Holiday pay audits advisable after De Mello ruling, says lawyer

As we reported last week, the Employment Appeal Tribunal has for the first time handed down a decision on the application of the Supreme Court’s ruling last year in Agnew that a three-month gap in deductions does not necessarily break a ‘series of deductions.’ The case, British Airways v De Mello, provides helpful guidance for employers on what payments will be included in holiday pay and the limited scope for arguing that holiday pay claims are out of time. As a result employers are being advised to review their holiday pay arrangements to limit potential liability, especially in the energy and construction sector where this is a big issue. We’ll speak to a holiday pay expert about conducting holiday pay audits and HR’s role in that exercise.

A reminder. Holiday pay claims are often brought as unlawful deduction from wages claims, the deduction being the failure to pay the full amount of holiday pay due. Before last year's Supreme Court judgment in Chief Constable of the Police Service of Northern Ireland v Agnew previous case law held that if there was a gap of more than three months between deductions, the ‘series’ would be broken so preventing a claimant going further back in time in their claim in order to recover earlier underpayments. That limitation on the employer’s liability was overturned by the Supreme Court in Agnew and the EAT has now followed Agnew in the De Mello case. It means claimants can link a series of underpayments into one claim, albeit with the proviso that the claim is brought within three months of the last deduction in the series. Employers in Great Britain can take some comfort from the fact that The Deduction from Wages (Limitation) Regulations 2014 limits claims for backdated holiday pay to a maximum of two years. However, those regulations don’t apply to Northern Ireland which means employers in Northern Ireland do not enjoy the benefit of that 2-year backstop so are exposed to a greater potential liability. 

The facts of this case briefly. The claimants were cabin crew for British Airways and they had a complicated pay structure including multiple different allowances. They argued these allowances should be included as "normal pay" when calculating their holiday pay and since BA had not included the allowances, they made claims to the Employment Tribunal for unlawful deductions from wages. The case reached the EAT where the main issue at stake was the type of holiday leave is being taken. 

There are three types of leave, namely EU-based leave (Regulation 13 of the Working Time Regulations), UK statutory leave (Regulation 13A) and contractual leave, and they are paid at different rates. Problems have arisen over the years as a result of these different leave entitlements, and how pay for that leave should be calculated, resulting in different elements of variable pay applying to Regulation 13 and Regulation 13A leave. So, can the employer specify the order in which workers take their leave and so dictate the level of pay and choose the least generous rate first? On the facts, the EAT ruled against BA on the basis they had not made any such designation and so all leave days were to be treated equally as part of a composite whole. However, the EAT has left open the possibility of an employer being able to designate leave provided they made it clear in the contract of employment. In other words, the employee needs to know that that is how their holiday leave is being treated from the outset.

So, clearly this is a complicated area with a myriad of rules in play which dictate the level of pay employees are entitled to. Going forward, it’s important that employers get those payments right and, looking back, it’s equally important to identify any miscalculations which could give rise to back pay claims. Those claims can go back 2 years for employers in Great Britain and, in Northern Ireland, all the way back to 1998, potentially. Given the EAT has now, for the first time, applied the Supreme Court’s ruling in Agnew it is something of a call to action for employers to check the compliance of their holiday pay structures. 

That compliance check will typically take the form of a detailed holiday pay audit so let’s consider that. Anthony Convery has been helping a number of clients with that exercise and earlier he joined me by phone from Glasgow to discuss what is involved: 

Anthony Convery: “A holiday pay audit involves an employer looking at how they're paying holiday pay and essentially making sure that they're doing it in compliance with the law, or at least ensuring that they are doing it in a way that mitigates any risk of ongoing claims for back pay. Since the Working Time Regulations were amended in January we've been looking at holiday audits for a number of clients. Some clients had already been paying average holiday pay for a long period of time and it's just been a case of checking their current practices against the amended legislation. Other employers haven't really been paying much in the way of average holiday pay and the new legislation has been a trigger for them to look at their holiday pay calculations and amend them so they are compliant with the correct legal position. A holiday pay audit typically involves looking at three key things. The first is looking at the pay elements and identifying which payments are in scope for holiday pay in which payments are out of scope and that can be quite a complex exercise because sometimes it's not entirely clear what side of the line payments fall on. Most employers have a number of payroll elements and you can get into tricky issues around things like payments that are categorised as bonus payments but which may be paid quite regularly which historically haven't been included, or commission payments or payments that may be expenses payments, and there can be some question mark for failure should be included. So there are lots of tricky issues when it comes to looking at pay elements. The second thing that we typically look at in a holiday pay audit is the method of calculating holiday pay. So, once you've identified the pay elements, how do you actually go about translating that into holiday pay? That usually involves an averaging calculation over the reference period, and it is usually 52 weeks, but there are various complicated rules about skipping weeks. For, example, what do you do about weeks when someone is off sick or someone is on family-related leave and so we need to get into the detail of how those payroll calculations work. Then the third thing we typically look at as the holiday pay policy in terms of things like carry over of leave because there are very complicated also about carry over, and the order that leave is taken in because of the complicated position regarding which days of holiday represent which type of annual leave. So there are lots of tricky issues that are involved in a holiday pay audit but looking at all of these things we can ensure that clients are complying with the law, or that they are at least mitigating any risk.”

Joe Glavina: “So when you’re conducting these holiday pay audits, Anthony, how do you work with HR and payroll?”

Anthony Convery: “Their role is to provide information about how things work on the ground in relation to the pay elements and the payroll system and their specialist knowledge is crucial in that process. So normally the client would normally collate a spreadsheet with all the details on it and then we would have a call, we would go through each pay element and also the payroll calculation in detail just to understand exactly what each pay element is for and how it works in practice. Having that specialist input into the process is absolutely crucial to make sure that it meets the required objectives.”

Joe Glavina: “This is concept of composite leave is very complicated so is there any merit in the employer simplifying matters and paying everyone the same more generous rate, albeit that’s more expensive?” 

Anthony Convery: “I think paying average holiday pay for all holidays and not distinguishing between the different types of leave definitely takes out complexity. It does make the payroll system easier to administer because it doesn't matter which day of holiday it is as it would be paid at the same rate. It doesn’t take away all the complexity because even if you pay all holidays at the same rate there still is this point around carry over of annual leave and because the rules are different regarding different types of annual leave. So for example, in the case of sickness absence the carryover is limited to four weeks’ annual leave, in relation to family-related leave when someone can't take their holiday because of family-related leave then it's the full 5.6 weeks. So even if employers pay holiday pay at the same rate it still is important to try to designate which days are which type of leave.”

Joe Glavina: “Now although these rules very much favour employees, we know that any claim does still need to be brought within three months of the last deduction in the series. So is the message to employers to try to limit any potential liability by starting to pay correctly from now on?”

Anthony Convery: “Yes, absolutely. Many employers have already started paying holiday pay correctly and have been doing so for some time but for those who haven't yet addressed it then, yes, we’re certainly advising them that the best thing to do is to address it as soon as possible because the sooner that employers start paying correctly the time can start running and the risk of claims for back pay reduces as the time goes on.”

Last week Anthony talked to this programme in some detail about the EAT’s ruling in De Mello and the three main issues decided in that case, namely which allowances should be included in holiday pay, which payments form part of a series of deductions and which type of holiday leave is being taken. That programme is called ‘EAT provides guidance on holiday pay after UK Supreme Court’s ruling in Agnew’ and is available for viewing now from the Out-Law website.

LINKS
- Link to HRNews programme: called ‘EAT provides guidance on holiday pay after UK Supreme Court’s ruling in Agnew’
- Link to judgment: British Airways v De Mello