Furlough and administration: when is a contract of employment ‘adopted’?

October 13, 2020

This article first appeared in the Autumn 2020 Edition of RECOVERY magazine and is reproduced with the permission of R3 and GTI Media.

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By Lisa Linklater and Harriet Hartshorn

The Coronavirus Job Retention Scheme (the scheme) has been ground breaking for employers, employees and administrators of insolvent companies, each of whom have swiftly adjusted to the practical and commercial effects of the scheme. The scheme very quickly gave rise to applications to the High Court, by administrators of high-profile companies, for directions as to whether a contract of employment of a ‘furloughed employee’ had been ‘adopted’ by an administrator. If it was, the ‘wages or salary’ (which are defined by paragraph 99(6) of schedule B1 of the Insolvency Act 1986 (the Act) to include holiday pay and sick pay) would have super-priority over (a) the administrators’ remuneration and (b) a floating charge, under paragraph 99(3) and (4) of schedule B1 of the Act.

This issue has far-reaching financial and practical impact in administrations. The Court of Appeal decision in the matter of Debenhams Retail Limited (in Administration) [2020] EWCA Civ 600 on 6 May 2020 that the administrators of Debenhams had ‘adopted’ the contracts of employment of furloughed employees is significant for both employees and administrators. Even when the scheme concludes (currently anticipated to be in October of this year), the decision will continue to be important for the issue of ‘adoption’ of contracts of employment by administrators.

The case background

By the time of the appointment of the administrators, Debenhams Retail Limited (the company) had closed its stores and written to the majority of employees, informing them that they were being placed on furlough. The administrators were subsequently appointed by the directors of the company. The purpose of the administration was to seek to rescue the company as a going concern. The administrators had consented to management continuing to exercise their functions, with the aim of resuming trading from its stores once the lockdown measures were lifted. The administrators considered that the purpose of the administration would be best furthered if the employees remained on furlough under the scheme. They would continue to pay salaries up to the limits reimbursed or funded under the scheme, but they would not make any further payments to top up salaries. The vast majority of employees expressly agreed to being furloughed and a consequent reduction in pay following correspondence from the administrators.

Analysis

The administrators contended (at [46]) that there had to be: (i) words or conduct on the part of the administrators; (ii) which objectively construed evidences an election on the part of the administrator; (iii) to treat the liabilities arising under the contract of employment as enjoying super-priority. The administrators accepted that such election was to be judged objectively and not by reference to the subjective intentions of the administrators.

There is no statutory definition of ‘adoption’ in the Act. The Court of Appeal considered and applied the leading House of Lords decision of Powdrill v. Watson, Re Paramount Airways Ltd [1995] 2 AC 394 (Paramount). David Richards LJ, giving the leading judgment of the court, identified ‘one crucial difference’ between the facts in Paramount and those in Debenhams: the employees in Paramount had all performed services for their employers after the 14-day grace period for which they had not been paid (at [34]). By contrast, under the terms of the scheme, as it was when considered by the Court of Appeal, a furloughed employee must be instructed to cease all work for 21 days or more (at [22]).

At [39], David Richards LJ stated that Lord Browne-Wilkinson in Paramount dispelled the notion that by doing nothing, an office-holder adopted an employment contract. It was not necessary, to avoid adoption, for the office-holder to give notice of termination before expiry of the 14 days after appointment or at all. David Richards LJ stated that the question is ‘not whether the employment continues, but whether the office-holder has adopted the employment contract’, the company being the employer.

David Richards LJ set out Lord Browne-Wilkinson’s summary in Paramount at [44]:

‘I therefore reach the following conclusions: (a) for the purposes of both section 19 and section 44 an employee’s contract of employment is “adopted” if he or she is continued in employment for more than 14 days after the appointment of the administrator or receiver; (b) it is not possible for an administrator or receiver to avoid this result or alter its consequences unilaterally by informing the employees that he or she is not adopting their contracts or only doing so on terms; (c) in the case of both administration and receivership the consequence of adoption of contracts of employment is to give priority only to liabilities incurred by the administrator or receiver during his or her tenure of office.’

