Debenhams, Carluccio's Administrators Seek Judicial Guidance on Adoption of Employee Contracts Under Covid-19 Job Retention Scheme; Government Guidance Lacks Detail for Administration Application

Relevant Documents:
Debenhams’ Judgment
Carluccio’s Judgment

The English High Court has found the U.K. government’s guidance on the Covid-19 Job Retention Scheme, JRS, deficient in prescribing how the scheme is meant to interact with the current English insolvency regime.

The administrators of both Debenhams and Carluccio’s applied to the High Court separately for guidance on how their respective administrations should treat the employment contracts of “furloughed” employees. Both cases gave rise to a possible conflict in the role of the administrator between: i) preserving the value of the estate: and ii) avoiding redundancies by utilizing the JRS.

Under the JRS, where there is an impact on the business of a company caused by the restrictions imposed by the government in its efforts to reduce the spread of Covid-19, the government will pay up to 80% of the wages (capped at £2,500 per month) to employers to avoid them having to make employees redundant. The JRS is also available to administrators, however they are required to dispose of assets of the company in administration (including monies received from the government under the JRS) in accordance with the U.K. insolvency legislation and, in particular, by making payments in the order of priorities prescribed in that legislation.

The directions provided last week by Justice Snowden in Carluccio’s’ application and by Justice Trower in Debenhams’ application are not binding on either the government or other third parties, but do provide some guidance to administrators considering using the JRS in respect of adoption of employment contracts. Employment contracts are between employees and the employing company, so when a company enters an administration, the administration must choose to “adopt” the contract.

The key points are as follows:
 

• Where an employee consents to variation of their employment contract allowing them to be placed on furlough, adoption of that contract by the administrator would take place at the earlier of:
  • The administrators making payments to the consenting employees under their employment contracts, and
  • The administrators making an application in respect of the employees under the JRS.

• Paragraph 99 of Schedule B1 of the Insolvency Act 1986 would apply to employment contracts of furloughed employees that were adopted by the administrator:
  • This would mean that employees’ claims for wages were to be given super-priority in the administration.
  • The treatment of holiday and sick pay claims with respect to the 80% cap was unclear, although they would still enjoy priority.

While it has offered some guidance, further issues need to be addressed by the government.

In Debenhams, the administrators considered that they may well have no alternative but to dismiss some or all of the furloughed employees and look to re-employ specific employees at a later date, as appropriate, rather than use the JRS. This would not only have significant negative consequences for the company and its employees, it would also have an adverse impact on the wider rescue culture underlying the administration regime.

This is because if administrators were deemed to have adopted employment contracts of employees by making JRS applications, there could be significant value loss to the administrators estate. If the employees' contracts of employment were not amended (by consent to variation), the administrator would have to give super-priority to the remaining 20% claims (as well as holiday and sick pay claims) under paragraph 99. In Debenhams, this could have been up to £3 million per month.

The administrators of Debenhams considered that this would be an unsatisfactory outcome, because it would significantly reduce, at a very early stage of the administration, their ability to retain value in the business as they pursue options for its rescue and its exit from administration. It was argued that this would undermine the purpose of the administration and would be inconsistent with the purpose and policy of the JRS itself.

Although the Debenhams’ administrators were successful in procuring consent to the furloughing arrangements from a large number of employees, their counsel Tom Smith QC said it is unsatisfactory that it had to be done this way in order to ameliorate the impact on the administration of adoption of the employment contracts of furloughed employees. There will be other cases in which administrators are not so successful in procuring the requisite consents.

Details of the JRS, the relevant insolvency regime and each of the applications in Debenhams and Carluccio’s can be found below.

The Job Retention Scheme

The scheme was announced on March 20 by Chancellor Rishi Sunak and details can be found on the government website, HERE. The scheme is addressed to employers and sets out:
 
The scheme provides that, to be eligible for the grant, employers must write to their employees confirming that they have been furloughed. Further, the grant paid is to be treated as income of the employee and that the amount to be paid to a furloughed employee is intended to be at least the same as the amount of the grant paid by the government.

The scheme guidance sets out that, in order to claim, an employer must have created and started a pay-as-you-earn (PAYE) payroll scheme on or before Feb. 28, 2020, have enrolled for PAYE online, and have a U.K. bank account. The employer can claim for furloughed employees who were on the PAYE payroll before Feb. 28, 2020. It also explains that, while on furlough, the employee cannot provide work or services to the employer.

The JRS is intended to apply to companies which are not in an insolvency procedure, it also potentially applies to companies in administration. It sets out that:
 
The Insolvency Regime

The JRS guidance does not explain how administrators might be entitled to pay furloughed employees consistently with the insolvency legislation. The issue that arises in both the Carluccio’s and Debenhams administrations is how to treat monies that are paid to the administrators’ estate from the government under the JRS.

Under the JRS guidance, a claim is made by the employer and not the employee and the government will pay any grant monies to the employer and not the employee. If the administrator is the employer of the employee, then any grant monies paid will constitute assets of the company in administration. Under the insolvency legislation, administrators are not free to dispose of the assets of the company in administration as they see fit, but must do so in accordance with the insolvency legislation and, in particular, by making payments in the order of priorities prescribed in that legislation.

The JRS guidance did not provide for any trust mechanism that a trustee could use to bypass the insolvency legislation. In the Carluccio’s judgment, Snowden J commented that:
 
Administrators therefore require a mechanism under the existing insolvency legislation to justify payment of such wages and salary in priority to other claims against the Company. Snowden J held that only paragraphs 99 or 66 of Schedule B1 of the Insolvency Act 1986 could do this.

Paragraph 99 deals with the remuneration and expenses of the administrator and includes “wages and salary” but not all liabilities under a contract of employment (excluding redundancy payment, unfair dismissal etc).

