Out-Law Legal Update | 21 Apr 2020 | 1:39 pm | 4 min. read
The Scheme was introduced by Government to support employers whose operations have been impacted by the COVID-19 outbreak. It seeks to preserve jobs by giving employers an alternative to making staff redundancies, as they can instead furlough employees until they are allowed tor return to work. Under the Scheme, HMRC will pay eligible employers a grant of 80% of a furloughed employee's basic wages, subject to a cap of £2,500 per month, together with the employer's associated national insurance and pension contributions. Where there is no contractual lay-off clause, it will be necessary to vary the furloughed employee's contract by consent to reflect the terms of the Scheme.
Debenhams and Carluccio's are both so called "light touch" administrations; a mechanism used during the current COVID-19 pandemic which gives the benefit of a moratorium but allows directors to retain day-to-day control of the company once administration has been filed for. Where "light touch" administrations hope to rescue the business as a going concern once the lockdown restrictions are lifted, it is crucial that they are able to retain their workforce. Access to the Scheme is only possible where there is a reasonable likelihood that the furloughed workers will be re-hired. The court in Re Carluccios Limited was satisfied this condition was met as considerable interest from prospective buyers meant there was a reasonable likelihood the business would be sold and the furloughed employees would therefore transfer to the buyer to resume work once restrictions had been lifted.
While guidance clearly states applications can be made by administrators in respect of companies under their management, there is no explanation as to how they can apply the Scheme in a manner consistent with insolvency legislation. These issues were recently brought before the court, firstly by the administrators of Carluccio's and secondly by the administrators of Debenhams. Both sets of administrators are from FRP Advisory and one of the administrators is appointed over both companies. In both cases directions were sought on how the administrators could lawfully give effect to furloughing arrangements. Both judges noted the difficulty of providing rulings where there was no legislation, only guidance, and where due the urgency adversarial arguments had not been heard but agreed that "[t]he COVID-19 pandemic is a critical situation which carries serious risks to the economy and jobs in addition to the obvious dangers to health…[I]t is right that, wherever possible, the courts should work constructively together with the insolvency profession to implement the Government's unprecedented response to the crisis in a similarly innovative manner."
Re Carluccios Limited was heard first. The administrators had not yet furloughed any employees but had sent letters requesting consent to vary their employment contracts so that the employees would only be entitled to monies received by the company under the Scheme. The administrators received consent from 1,707 employees, four rejections and no response from 77 employees. In Re Debenhams Retail Ltd, the employees had already been furloughed, 12,700 of which had consented to the terms of their contracts being varied in a similar fashion to the Carluccio's employees, four had objected and 359 had not responded.
In Re Carluccios Limited, Mr Justice Snowden held that administrators adopt employment contracts if they make an application under the Scheme or otherwise make a payment to the employees. For the consenting employees, their contracts had been varied and applications under the Scheme could now be made in accordance with those terms, constituting adoption of the contracts by the administrators. The administrators would only be liable for amounts payable under the varied terms, which would be fully reimbursed through the Scheme. The adoption of the contracts meant that monies received from the Scheme could be paid to the employees as an expense of the Scheme under the super-priority principle. The objecting employees would be made redundant but there was no pressure to dismiss non-responding employees as the contracts would not be adopted until the administrators made an application or payment to the employee. They could therefore simply wait until responses were received. Crucially, this means that the contracts of employment are not adopted simply because they are not terminated, providing breathing space for the administrators to decide what course of action to take.
In Re Debenhams Retail Ltd, the employees had been furloughed prior to appointment of the administrators or within the first 14 days of administration. The administrators, therefore, sought directions on whether the contracts would be adopted after the 14 days if employees continued to be furloughed. The Debenhams administrators challenged the decision in the Carluccio's case, arguing that if they were considered to have adopted the employment contracts as a result of participating in the Scheme, then absent any variation to employment contracts, the full amount of wages and salary would have super-priority and not just those which would be reimbursed under the Scheme. The Debenhams administrators argued that this would not only have significant negative consequences for Debenhams, but also an adverse impact on the wider rescue culture underlying the administration regime.
Mr Justice Trower agreed with the decision in Re Carluccios Ltd and added that continued participation in the Scheme after the 14 day period would amount to adoption of the contracts. As such, unless contracts were terminated or varied before the 14 days expired, the administrators would be deemed to have adopted the unvaried contracts and would therefore be liable for the full amounts payable, being 100% of the basic salary together with other benefits and entitlements. This would give rise to a shortfall for the administrators as they are only able to recover 80% of basic wages, up to a cap of £2,500, through the Scheme. Such liabilities will also be payable as an expense of the administration and in priority to other liabilities. In these circumstances, it is likely the administrators will have no alternative but to make redundancies to avoid incurring a non-recoverable expense. This scenario has been largely avoided in both cases as the administrators have been successful in obtaining consent from a significant number of employees.
Co-authored by Molly Dyas, a restructuring expert at Pinsent Masons, the law firm behind Out-Law.