Company directors and insolvency practitioners responsible for the carrying out of furlough schemes in response to Covid-19 must consider their financial and legal implications. However, this exercise may be complicated by the lack of judicial interpretation on how emergency government measures are to interact with existing legislation.
The Court of Appeal in the case of Debenhams Retail Ltd (In Administration)  EWCA Civ 600, faced an unprecedented legal issue in the interaction of insolvency legislation with the UK Government’s emergency response measures taken as a result of Covid-19. This case has called into question what regard administrators need to have in how they manage the employee affairs of a business under the UK Government’s Coronavirus Job Retention Scheme (‘the Scheme’), with the Court’s decision raising new questions on the priority of certain creditors.
On 09 April 2020, Debenhams (‘the Company’) officially entered administration, with the Company’s directors appointing administrators under provisions in the Insolvency Act 1986 (‘the Act’). The objective of the Joint Administrators (‘Jas’) overseeing Debenhams’ administration was to rescue the retailer and help it trade into the future.
From 25 March 2020 to the appointment of the JAs on 09 April 2020, the Company wrote to nearly 14,000 of its 15,000 employees advising them that they were being furloughed in accordance with the terms of the Scheme.
The JAs allowed the Company’s directors to continue to exercise their functions in the day-to-day management of the Company. The JAs provided support to the Company, with the aim of helping it to maintain trading in the future, and therefore, it was also in the JAs’ interests to ensure Debenhams retained its workforce during the Covid-19 lockdown.
The practical uncertainty
The key commercial issue faced by the JAs related to the impact of the Scheme’s pay-out mechanics and how these interacted with the employment contracts of the furloughed employees and core provisions of the Act relating to the payment of wages as administration expenses. Under the Scheme, employees would receive 80% of their salary up to £2,500 a month from the Company which was reimbursed through the Scheme.
The JAs were concerned that they would have been deemed as having ‘adopted’ these employment contracts in the context of the administration. If so, furloughed employees would enjoy ‘super-priority’ status in respect of their entitlement to the remaining 20% of their wages ahead of valid claims from other creditors and other expenses of the administration, such as the JAs’ remuneration. The exposure to the Company was estimated by the JAs at circa £3 million a month.
The JAs sought directions from the court on an urgent basis to determine whether the employment contracts of the furloughed employees, pursuant to Debenhams’ participation in the Scheme, would be deemed to have been adopted by the JAs if (1) these employees remained furloughed, and (2) the JAs took no further action in relation to these employees except to pay to them the amounts that would be reimbursed to the Company through its participation in the Scheme.
At first instance the court found that the JAs had adopted these employment contracts as they were seen as engaging in ‘positive conduct’ by making an application under the Scheme and paying the furloughed employees in accordance with the Scheme. This created the assumption that the employment contracts would continue to exist during and after the work of the JAs.
The JAs appealed this decision to the Court of Appeal. The Court of Appeal held that:
- the JAs’ continuation of the capped payments to the Company’s furloughed employees, in accordance with the Scheme;
- the furloughed employees’ agreement to be bound by the new terms of their employment contracts due to the Company’s application under the Scheme; and
- the JAs acting in a manner consistent with their objective of rescuing the company as a ‘going concern’;
were all factors supporting the court’s ruling that the employment contracts of the furloughed employees continued during the administration
While the Court of Appeal supported the ruling of the previous court, it further commented that although the employment contracts had been adopted for the purposes of the Act, the value of the remaining 20% of wages not covered by the Scheme would not enjoy super-priority payment status compared to other Company creditors. However, the Court of Appeal observed that the entitlement to full holiday pay under the Act may enjoy ‘super-priority’ status.
The Court of Appeal decision in Debenhams Retail Limited underlines the conflicts between certain core provisions in insolvency legislation and the mechanics of government schemes in response to Covid-19. As stated by the court in its initial ruling, it is not exactly clear “how the [Scheme] is intended to work in the context of mandatory principles of insolvency law”. This situation has placed insolvency practitioners in a reality where they must try to balance the duties they owe under the Act, with what is practical and feasible with government schemes in response to Covid-19.
The Court of Appeal’s remark that holiday pay may attract super priority status is now an important consideration for administrators when assessing how to best manage employee affairs, keeping in mind the need to minimise potential liabilities.
It is likely that other aspects of the government’s response to Covid-19 and how this interacts with pre-existing legal provisions, will also become the source of further legal debate before the court.
Please contact James Russell for further enquiries at firstname.lastname@example.org