve significantly, thereby improving its credit rating and lending terms.
5. There is also the construct of liquidation insurance. How is this different from a pension buy-out?
In general terms, these are two very different approaches.
Liquidation insurance eliminates the aforementioned temporary secondary liability and biometric risks. However, the cessation of business and the liquidation of the company that is the beneficiary of the pension commitment are prerequisites for liquidation insurance. In the case of a "living company", the insurance solution must therefore at least be combined with a legal reorganization measure. From an economic point of view, this type of solution is often not all that interesting. A buy-out, on the other hand, does not require the liquidation of the company. The future results of the continuing business of the transferring company may even favor the buy-out.
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