How holiday pay and employment status can affect company restructuring

2017 saw significant developments in employment law favouring the employee, reinforcing the need for investors and potential purchasers to carefully evaluate the employee position as part of their due diligence process.

Holiday pay

Anyone looking at purchasing a business in distress should review its practices on holiday pay because court rulings in recent years have increased companies' liabilities.

It may be the business has already taken steps to address the calculation of holiday pay and put this right. However, for those who have not done so, this remains a liability that could raise its head at any time. This will be particularly material for businesses that are heavy users of voluntary overtime or which operate generous commission schemes or have complex shift and on-call payment arrangements.

In 2012 the Supreme Court ruled (29-page / 132KB PDF) that a group of British Airways pilots should have two supplements contained in their terms of employment included in calculations of holiday pay, having referred the case to the Court of Justice of the European Union (CJEU). The supplements were a ‘flying pay supplement’ of £10 per flying hour, and part of a ‘time away from base’ allowance that covered meals and other costs.

The CJEU had said that the calculation of holiday pay as currently provided under the UK’s Working Time Regulations 1998 (WTR) was incompatible with the EU’s Working Time Directive.

The position as stated in the WTR is that for employees with normal working hours, it is legitimate for the employer to calculate holiday pay by reference to basic salary only, ignoring regular voluntary overtime, commission and similar payments such as shift allowances. But following this and other decisions a worker’s holiday pay should correspond to the “normal remuneration” they receive when at work and so they should not suffer any financial disadvantage when taking leave.

The courts have ruled that a worker working regular overtime will suffer a financial disadvantage when taking annual leave if they only receive a payment equivalent to their basic salary excluding these regular overtime payments.

As a result UK employers now face the prospect of claims for historic underpayment of holiday pay together with the increased payroll costs associated with applying this more generous method of calculating holiday pay from now on. This will be particularly expensive for businesses that currently calculate holiday pay based on basic salary only but operate a high level of voluntary overtime and / or have a generous commission scheme etc.

Based on these rulings the correct approach is to look at average pay incorporating not only basic salary but also incorporating:

• voluntary overtime that is worked on a regular and / or recurring basis;
• commission payments intrinsically linked to a workers tasks;
• certain bonus payments linked to productivity / work undertaken; and
• shift and standby payments.

This more generous interpretation only applies to the 20 days of annual leave required by the Working Time Directive. It does not apply to the additional eight days required by the WTR or any further holidays the employer chooses to grant under the contract of employment.

But at 20 days a year the back pay liability has the potential to be large, especially in relation to those who work significant overtime. Dealing with these claims can also involve a significant administrative burden. If settlement cannot be agreed at a sensible generic sum, the employer must review each individual employee’s working history and calculate the historic payments to identify the actual sums owed. This can be a time consuming and expensive exercise.

The UK government introduced legislation in the summer of 2015 which limited back pay claims of this kind to a maximum of two years. However, a decision of the CJEU in late 2017 cast doubt on the lawfulness of this two year restriction and a challenge by employees is anticipated during the course of 2018. Whilst the two year back stop remains good law for now, the risk exists that this could fall away at some point in the future, opening up claims dating back across a number of years and in turn significantly increasing employers’ liability in this respect.

Employment status and disguised employment status

A number of cases in 2017 challenged the employment status of groups of people, opening companies up to significant ongoing extra costs and the potential for major backdated claims.

So anyone looking at a business that uses significant numbers of self-employed consultants should carefully take stock of those arrangements to determine if they would stand up to scrutiny in the event that the individuals or Her Majesty's Revenue & Customs (HMRC) seek to challenge the legitimacy of the same.

Correctly identifying status is important, not only in the context of employment rights but also taxation. A lack of any clear statutory definitions means that the definitions of 'employee' and 'self‑employed' have evolved via case law and the exact terms used in a contract do not decide the matter, so determining status can be very difficult for all concerned. The courts and HMRC will, then, look at the day-to-day relationship of the people and companies involved.

Attention in 2017 focused on the 'gig economy', especially on cases involving Uber, Deliveroo and Addison Lee. Less well-covered were cases involving more traditional areas such as plumbing and double glazing.

The courts and HMRC are demonstrating an increasing willingness to scrutinise the relationship between a business and self-employed consultants. If that relationship does not stand up to scrutiny the engaging business can suddenly find that it owes liabilities to individuals whom it had previously regarded as legitimately self-employed, plus historic tax liabilities.

HMRC is taking an increasing interest in this area owing to the rise in self-employment and the negative impact this is having on the UK income tax and national insurance tax take. In late 2016 the UK government announced it was establishing a new HMRC team to be called the ‘Employment Status and Intermediaries Team’. This team has been active throughout 2017 and has highlighted numerous examples of disguised employment.

All of this presents a real headache for the employer or engager given the lack of a clear definition under UK law and the focus resting on the day-to-day reality of any arrangement. The issue is further complicated by the fact that the tests used to determine status vary slightly for the purposes of tax, employment law and pensions auto-enrolment.

Employment tribunal fees

The summer of 2017 brought with it a unanimous judgment of the Supreme Court that immediately abolished the system of charging fees of up to £1,600 to bring an employment tribunal claim.

The basis for abolishing the charging structure was that it restricted access to justice and indirectly discriminated against women because the higher fees for bringing more complex claims put women at a particular disadvantage.

The abolition of fees has already resulted in a significant increase in employment tribunal claims and employees are now much more likely to issue proceedings than under the fee regime which required them to pay the fee at the outset.

This is likely to impact the turnaround profession in as much as it increases the risk of claims from disgruntled employees who may feel that their employment rights have not been respected.

Neil Black is an employment expert and Dawn Allen is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com