Italy Parmalat Clawback Actions

Journal Issue

Feb 2006

Column Name

European Update

Citation

ABI Journal, Vol. XXV, No. 1, p. 36, February 2006

Topic Tags

Fraud

International Insolvency

Practice and Procedure

Journal HTML Content

Editor's Note: 
European legislators and courts continue to wrestle with two
different issues, both of which are very much in the public eye: the

fallout from large-scale financial collapses and the funding of pension

schemes. In Italy, the Parmalat failure inspired rapid statutory
reform, important features of which are now in the early stages of
constitutional challenge. In the United Kingdom, there has been a
complete overhaul of pensions legislation, including the creation of

a new regulatory regime that effectively gives the new Pensions
Regulator a seat at the table in any restructuring scenario. 2006
will continue the pace of European reform in these areas. 
The special administrator of Parmalat
commenced clawback actions against various banks with a face value
of 7.5 billion euros. A recent decision by the Court of Parma in the

clawback action against one major bank (which is a test case to
establish a precedent for all of the claims against the banks) has
resulted in these proceedings being suspended. The Parma court has
referred the question of the constitutionality of Article 6 of the
Marzano law (under which the clawback actions are made) to the
Constitutional Court. The date for the Constitutional Court hearing
has not yet been set, but it is expected that it will take place in
mid-2006. Clawbacks under Italian law Depending

on the type of insolvency or restructuring proceeding, clawback
claims can potentially be made against any party that has entered into a

transaction with, has been granted security by or has received a
payment from the insolvent company during the relevant timeframe. A
claim will only succeed if the creditor was aware of the insolvency
at the time of the transaction. In practice, constructive knowledge
may be sufficient. The relevant timeframe depends upon the type of
transaction. At the time of the Parmalat insolvency, the relevant
timeframe was within either the 12-month or the 24-month period
preceding the insolvency. This timeframe has now been reduced by
statute to six months or 12 months. A new form of restructuring

proceeding was introduced by the Marzano law to deal with
complicated insolvencies such as Parmalat. This new type of
restructuring proceeding was substantially the same as an existing
type of proceeding: “extraordinary administration.” Both

types of proceeding have the same purpose, and the insolvent company

is able to continue in business during the restructuring.

However, the law on clawbacks in extraordinary administration is
different from that introduced for restructuring proceedings under
the Marzano law. When a company is in extraordinary administration,
the administrator can only bring a clawback claim once the
continuation of business phase has ended and the company is being
liquidated. Under the Marzano law, Article 6 provides that clawback
actions can be commenced at any time. Accordingly, the special
administrator of Parmalat commenced the clawback actions against the
banks that are referred to above while Parmalat continued in
business. The Grounds on Which the Parmalat Clawback Actions

Have Been Challenged The banks have challenged the clawback

actions brought by the special administrator on two grounds:
 1. The provision of the Marzano law that permits clawback actions to

be brought at any time is constitutionally invalid; and 2.
The clawback provisions are in breach of EU law on state aid. 
The case that has just been heard by the Parma court deals with the
first of these grounds. The banks argued that the clawback
provisions of the Marzano law were in breach of Article 3 of the
Italian constitution, which requires equality of treatment.
Extraordinary administration and special administration under the
Marzano law have the same purpose, yet clawback actions—it was

argued—are treated in a very different way. The banks
also argued that the clawback provisions were in breach of Article
41 of the Italian constitution, which requires freedom of competition.
At the time the clawback actions were filed, Parmalat was a large
company continuing to trade. If such a company were allowed to bring

a clawback action, this would give it a competitive advantage as it
would have an increased cash flow as a result of money received from

clawback actions brought against former creditors. The
Parma court held that both grounds gave rise to a serious challenge
to the constitutionality of Article 6 of the Marzano law and so should
be referred to the Constitutional Court. U.K.: New
Legislation Dealing with Underfunded Pension Schemes There
have recently been important changes in U.K. pensions legislation.
These changes relate to the powers of the new Pensions Regulator and the

legal obligations of sponsoring employers and some third parties in
relation to pension liabilities. The changes are likely to have a
significant impact on companies with a defined benefits pension
scheme, particularly where those companies are facing financial
difficulties. Moral Hazard Provisions To reduce

