To accommodate the desire for single member pension investment in private companies, pension trustees typically permit the investments to proceed by way of debt but also by way of equity investment in very limited circumstances. Broadly, the lending transactions between the borrowing company and the pension are similar to small private debt or alternative credit transactions. However, many aspects need to be tailored to the pension investor.

Structure and legal overview

IORP II

To begin, it should be noted that most single member pension providers are awaiting publication of the IORP II directive’s (the “Directive”) implementing regulations to assess the impact that it is likely to have on single member pensions. If the derogation for single member pensions is not included in the regulations, they will have to abide by the investment restriction included in the Directive. This restriction requires a pension’s assets to be invested predominantly in regulated markets.

Revenue

Investment by pensions in the shares of private companies is already restricted due to a Revenue requirement that limits all pensions’ private company shareholdings to 5% of scheme assets and 10% of the company’s issued share capital. However, at present there are no similar restrictions for debt such as the provision of a loan or purchase of loan notes from a private company.

Unit trust

More often than not, the relevant pension trustee will have in place a close-ended exempt unit trust to hold these loans or debt instruments on behalf of their pensions. This provides greater flexibility and reduces the administrative burden where an asset needs to be transferred to another pension or post-retirement vehicle. Where investment is made by way of debt, or equity, it must occur on an arm’s-length basis and for the sole purpose of providing relevant benefits for the pension member come retirement.

Documents

In considering the legal aspects of structuring a loan to a private company’s trustees, it is necessary that legal advice is taken. This should be done to ensure that the documentation is drafted with the pension in mind. For instance, it would be typical for:

• Specific pension events of default to be included in the loan agreement or loan note instrument. It might be stipulated that the death of the pension member is an event of default, and/or where the tax exempt status of the pension has been withdrawn by Revenue an event of default is triggered;
• A full set of borrower warranties and financial covenants to be included. These should be broadly similar to those that a corporate borrower will provide to an institutional lender. The warranties should be wide-ranging and unambiguous as to the borrower’s obligations and any financial covenants should ensure that the borrower must provide a complete set of up-to-date financials to the pension on a regular basis;
• The borrower’s constitutional documents to be reviewed in detail to ensure that there is nothing in those documents that will prevent the company from entering the transaction;
• The shareholding structure of the borrower and related companies to be reviewed to ensure that the beneficial owners of the company, if any, are not connected to the pension investor for the purposes of tax law;
• A property lawyer to be instructed to review title and to raise necessary queries where a fixed charge over a property asset is being provided by the borrower as security; and
• The borrower to provide the pension with signed and dated board minutes showing that its directors convened a board meeting to consider the loan and agreed that it was in the borrower’s best interests to incur the indebtedness and complete the loan transaction.

Commercial considerations

The commercial aspects of the loan such as the rate of interest payable by the borrower, the interest repayment frequency and the loan term will need to be agreed with the borrowing company at the outset as well the nature and scope of any security that is to be provided. It would be typical for the pension member and their financial advisor to negotiate and agree these aspects.

It will also be necessary for the financial advisor to assess the borrower’s solvency, market and business plan before proceeding. Depending on the nature of the borrower’s business and its trading status, certain fund regulations will also need to be considered by the pension investor and the trustee.

Conclusion

Since the recession, pension lending has become more prominent as an alternative source of funding to bank finance. It is especially useful for companies in growth stages; those seeking seed or expansion capital and particularly where companies are not yet at the stage where bank finance can be obtained.

The finance documents should be drafted to consider the fact that the lending entity is in fact a pension(s) and not a bank or private equity firm. Revenue rules must also be considered by the financial advisor and the trustee and the pension investor’s financial advisor should carry out a detailed investigation of the borrower’s business.

The IORP II implementing regulations, whenever they appear, are likely to have a major impact on single member pensions. If the regulations are implemented without the existing derogation, it will add a further restriction on the extent to which these pensions can seek the potentially higher returns available in unregulated investments such as private company finance or directly held property.

For more information regarding single member pension investment in private companies, contact a member of our Pensions team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.