High Court provides guidance on furlough and insolvency

A High Court judgment has provided important guidance on the provisions for furloughing employees where a company has gone into administration due to COVID-19. Peter Linstead explains how it is no less relevant despite the new Treasury Direction on furlough leave.

On Easter Monday 13^th April, a High Court judgment gave declaratory guidance on how the provisions for furloughing employees should be applied by administrators where a company had gone into administration as a result of the effects of coronavirus.  The judgment succeeds in providing essential clarity on the status of employees’ claims in an insolvency situation and has wider application to contractual variations in the context of furlough. It remains relevant in both these areas despite the publication on 15 April of the Treasury Direction on the rules of the Coronavirus Job Retention Scheme.

Background

The judgment in Re Carluccio’s Ltd (in administration) And In The Matter of the Insolvency Act [2020] EWHC 886 (Ch) arose following the restaurant chain’s inability to trade in the current crisis.  They appointed Administrators on 30 March 2020, whose aim was to “mothball” the restaurants whilst seeking a sale of the business.  The Administrators wished to retain the employees meanwhile but were only willing to do so if and so far as the costs of doing so could be met by the Government under the Coronavirus Job Retention Scheme (the “Scheme”) by which the Government undertakes to cover 80% of salary (up to £2,500 per month).   The Government Guidance provides that “the administrator will be able to access the Job Retention Scheme. However, we would expect an administrator would only access the scheme if there is a reasonable likelihood of rehiring the workers. For instance, this could be as a result of an administration and pursuit of a sale of the business.”

However, the Scheme Guidance does not explain how administrators might be entitled to pay furloughed employees consistently with the statutory insolvency regime.  Since this judgment, on 15 April the Government published the Coronavirus Act 2020 Functions of Her Majesty’s Revenue and Customs (Coronavirus Job Retention Scheme) Direction (“the Direction”). However, this says nothing expressly about the position of administrators.  There is a particular problem because grant money will be paid directly into the employer’s bank account and as such, will constitute assets of the company in administration.  The Scheme does not allow for techniques such as holding the money on trust, to keep it separate from the insolvent estate. The Direction states merely that it is integral to the Scheme that the amounts paid under a claim “are only made by way of reimbursement of” the wage costs.

The claim by the Administrators was for a declaration as to the lawfulness of their plans, in order to avoid any accusations of acting inappropriately, and to establish how liabilities to employees should be dealt with in the administration.

In the time available, it had not been possible to join any representative employees or other interested parties to the application.   The Government had not replied to a request to participate in the hearing.  Submissions were made on behalf of ‘Unite’, the Union who had among its members some of the affected employees.

The Judge (Snowden J) considered the option of leaving judicial consideration of these matters until after publication of detailed legislation giving effect to the Scheme.  He stated that he could not see his decision would bind either the affected employees or the Government, but considered it was better to give guidance due to the urgency and because he said the courts should work constructively with the insolvency profession to implement the Government’s response.

The Direction on 15 April does not appear to make this judgment any less applicable in relation to the key questions of the employment law duties of employers and administrators and the date of adoption of the employment contracts in insolvency law.

Employment Law: the decision in brief

The Administrators wrote a variation letter to nearly 2,000 employees, seeking their agreement to be furloughed at 80% salary and stating that they would only be able to pay them if and when they received money from the Government. The vast majority confirmed that they agreed (“Consenting Employees”) but 77 employees did not respond (“Non-Responding Employees”). A handful refused the amendment (“Objecting Employees”).  In relation to the contractual consequences for the different groups, the Judge decided as follows:

• The amendment letters were effective to vary the contracts of Consenting Employees. Their entitlement was only to the 80% and they were not entitled to be paid until receipt of the grant fund.
• In respect of the Non-Responding Employees there had not been an implied variation. The Judge considered the case law on variation implied by silence in some detail and concluded that it required some conduct by the employee, such as attending work, from which an inference of consent could be drawn. He said:

“It would I think require very strong evidence to reach a conclusion that, without more, the absence of objection over such a short period was to be equated to consent.”

• He rejected a submission from Unite that the Administrators had a duty to apply under the Scheme even in respect of the Non-Responding employees. This rested on case law about permanent health insurance benefits which suggested it was a requirement of the term of trust and confidence that the employer may be under a duty not to dismiss an employee on long term sickness until it has explored whether they were covered by PHI. This analogy did not work, he said, because there was no agreement from employees to make that application, which was what the Scheme seemed to require.
• He refused to determine an argument that Administrators were under a duty to go a step further and send a letter to non-responders stating that they would be taken to accept if they did not respond. However, he endorsed their efforts to ensure that all the individuals had received the letters as “entirely sensible and appropriate”.

Insolvency Law: the decision in brief

The Administrators particularly wanted to establish that any liability to Non-Responding Employees, such as contractual liability for their wages and any termination payments, would not qualify for ‘super-priority’.  This is the position created by Paragraph 99 Schedule B1 of the Insolvency Act 1986 whereby the administrator’s remuneration and expenses rank behind any liability for wages and salary arising out of a contract “adopted” by the administrator or a predecessor.