the risk of pension schemes falling into the Pension Protection Fund

(which is modelled on the U.S. Pension Benefit Guaranty Corp. (PBGC)),

the Pensions Act 2004 includes “moral hazard” provisions.
As of April 6, 2005, the Pensions Regulator has significant powers
to look to third parties (i.e., not just participating
employers) to contribute to pension schemes in certain
circumstances. These powers are: • Contribution
Notices: The Regulator can, by issuing a notice, require
contributions to schemes (other than money-purchase schemes, unap-proved

schemes, schemes for over-seas employees and most public-sector
schemes) not only from participating employers, but also, in
appropriate circumstances, from other connected and associated
persons. • Financial Support Directions: The
Regulator can also require financial support to be put in place
where a participating employer is a “service company” or

is “insufficiently resourced.” In addition, there
is a new funding requirement on ceasing to participate: As of Sept.
2, 2005, the debt arising under s75 Pensions Act 1995 when an
employer ceases to participate in a multi-employer scheme has increased
from the Minimum Funding Requirement (MFR) level to the buyout
level. The buyout level is the cost of securing all benefits by
purchasing matching policies with an insurance company. This is
usually a far greater amount than the MFR level, and represents a
very significant change with a major impact on corporate
transactions and internal restructurings. These provisions can
affect intra-group reorganisations as well as sales to third parties

if the effect is that employer ceases to be a participating
employer. Contribution Notices The
power. The Regulator can issue a contribution notice (CN) to a
person stating that the person is under a liability to pay the full s75

debt. The notice may be issued to an employer or a person who is
“connected with” or “an associate of” an
employer where: • there has been an act or deliberate
omission (on or after April 27, 2004, and within the last six years)

that reduces the recovery of a s75 debt or, otherwise than in good
faith, reduces the amount of the debt; • that person was a
party to (or “knowingly assisted” in) that act or
omission; • the Regulator considers that reducing the s75
recovery/debt was the main purpose (or one of the main purposes) of
the act or omission; and • the Regulator thinks it is
reasonable to impose the debt on that person. The definitions
of connected parties and associates are very wide and includes other

group companies, directors and 33 1/3 percent shareholders.

Financial Support Directions The power. The
Regulator can issue an FSD where, at any time within the last 12
months, the employer is or was: • a service company
(i.e., its turnover principally derived from providing
services to other group companies); or • insufficiently
resourced (i.e., it did not have sufficient assets to meet 50

percent of the s75 debt in relation to the scheme and at that time
there was a connected or associated person who did have sufficient
resources). An FSD requires the person to whom it is issued
(again, it must be reasonable for the Regulator to do this) to
ensure that financial support for the scheme (broadly, funding or
guarantees) is put in place within a specified period and maintained

throughout the life of the scheme. (Companies must notify the
Regulator of anything that later has an impact on the financial
support.) The FSD can be directed at the employer or person
“connected” with the employer, but unlike CNs, it cannot

generally be issued against an individual. Practical
effect. This provision could be triggered even where the sale or

restructuring has occurred for legitimate reasons. Recipients of an
FSD will have to consider carefully the most appropriate type of
financial support to provide. Agreeing that all group companies will

be jointly and severally liable could cause problems with later
transactions. Funding on Ceasing to Participate
(s75) Section 75 debt. The s75 debt is a statutory
debt on an employer that is triggered when it stops participating in

a multi-employer scheme (but other employers continue to
participate). The debt is a share of any total funding deficiency in

the scheme. The share is normally based on the share of the
liabilities attributable to employment with that outgoing employer
(including its share of “orphan” members whose service did
not relate to a current employer). Before Sept. 2, 2005,
the funding deficiency was calculated on the minimum funding
requirement (MFR) basis. Because this is a relatively low test, often

no debt arose. Since Sept. 2, this debt has increased to the much
higher buyout level, potentially giving rise to a funding deficiency

in most occupational pension schemes. Approved
withdrawal arrangements. The Regulator, trustees and the leaving

employer can agree that the debt payable by the leaving employer is
less than the buyout debt. The minimum is the MFR level (presumably in
the future the “scheme-specific level”) plus any
cessation expenses; the balance must be guaranteed, with payment
triggered if the scheme starts to be wound up, a relevant insolvency

