Insolvent businesses and obligations to furloughed staff

The interaction between the principles of insolvency law and the Coronavirus Job Retention Scheme (JRS) have come into sharp focus in recent weeks, with the administrators of Carluccio's and Debenhams seeking guidance from the English courts about how the scheme impacts on their obligations to employees.

In a decision handed down on 6 May 2020, the Court of Appeal confirmed that irrespective of whether employees had been furloughed before or after an administrator's appointment, an application to the JRS and/or payments made to furloughed employees under that scheme, would constitute steps taken by the administrator to continue the employment of those employees and therefore result in the adoption of their employment contracts.

While helpful in clarifying the position, administrators looking to conduct "light touch" administration will need to be mindful of the super priority given to liabilities under employment contracts of furloughed staff.

The decision also highlights the importance of ensuring that any variation in employees' contracts is carried out properly.

The most recent Government guidance suggests that while the employer needs to notify the employee in writing of the intention to place them on furlough, it is not necessary for the employee to have responded in writing.

However, that is separate to what may be necessary to ensure that the employment contract itself has been varied and that is the important aspect for administrators.

Let's look briefly at the cases that have culminated in the Court of Appeal's decision.

Carluccio's administration

In this case, the administrators wrote to employees offering to continue to employ them on varied terms, so as to take advantage of the JRS. In effect, each employee's pay was reduced to 80%, up to a monthly limit of £2,500.

The administrators applied to the Court, using a procedure provided by Schedule B1 to the Insolvency Act 1986, which allows them to ask for guidance on how to fulfil their duties.

The administrators sought these directions to provide assurance that if they acted on that basis, they could not then be accused of having acted inappropriately in dealing with the employees or making applications under the JRS.

The application for these directions was urgent because the "safe" period under the Insolvency Act 1986, during which the actions of administrators will not amount or contribute to the adoption of any contracts of employment, is only 14 days after their appointment.

In a remarkably comprehensive judgment, given the limited time to prepare, judge Snowden J considered the relationship between insolvency legislation and the JRS, particularly focusing on the principles underpinning administrators' adoption of contracts of employment.

Extensive reference was made to the House of Lords decision in Powdrill v Watson (Paramount Airways Limited) [1995] 2 AC 394 (Paramount).

Applying those principles to present facts, Snowden J concluded that the actions of the administrators would only be "explicable on the basis that they were electing to treat the varied contract as giving rise to liabilities which qualify for super-priority."

These comments were in relation to employees who had, by the time of the hearing, consented to the variation of their employment contracts.

For those employees who had not consented, it was held that if nothing else happened, then again, the Paramount principles would apply; the administrators would not be treated as having adopted the employees' unvaried contracts by the mere failure to terminate them prior to the expiry of the 14-day period.

If those employees decided after the 14-day period to consent to the variation, they could be treated in the same way as those employees who had already consented before the 14-day period ended.

Debenhams administration

Less than a week later, the Debenhams administration was addressed. The position here was slightly different in that the employees had been furloughed prior to the appointment of the administrators.

The administrators, not happy with Snowden J's conclusion for Carluccio's, sought directions from the court, arguing that if the employees remained furloughed and the administrators took no further action, except to pay them amounts that were to be paid to Debenhams through its participation in the JRS, this would not constitute adoption of the contracts of employment.

The understandable concern of the administrators was that if they were deemed to have adopted the employment contracts, it might have a significant negative impact on the company and indeed, the individual employees.

If it was right that an application under the JRS resulted in the adoption of employment contracts, this could lead to companies in administration deciding not to use the JRS, which seemed to go against why it was created in the first place.

However, judge Trower J did not accept these arguments and agreed with Snowden J that administrators who make an application under the JRS, or even make payments to employees under their varied employment contracts would constitute adoption of those contracts and lead to super priority being given.

The fact that Debenhams' employees had been furloughed before the administrators were appointed, did not make any difference.

Administrators lose appeal

Debenhams' administrators appealed to the Court of Appeal, arguing that while the test for adoption was to be applied objectively, it was an objective assessment of the administrator's state of mind, as judged by his words and conduct.

The Court rejected the appeal. The key question was whether the conduct of the administrators was such that they must be taken to have accepted that the relevant amounts due under the employment contract enjoy super priority.

It was a wholly objective question, focused on the conduct of the administrators.

The Court of Appeal agreed that the conduct of the administrators had continued the employment of the employees, notwithstanding the unusual circumstances and requirements of the JRS.

Will Scottish courts follow suit?

The guidance from the English courts is welcome. There is nothing to suggest that a Scottish court would not follow the same reasoning.

The operative legislation in both the insolvency and employment spheres is the same, and it would introduce unwanted uncertainty if the actions of administrators in Scotland were judged differently.

For insolvency practitioners the main question that is left is the extent of the super priority even with those contracts that have been varied (e.g. regarding sick pay and holiday pay).

While the Government has issued further guidance on this point, Trower J acknowledged that it was still not clear to what extent those matters will be covered by the JRS.

The decisions also confirm that paragraph 66 of Schedule B1 is still available to administrators who wish to make payments to employees. This point was specifically highlighted by the Court of Appeal.

The JRS is extended in its current form until 31 October 2020, with flexibility introduced from August that will allow furloughed workers to return to work part-time, and employers being asked to pay a percentage towards the salaries of their furloughed staff.

For employers, the scheme rules make clear that staff should only be on furlough if there is a sufficient likelihood of their jobs being saved.

With these recent judgments offering little room for manoeuvre to insolvency practitioners, many regrettably will see the option of retaining staff as too high a risk to take.