‘Continued in employment’, referred to the conduct of the office-holder in continuing the employment (at [45]).

At [53], David Richards LJ noted that ‘the essence of the test’ as Lord Browne-Wilkinson said in Paramount, ‘is whether the office-holder has “continued” the employment of the relevant employees … If the office-holder has continued their employment, in other words has taken active steps to continue their employment, that necessarily results in super-priority for the relevant liabilities under the contracts of employment’. The key issue was wholly objective, focused entirely upon the conduct of the administrator.

At [54], David Richards LJ confirmed that the Court of Appeal agreed with the way Laddie J summarised the effect of Paramount on the meaning of adoption in Re Antal International Ltd [2003] EWHC 1339 (Ch), [2003] 2 BCLC 406:

‘What Lord Browne-Wilkinson was pointing out was that it was important to find some conduct on behalf of the administrator or receiver which could be treated as an election or could be regarded as him exercising a choice as to whether or not the contracts of employment were to be adopted’.

‘Adoption’ on the Facts of Re Debenhams

David Richards LJ identified the following three facts to support the conclusion that the administrators had continued the employment of the furloughed employees:

• The administrators will continue to pay the wages or salaries of the furloughed employees up to the limits of the scheme [57]. David Richards LJ noted that the ‘employees’ entitlement to those payments is derived exclusively from their contracts’.
• All furloughed employees who have accepted the continuation of their employment on these terms ‘will remain bound by their contracts of employment, save only as regards the obligation to be available for work during the furlough period’ [58].
• In continuing to pay the furloughed employees, the administrators are acting with the objective of rescuing the company as a going concern, that being the purpose of the administration, and in the interests of the company’s creditors as a whole [59].

The appellants relied upon three grounds to oppose this conclusion (see [60]):

• First, that the employees ‘are not and will not be providing any services to the company’. While David Richards LJ considered this to be a significant factor distinguishing the case from Paramount, he concluded that it is ‘not decisive and must be balanced against the continued performance of the employment contracts by both sides in all other respects, save for the limit on remuneration, and against the administrator’s purpose in continuing with the employment contracts and the potential benefit to the administration’ [61] – [62].
• Secondly, that the employees’ remuneration is limited to that which is covered by the scheme such that the effect was neutral as far as the administration was concerned. The court determined that the furloughed employees remain employed and are paid the ‘remuneration due under their contracts, subject to the maximum under the scheme. The remuneration is an expense of the company and the government grants are income of the company’ [63].
• Finally, that any decision regarding terminating the contracts of the furloughed employees would take place only after the scheme ends. In this respect David Richards LJ noted that the administrators had taken steps to keep the contracts in being ‘in the hope, for which there must exist reasonable grounds, that the employees will be able to resume work under their contracts either during the administration or on its successful conclusion’ [64].

The court was therefore satisfied that, having taken these competing factors into consideration, the administrators had adopted the contracts of the furloughed employees [65].

It is of note that the court agreed with the appellants’ submission that paragraph 66 of schedule B1 to the Act is an appropriate and ‘perhaps the most obvious source of authority for these payments’ [68].

In conclusion at [71], David Richards LJ identified 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.’

Conclusion

In Debenhams, by the time of the Court of Appeal decision, the administrators had been able to obtain the express consent of employees to being furloughed and to their pay being reduced to the amount payable by the scheme (at that time 80% of gross earnings, employer national insurance contributions in respect of those earnings and minimum automatic enrolment employer pension contributions), ([31] and [71]). However, there was still ‘arguably’ super-priority for 20% of holiday pay.

Administrators will have to take into account practical factors such as ease of communication with employees and the timing of the next payroll to allow any variation of their employment to be agreed. The high level of agreement from employees in Debenhams indicates the financial importance of the content of the communication by administrators with employees.

With changes to the scheme to allow for flexible furlough and the amount of government contribution, the practical issues for administrators have become even more intricate. The decision in Debenhams will need careful consideration and application to the facts in each case as the scheme changes.