event occurs in relation to all the current active employers or the
Regulator reasonably so decides. The detail is complex, and
there are numerous conditions—e.g., the Regulator must
be satisfied that the s75 debt “is more likely to be
met” if the agreement is approved. It is not yet clear how the
Regulator will interpret this condition. Notification to

the Regulator Employers and trustees are obliged to notify
the Regulator of certain events under s69 of the Pensions Act 2004,
including any decision causing a pension debt not to be paid in
full, any change in an employer’s credit rating and a
controlling company decision to sell an employer. The Impact

of These Provisions on Restructuring and Insolvency When
the financial condition of an employer is precarious, the fact that
the potentially greater buyout debt is triggered by the commencement of
formal insolvency proceedings may have a bearing on the decision to
continue to trade. The directors might conclude that, properly
having regard to the interests of the company’s general body
of creditors, it is in the best interests of the creditors as a
whole for the company to avoid formal insolvency proceedings so that

those claims are not diluted by a claim made by the pension scheme
that is valued on the buyout basis. The combined effect of the
new regulations and changes to the accounting standards (which
require companies to show any scheme deficits on their balance
sheet) will be to increase the prominence of defined benefit schemes
that are in deficit or are underfunded. This will further
differentiate the financial stability of employers that contribute
to defined benefit pension schemes from those that do not.

As we see it, this may have two consequential effects on the insolvency

and restructuring market. First, companies that have a primary
liability (that is, as employer) to defined benefit schemes that are

in deficit on a buyout basis may be forced to restructure or, in the

worst-case scenario, commence insolvency proceedings. At the very
least, such companies may find it harder and more costly to raise
debt. As a consequence, the Regulator may consider issuing FSDs and
CNs to other companies within the group. This may lead to a second
raft of corporate restructurings and failures, caused by the
overburdening of companies’ cash flow and balance sheets as a
result of their financial obligations under FSDs and CNs. 
Mitigating the Risk Restructurings need to be planned
carefully if they are to avoid triggering a buyout debt under s75 or

the risk of participants being issued with CNs or FSDs. In
particular, care must be taken where it is proposed as part of a
restructuring that employees be transferred, companies wound up or value

extracted from the group (for example, by way of payment of a
dividend or the grant of security). This will be an issue even where

the company’s pension scheme has no deficit on an ongoing
basis because the Regulator is concerned with ensuring there is
potential funding for the (much) higher buyout basis required under
statute in certain situations. There are, however, some steps that
can be taken to minimise the moral hazard risk. Purpose.

Purpose is a key part of the CN test. Care must therefore be taken
in minuting the purpose of decisions that might weaken the strength
of the participating employer’s ability to fund the pension
scheme. “Purpose” will be assessed with the benefit of
hindsight, and experience with insolvency and tax legislation is
that it is notoriously difficult to assess. 
Clearances. Where a restructuring involves, or might affect the
financial position of, a participating employer of a defined benefit

pension scheme, the parties to the restructuring should seriously
consider the need to seek from the Regulator a clearance statement
prior to completion.2 Assuming full and
accurate disclosure to TPR in a clearance application, the transaction

will not be at risk of later being the subject of CNs or FSDs. Even
where formal restructuring tools available in the United Kingdom are

to be used, obtaining clearance could be prudent. This is because
the decision by scheme trustees to seek to compromise a pension
scheme debt gives rise to a duty on the employer and the scheme
trustee to notify the Regulator of the proposed compromise. This
might lead to a review of the proposed transaction by the Regulator.

Unless a clearance notice is obtained in respect of the compromise,
it is possible that the Regulator might issue a CN or FSD with respect
to any deficit. As a result of the compromise of scheme debt, the
scheme might also be excluded from the scope of the Pension
Protection Fund. This would clearly be a result to be avoided if
possible.

<hr><h3>Footnotes</h3>1 Contributing authors are Enrico Castellani,
Milan; Catherine Derrick, London; and David Pollard, London. 2
Transactions where companies should consider seeking clearance are
called “Type A Events.” These include issuing security
over material assets (other than security for new borrowings); returns

of capital, including special dividends, share buy-backs and capital
reductions; and changes in (direct or indirect) control of
employers—e.g., a disposal or group reorganisation.<hr>

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Journal Authors

Sandy Shandro

Journal Date

Wednesday, February 1, 2006 - 12:00

Bankruptcy Rule

2006

none