Furloughed staff considered ‘super-priority’ creditors during administration

Furloughed staff considered ‘super-priority’ creditors during administration

Recent court rulings clarify legal grey area caused by furlough scheme

Administrators are liable to pay employees of in-distress companies even if they are furloughed under the Coronavirus Job Retention Scheme (CJRS).

The English Court of Appeals ruled last week on a case concerning Debenhams that the use of CJRS by administrators amounted to them adopting Debenhams employees’ contracts.

“Administrators have 14 days after their appointment to decide whether to adopt the contracts of employees. In an ordinary non-coronavirus world, that would be having the employees attend work in the usual way and if they continue to work beyond the 14 days then their contracts are adopted”, says Richard Hodgson, restructuring and insolvency partner at Linklaters.

Under the Insolvency Act of 1986, employees’ contracts are ‘adopted’ by the administrator if they are kept employed after 14 days of an administrator taking over. Adopting an employee contract gives those staff super-priority on funds.

In the approved judgement of the appeal, the presiding justices wrote: “Overall, for the reasons we have given, which do not essentially differ from those given by [Justice Trower], we conclude that the administrators have, for the purposes of paragraph 99 [Insolvency Act], adopted the contracts of those employees who have consented to be furloughed.

They added: “We can see that there may be good reasons of policy for excluding action restricted to implementation of the Scheme from the scope of ‘adoption’ under paragraph 99, but such exclusion cannot be accommodated under the law as it stands.”

One of the requirements needed to put staff onto the CJRS is that furloughed staff “cannot undertake work for, or on behalf, of the organisation”. But the ruling has meant that while staff are not working there are still considered employees.

“What the Debenhams case says is the decision by the High Court which was also confirmed by the Court of Appeals is that if the employees are furloughed, with either the administrators putting them on furlough or continuing an existing furlough arrangement beyond the 14 days period, then that constitutes adoption,” says Hodgson.

In an earlier court decision, administrators for Carluccio’s put staff on furlough – and it was ruled furloughing staff amounted to adopting their contracts. In the Debenhams case, staff were furloughed before administrators were appointed but since the administrators kept the staff in the CJRS, their contracts were also found to be similarly adopted.

“Usually in an administration, in a pre-coronavirus situation and absent the furlough scheme, what [administrators] do in the period before their appointment and certainly before the expiry of the 14 days, is they start making a decision about which employees they can keep and which they need to make redundant.”

Government guidance for accessing the CJRS is that employees should only be put on the scheme if there is reasonable likelihood of the staff being reemployed by the company at some point in the future.

Rick Smith, managing director of Forbes Burton, a business rescue and recovery firm, says that given the current set of circumstances Debenhams’ administrators made the correct choice in continuing to furlough.

“It’s a real tough [question] for the insolvency industry at the moment, as to what is the right move to make,” he says. “Many other companies have adopted a furlough scheme and are trading in that same way. If they hadn’t [continued furloughing], then I think it would have been the wrong decision, and they would have been accountable for that. I think is the was the right decision to make.”

CJRS currently pays 80 percent of a furloughed employee’s salaries. The approved judgement of the appeal noted that more than 13,000 Debenhams staff had accepted going onto furlough and acknowledged that their salary would be 80 percent of their usual pay.

However, staff whose contracts were adopted without explicit consent of a pay cut may find the administrator liable to pay the 20 percent not covered by the furlough scheme, says Hodgson. This difference, combined with any other monetary benefits, like holiday pay would be given super-priority in terms of administrator expense.

“If an [administrator] adopts a contract, but an employee doesn’t consent to reducing their claim to 80 percent. You have to pay them the full hundred percent but the government will only reimburse you for 80 percent.”

With CJRS being extended until the end of October, Hodgson says future administrators will need to examine whether it is necessary to terminate staff rather than furlough them.

“As the administrator you would make a binary choice. Either having it so an employee consents to being entitled to 80 percent, in which case the contract gets adopted and the employee receives super-priority,  or don’t consent, where the contract wouldn’t be adopted and their salary would become an unsecured claim”

Smith says that while administrators should be taking advantage of the CJRS they need to be also forecasting what will happen once the scheme ends.

“The government with this scheme is giving an 80 percent [subsidy], but its going to be reduced. The added expense will go back onto the administrators. This would have to be the budgeted for, when moving forward to keep the business going through the furlough period.

“It’s really managing the financial obligations of the business and forecasting up to the point of when the furlough scheme is no more. Where is the businesses going to be, by the time they don’t have that assistance anymore.”

Resources & Whitepapers

Why Professional Services Firms Should Ditch Folders and Embrace Metadata

Professional Services Why Professional Services Firms Should Ditch Folders and Embrace Metadata

1y

Why Professional Services Firms Should Ditch Folde...

In the past decade, the professional services industry has transformed significantly. Digital disruptions, increased competition, and changing market ...

View resource
2 Vital keys to Remaining Competitive for Professional Services Firms

2 Vital keys to Remaining Competitive for Professional Services Firms

1y

2 Vital keys to Remaining Competitive for Professi...

In recent months, professional services firms are facing more pressure than ever to deliver value to clients. Often, clients look at the firms own inf...

View resource
Turn Accounts Payable into a value-engine

Accounting Firms Turn Accounts Payable into a value-engine

1y

Turn Accounts Payable into a value-engine

In a world of instant results and automated workloads, the potential for AP to drive insights and transform results is enormous. But, if you’re still ...

View resource
Digital Links: A guide to MTD in 2021

Making Tax Digital Digital Links: A guide to MTD in 2021

1y

Digital Links: A guide to MTD in 2021

The first phase of Making Tax Digital (MTD) saw the requirement for the digital submission of the VAT Return using compliant software. That’s now behi...

View resource