According to the Pension Protection Fund during March 2011 in the UK 3,675, or 56%, of defined benefit pension schemes were in deficit, with a combined shortfall of £48.8bn. Managing these pension deficits is a big task requiring significant attention from lawyers.

Over the past year or so, innovative solutions to manage these deficits have also appeared, using contingent non-cash assets. Such funding arrangements are supported by legal structures, transfer agreements, licence agreements and contracts, for which fund trustees and corporate sponsors rely on their lawyers for advice and implementation. This is a relatively new area which is open for development and represents a big opportunity for law firms.

There are many benefits to lawyers offering these services. First, there’s a lot of work to be done, requiring the involvement of lawyers across the firm in different practices, including pensions, intellectual property (IP) and corporate. Secondly, offering innovative solutions to clients makes the firm more relevant to them with the potential to gain further work as a result. Thirdly, this is likely to be a growth area which requires ongoing maintenance and therefore on-going involvement for lawyers. Law firms not up-to-speed with these developments risk losing out to the benefit of rivals.

Intellectual property, such as brands, trademarks, patents, copyright, software and contracts, are becoming increasingly attractive as an asset class suitable for such solutions. This is because IP is frequently highly valuable, can be separated simply, valued reliably, sold relatively easily and is often free of existing obligations – unlike property which is generally secured.

Structure outline

There are a number of variations on how such arrangements are structured. The simple premise is that the corporate agrees to transfer rights to the IP to a special purpose vehicle (SPV) over which the pension fund has rights in event of defined default under specified circumstances. The company continues to operate the IP and pays a royalty for its continued use into the SPV under a licence agreement. These cash flows are in turn contributed to the pension fund. The pension fund deficit is reduced by the value of the contributions of the security.

Company benefits

There are many benefits to the company. The deficit reduction is immediate and automatically lowers the payment protection fund levy which the sponsor generally pays. Contributions are also lowered as the IP is transferred in lieu of cash as the deficit payments are spread over a longer period of time. This improves the company’s cash flow which makes the company healthier and more able to invest in existing or new initiatives and this, combined with the more effective management of what was a significant liability, can also have a positive impact on the share price.

Another benefit to the corporate sponsor is the effective use of a previously unleveraged asset. Brands and IP can only be recognised on a company’s balance sheet if they have been acquired – and then the values are immediately out of date and generally undervalued. Using brands in this way is an effective way to leverage the capital value of the asset and communicate this to shareholders. Paying to continue using the IP under licence from the special purpose vehicle focuses management’s attention on its value, whereas previously it was being used as if it were free.

There is also an accelerated corporation tax benefit as future pension contributions are being made in one lump sum through the transferral of the IP assets. The higher the IP asset value the greater the benefit which can be considerable and make the scheme immensely attractive.

Trustee benefits

The trustees also gain from the company’s benefits. The company will be in a much healthier position, more able to meet its ongoing obligations and cash requirements. There is a trade-off between the scheme’s cash requirements to meet its obligations to pensioners and the need for security, which the scheme provides.

Trustees also benefit by having security over a valuable asset, or bundle of assets, which have been transferred at an amount which puts the trustees in a much stronger position in the event of distress.

The needs of the pension scheme and its trustees are a very important part of this process. The value at which the IP is transferred is one of the most crucial elements as this can also influence the proportion of cash the scheme continues to receive. The terms and definition of the default situation are also critical to protect the scheme and security for the trustees. A default trigger mechanism should be built into the contractual arrangements and a monitoring system put in place to monitor the value of the IP, acting like a warning system.

Ensuring the IP assets are bundled together and that the rights to these are transferred into the new SPV is also important. Brands can be complicated, consisting of much more than their name – the trademark – alone. A telecoms brand, for instance, will have a valuable name but without other connected assets such as customer contracts, spectrum rights, supply agreements, software and technology, the value would be significantly reduced. There is a key role for lawyers to play, to protect the interest of both corporate sponsor and trustees.

Examples of physical property

Property has been the most common asset class used for assetbacked funding. Marks & Spencer contributed £1.1 billion of property in three tranches in 2007, 2008 and May 2010. Another retailer, John Lewis, transferred £150 million of property in January 2010. Whitbread provided £228 million of property and other assets in May 2010 and in the same month Sainsbury’s transferred £750 million of property to its pension fund. Travis Perkins followed in June 2010 with 16 properties being contributed to its scheme.

Examples of intellectual property

Different types of intellectual property have also been contributed, such as loan notes, shares, contracts and trademarks. Interserve was first to market by transferring 13 public finance investment (PFI) contracts in December 2009 for £61.5 million which reduced its deficit of £250 million. Lloyds followed in January 2010 by transferred £5 billionn of loan note assets.

Shares are another popular intangible assets to use. ITV transferred shares in its digital terrestrial television licenseholding company SND Ltd. to its pension fund in May 2010 with trustees receiving £8.4 million a year for 12 years and a bullet payment to remove any remaining deficit up to £150 million. Food producer Uniq ceded 90% of its shares, worth about £9 million, to its pension fund in March 2011 to relieve the company of its £400 million pension deficit.

Trademarks have also been used with engineering group GKN transferring £331 million of assets including property and trademarks in March 2010 with trustees receiving £30 million a year for 20 years. Other more unusual assets have also been used, such as Diageo transferring £500 million of maturing whisky stock in July 2010.

Also in May 2011, travel operator TUI Travel, announced details of its new partnership arrangement to fund £275 million of its £431 million pension deficit using its leading brands, Thomson and First Choice, as security making annual income distributions to the pension fund of £16.5 million for 15 years until 2026 from the royalty payments. Intangible Business valued the Thomson and First Choice brands for TUI Travel and assisted in the implementation of the scheme. This is a watershed moment for the industry as it is the first time such valuable brands have been used in isolation of other assets.

There are plenty of precedents to refer to which will reassure clients of the benefits of the scheme. This creates considerable opportunities for clients with brands and pension deficits, whether business-facing brands such as GKN, or consumer-facing brands such as TUI’s.

Implementation

A number of different advisors need to be lined up to implement these schemes. Actuarial advice is essential to ensure the pension scheme is funded sufficiently; tax and accounting advice is required to set up the structures; and independent brand valuation specialists are required to value the assets, assist with negotiations and carry out the on-going brand monitoring. Legal guidance underpins the whole structure and agreement and is an essential component. Lawyers should be suggesting these schemes to their clients which have pension liabilities and intellectual property.

Deficit reduction and de-risking is very much a priority for both companies and trustees so clients will be increasingly seeking innovative schemes such as this. While a number of schemes have been completed already, the market is just beginning to open up so now is an opportune moment to capitalise on the trend and help clients reduce and manage a major liability more efficiently.

With the majority of defined benefit pension schemes in deficit and an average 80% of most company’s value being in IP, the marriage of the two is a win-win situation for corporates and trustees alike.