The effect is that liabilities for wages or salary arising out of contracts of employment adopted by an administrator following the onset of administration (subject to the condition that no act taken within the first 14 days of the administrator’s appointment may amount or contribute to such adoption) are payable out of the assets held by the administrator in priority to the administrator’s remuneration and expenses, which in turn have priority over the claims of floating charge creditors and unsecured creditors.

In contrast, employees whose contracts of employment are not adopted do not gain the benefit of super-priority and their claims are instead merely unsecured provable debts.

Paragraph 66 of the act provides that the administrator of a company may make a payment (otherwise than in accordance with paragraph 65 or paragraph 13 of Schedule 1) if they think it is likely to help achieve the purpose of the administration.

Carluccio’s

Following the administration order made on March 30, placing Carluccio’s in administration, the joint administrators applied to the High Court for directions on the legal basis on which the group could place its 2,000 employees on furlough under the JRS.

The group claims to have entered into administration as a direct result of the impact on its business of the restrictions imposed by the government in the effort to reduce the spread of Covid-19. The company had no money to pay employees and unless it could take advantage of the JRS, would have to make its workforce redundant. Doing so would both prejudice the employees and the value of the business, which the joint administrators were hoping to sell.

The joint administrators therefore made an offer, by way of a “variation letter”, to place all employees on furlough. The vast majority accepted (consenting employees), a few indicated they would like to be made redundant and retire (non-consenting employees) and a small remainder did not respond (non-responding employees). The strategy of the administrators was to “mothball” the company’s business and, in parallel, seek to sell it, wishing to retain employees rather than make them redundant.

The administrators’ difficulties arose because although the JRS had been explained by the government in broad terms, there has been no precise detail on how it was to operate consistently with insolvency legislation. Snowden J noted that it was not possible for any interested parties (such as the government or employees) to join the application and therefore the decision given could not bind the employees or the government.

The judge therefore considered whether it was even appropriate for him to give directions or whether he should allow the administrators to follow the advice of their lawyers and leave any judicial consideration of the issuer to a later date, after the government had published legislation. The judge decided that, given there was not the luxury of time and because the administrators should be able to benefit from the JRS, the court should do what it could to give a view of legal issues to assist.

He explained, “The courts should work constructively with the insolvency profession to implement the government’s unprecedented response to the crisis in a similarly innovative manner.”

Snowden J held that paragraph 66 of the Insolvency Act was drafted in very wide terms, and had proven useful to administrators in dealing with particular difficulties arising in administrations. However, paragraph 99 is the provision which is specifically designed to deal with the ability and obligation of administrators to pay wages or salary to employees in an administration.

The judge considered case law on the provisions, including Re Antal International Ltd from 2003, and where it was held that the mere fact that contracts between a company and an employee had, unbeknown to the administrators, continued in existence for more than 14 days after the commencement of the administration, this did not amount to adoption.

The judge therefore made the following directions (set out in the annex to the judgment):

i) Consenting Employees: These employees did have their employment contracts amended and their employment contracts were adopted by the administrators, once certain steps were taken. Adoption occurred upon the earlier of:
 

1. The joint administrators making payments to the consenting employees under their employment contracts (as varied in accordance with the variation letter); or
    
2. The joint administrators making an application in respect of the consenting employees under the scheme (Note that Smith QC in the Debenhams application disagreed with this point).
    

ii) Objecting Employees: These employees did not have their employment contracts terminated and those contracts were not adopted by the administrators.

iii) Non- responding Employees: These employees did not have their employment contracts terminated and those contracts were not adopted by the administrators.

For (ii) and (iii) in each case the contracts are adopted unless the employee subsequently accepts the amendments in the variation letter prior to the termination of their employment contract by the administrator.

It was further held that:
 

• Before the adoption of their contracts by the administrator, all claims by employees under pre-appointment employment contracts were unsecured provable debts;

• There was no duty on an administrator to apply for a grant under the scheme unless and until the relevant contract of employment was varied;

• Contracts of employment would not be adopted by administrators merely by virtue of not terminating the contract of employment of a particular employee.

Debenhams

The application was bought by the joint administrators of Debenhams a week or so after Carluccio’s’ application on April 15. The majority of the 15,000 employees of the retail company had already been furloughed under the JRS before the application was made. The administrators applied to the High Court and sought an order from the court prescribing that:
 
Justice Trower heard the application and it was highlighted that the administrators needed to make an urgent decision as to whether or not to dismiss a significant number of the company’s employees. If the contracts of employment are adopted, the relevant employees will then enjoy super-priority status in the administration in respect of their wages or salary referable to periods post-adoption pursuant to paragraphs 99(5) and 99(6) of Schedule B1.

This means that they will rank ahead both of the provable claims of other creditors and of other expenses of the administration, a consequence which may have a significant effect on the future conduct of the administration. Because of the way that the JRS works (and subject to the impact of consents of furloughed employees), the company could still be liable for the 20% shortfall between the 80% JRS reimbursement and full wages. This exposure could have been as high as £3 million per month and would be a super-priority liability of the administration, leaving the administrators with “no alternative but to dismiss the furloughed employees.”

Again, it was not possible for any representative employees or interested parties (such as the government) to join the proceedings and therefore the decision could not be binding, but served as direction.

Trower J did not give the order sought, but instead held that the administrators be at liberty to act on the basis that they will be taken to have adopted any contract of employment between the company and its employees in circumstances where, in respect of any particular employee or employees, at any time after 14 days from the time of their appointment:
 

• The joint administrators cause the company to make payments to such employee or employees under and in accordance with their employment contracts including in respect of amounts which may be reimbursed to the company by a grant under the JRS; or

• The administrators make an application in respect of such employee or employees under the JRS.