Client Alert

Employment Issues for Distressed Businesses: Initial Pointers for GCs

15 Jun 2020

The announcements last week about the closure of 125 Frankie and Benny’s outlets, 35 Monsoon Accessorize shops, and the thousands of resulting job losses highlight the difficulties facing businesses in the wake of the COVID-19 pandemic. GCs of the many businesses facing distress at the moment in the UK will have a myriad of challenges ahead of them, whether dealing with administration, liquidation, or another insolvency procedure. One of the most pressing concerns will certainly be the implications for, and the company’s obligations in relation to, its employees. With this in mind, we have shortlisted some initial questions GCs of global organisations may be asking themselves about what might happen to their employees in the UK.

1. What happens to employment contracts in an insolvency situation?

This will depend on the type of insolvency procedure being followed, with liquidations and administrations being the two most common in the UK – the former for terminal cases, and the latter for those companies that may still be viable in a restructured form.

  • In a liquidation, employees’ contracts terminate. This happens automatically and with immediate effect on a compulsory liquidation. There is no such automatic termination in the context of a voluntary liquidation, as the business of the company does not immediately cease. However, in practice, the likely outcome of a voluntary liquidation will still be the termination of employment contracts, as the liquidator will have to terminate its employees as it winds up operations.
  • On the other hand, in an administration, where the administrator’s aim is to rescue the company and restructure it so that it can continue trading, the employment contracts do not terminate automatically with effect from the appointment of the administrator. Instead, the administrator has a 14-day window in which to make an assessment as to which employees the business needs and can afford, and to dismiss those it cannot without incurring personal liability or creating preferential creditors (any dismissals carried out during this 14-day window will not give rise to personal liability on the part of the administrator for any claims brought by the dismissed employees). The contracts of any employees who have not been terminated in this 14-day window are deemed to have been “adopted” by the administrator.

It’s worth noting that in “pre-pack” administrations, where the asset sale has already been negotiated and arranged prior to the administrator being formally appointed, the issue of adoption of employment contracts generally does not arise. The decision as to which assets, and consequently which employees, will transfer will already have been made before the 14-day countdown begins.

2. What does adoption mean for the administrator? What if employees have been furloughed?

The effect of adoption is to create a “super priority” liability for the administrator, whereby employees’ wage costs gain preferential ranking amongst other creditors and the expenses of administration, including, importantly, the administrator’s own fees and expenses. 

This super priority ranking has been a source of contention in relation to the recent insolvencies of two high street chains – Carluccio’s and Debenhams – and its interplay with the Government’s Coronavirus Job Retention Scheme (the “CJRS”). The courts confirmed that by placing employees on furlough or, in the case of Debenhams, continuing to pay previously furloughed employees the amounts reimbursed through the CJRS, the administrators will be deemed to have adopted the contracts of these employees. Despite the administrators’ protests that exposure to super priority liability for these contracts could hinder their ability to rescue the company and in fact even result in terminations (thereby undermining the very purpose of the CJRS), the courts confirmed that the usual rules of adoption would continue to apply.

3. So if the business is salvageable at the end of the administration process, what then?

The likelihood of employees retaining their jobs will depend on the administrator’s plans for the business. If they continue to operate the business in the hope of selling it later as a “going concern”, then at least some of the employees will be needed for ongoing operations, and their contracts will be adopted by the administrator. On the other hand, if the administrator agrees a “company voluntary arrangement” with the company’s creditors, then some jobs may be lost as part of a restructuring but others retained (see below for a brief summary of the consultation obligations applicable in the event of collective redundancies).

If the administrator finds a buyer to take over the business, or at least some of the company’s assets, some or all of the employment contracts may transfer from the company or the administrator (if the contracts have been adopted) to the buyer.

4. We’ve found a buyer. Do all employees just transfer to the buyer?

Likely yes. If the employees are employed in the part of the business being acquired, then the Transfer of Undertakings (Protection of Employment) Regulations 2006, or “TUPE”, may apply, as with any business sale, to transfer the contracts of these employees automatically to the buyer with the employees’ rights protected. This is the case even if employees are furloughed, and they can remain furloughed post-transfer.

GCs may be relieved to hear that there are some special rules that apply to TUPE transfers in the context of an administration, which make the process more palatable for potential buyers.

  • Liability for statutory redundancy or insolvency payments in respect of employees who have been made redundant prior to the sale/transfer, which would transfer to the buyer in an “ordinary” TUPE transfer, does not transfer to the buyer. In those circumstances, the payments will instead be paid to the affected employees from the National Insurance Fund via the Redundancy Payments Service.
  • A buyer also has some freedom to vary the employees’ terms and conditions, provided that these are intended to safeguard employment by ensuring the survival of the business and within the framework set out under TUPE (which would include agreeing the changes with appropriate representatives of the employees). With a proper consultation process, a buyer could even reduce salaries or benefits – actions that would be severely penalized and/or considered void in an ordinary TUPE transfer. Contracts of furloughed employees can be varied too without hindering the new employer’s ability to claim under the CJRS.

For the avoidance of doubt, TUPE will not apply to transfer employees to a purchaser of assets of a company that is subject to a compulsory liquidation procedure.

5. We can’t save the business and we’re heading for liquidation. How do we make employees redundant?

The commencement of insolvency proceedings does not lessen the requirement for a formal redundancy process to be followed. Where 20 or more redundancies are contemplated at one establishment, the insolvency practitioner will need to comply with the requirements for collective consultation, including notifying the Secretary of State in advance of the proposed redundancies (using a Government ‘HR1’ form) and informing and consulting with elected employee representatives (or holding elections where there aren’t any elected representatives).

Where the collective consultation obligations are not met, employees could become entitled to a “protective award” of up to 90 days’ uncapped pay each. Although there is a “special circumstances” defence potentially available to the employer or insolvency practitioner if there has been a failure to meet these obligations, insolvency of itself will not be a special circumstance. You might think COVID-19 is a clear case for an unforeseen special circumstances defence, but, taking Carluccio’s and Debenhams as examples, these businesses were already in distress prior to the lockdown, so it may be difficult to argue that this is truly an unforeseen situation that would give rise to the defence. That being said, even if employment contracts have been adopted by the administrator, any protective award would not rank as super priority.

6. We have a range of creditors and limited assets. Where do employees rank in all this?

Most debts owed to employees (other than those with super priority) will rank pretty low in the order of priority on a realization of assets; second to last, in fact, as “unsecured creditors”. That said, employees can claim for certain aspects of their remuneration as “preferential creditors”, meaning that they are paid in full after fixed charges and the expenses of insolvency are realized, but claims are limited to:

  • unpaid wages for work done in the four months prior to the insolvency, up to a cap of £800 per person;
  • accrued holiday pay of up to six weeks, uncapped;
  • pay in lieu of notice or redundancy pay; and
  • unpaid contributions to occupational pension schemes and state scheme premiums, up to certain limits.

If, however, employees’ contracts have been adopted by an administrator, then sums payable to employees under these contracts from the time of adoption are considered debts or liabilities arising out of a contract entered into by the administrator and gain super priority over even the administrator’s own remuneration and expenses. 

As some UK business start to open their doors to customers in the coming weeks, the hope is that the number of GCs facing these complex issues can be limited. But for those for whom this cannot be avoided, these initial points address some of the key questions that will arise in relation to those employees whose jobs will, unfortunately, be affected by the economic downturn caused by the unprecedented situation we are in.    

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