There is, however, a 14 day window after appointment during which the actions of an administrator cannot amount to the adoption of a contract (Para 99(5)(a)).  The issue here was whether the Administrator had adopted the employment contracts of the Non-Responding employees, or would do so if they were still employed at the expiry of the 14 day window on 13 April 2020.   If so, they would have super-priority as opposed to merely ranking as unsecured creditors, so the Administrators would be forced to make them redundant immediately to avoid this.

A further issue was to establish whether and when Consenting Employees had super-priority.

The Judge identified that the Insolvency Act had been created and amended to support a rescue culture which encouraged the continuation of business and the protection of employees where possible.  He therefore dealt with these issues as follows:

• He rejected the suggestion that no employee (consenting or otherwise) could be adopted unless they actually rendered services to the company. Paragraph 99 should be interpreted to permit the furlough scheme to be given effect.
• The appointment of an administrator does not terminate a contract of employment, but the failure to terminate does not necessarily mean it has been adopted (applying Paramount (HL) [1995] 2 AC 394).
• Adoption requires some conduct by the administrator that amounts to an election to treat the contract as giving rise to liabilities which qualify for super-priority. That would normally occur where an administrator tells an employee to attend work.
• Because the Consenting Employees’ contracts were varied within 14 days, nothing had been done here which could amount to an adoption. However, as and when the Administrators make an application under the Scheme in respect of the Consenting Employees or make any payment to them, this would amount to adoption of their contracts of employment.  This would enable super-priority payments to be made to them using the grant monies as and when received.
• As to the Non-Responding group, none of the Administrators’ conduct, including failing to terminate after the end of 14 days, could amount to an adoption. Hence they did not need to take the precaution of dismissing them before that point.  If they subsequently consented, adoption would only occur when the Administrator applied under the Scheme, or paid wages.
• Non-Responding Employees who continued not to respond would merely be unsecured creditors in the administration in respect of any claim under their contracts.
• The contracts of Objecting Employees were not varied or adopted and it was recognised they would be made redundant.

Analysis and the significance of the Treasury Direction

The decision provides welcome guidance for administrators, who faced real uncertainty as to their potential duties and liabilities, albeit this is diluted by the Judge’s view that his words had no binding legal effect.  Importantly, Snowden J recognised that both the insolvency legislation and furlough leave share a common aim in promoting a rescue culture for the continuation of businesses and the preservation of employment wherever possible.  He said the Insolvency Act should be interpreted to give effect to the Scheme.   This was reflected in an interpretation of Paragraph 99 which meant the Administrators had no imminent need to dismiss employees, even if they were being slow to consent.

Under the new Direction it appears that the administrator will qualify as a “new employer” and will be treated as if they had a qualifying PAYE scheme on the 19 March qualifying date, but the administrator would have to set up a PAYE scheme in its own right.  Under paragraph 9(3) of the Direction, for the administrator to acquire this status there would need to have been a change in employer while the employees remain in employment.  The effect of the Carluccio’s judgment is to suggest that this change would happen at the point when the administrator adopts the relevant employment contracts, which will normally coincide with the date of applying to the Scheme.

If a buyer is found and the purchase happens during the life of the Scheme, the furloughed employees will transfer under TUPE, with their varied contracts.  The new Direction is helpful in clarifying that the transferee purchaser could, in principle, continue to furlough the employees after the transfer.   In these uncertain times, this possibility could make the business more attractive to a potential purchaser, so this clarification from the Government is welcome.

Clearly it is the employer’s decision whether to furlough, subject to obtaining agreement.  The Administrators intended to apply to the Scheme in this case because there was a reasonable prospect of the employees being “rehired”, to use the Scheme’s terminology. They had received several expressions of interest in purchase of the business.

During argument, Unite raised the question of whether there was a duty to apply to the Scheme in respect of employees for whom letters of variation had been sent and accepted.  Snowden J said he did not need to reach a conclusion on this as it was clearly the Administrators’ intention to do so, but he observed that such a duty might be implied from the terms of the variation letter, subject to the administrators’ overriding duties.  It was clearly a concern of Unite’s legal team that whatever is in the variation letter, the Scheme does not impose any legal duty on an employer who has obtained consent actually to apply to the scheme.   The Judge did not directly engage with this point, save in relation to the PHI argument referred to above.  However, it should be noted that this apparent lacuna in the protection which the scheme provides, and the potential relevance of the trust and confidence term in tis context, is already being discussed in the employment law community and could well lead to more litigation in an appropriate case.

Despite all these uncertainties, the Carluccio’s decision shines a light on the fact that the Scheme creates a significantly better position than that which normally arises in administration, where employees have to be made redundant whilst attempts are made to find a buyer as there is no money to pay them. In a non-terminal insolvency situation, buyers already have the ability to pass certain employee liabilities on to the Secretary of State under regulation 8 of TUPE.     For the time being, the use of furlough in the manner clarified by this decision increases the avenues available to administrators seeking to sell an insolvent business, which can only be a good thing as this situation is likely to be all too common in the near future.

More information

This article is correct as on 16 April 2020 and was written by Peter Linstead of OTC’s Employment Team. Peter specialises in employment law, commercial disputes and insolvency. He is ranked as a “leading junior” by Legal 500 in UK Employment Law

Please contact David Smith on +44 (0)20 7427 4905 or Colin Bunyan on +44 (0)20 7427 4866 for further information on this area of law.

Covid-19 15 Apr, 2020