When is a contract of employment of a furloughed employee “adopted” by administrators? The Court of Appeal decision in Debenhams Retail Limited (in administration)

May 14, 2020

By Lisa Linklater and Harriet Hartshorn

Following their earlier articles on furlough arrangements and administration, Lisa Linklater and Harriet Hartshorn consider the very recent Court of Appeal decision in Debenhams Retail Limited (in Administration).

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. In light of the Chancellor’s announcement extending the Scheme until the end of October, those effects will continue to be important for some time to come.

The speed of development of jurisprudence on this topic has been meteoric and the decisions have been comprehensive, providing welcome guidance and clarification on this important issue at a very early stage of the Scheme in the context of administrations.  In the most recent and very significant development in this area in one month, the Court of Appeal handed down judgment in In the matter of Debenhams Retail Limited (in administration) [2020] EWCA Civ 600 on 6 May 2020.  David Richards LJ gave the leading judgment of the Court of Appeal.

The Court of Appeal dismissed the appeal from the first instance decision of Trower J [2020] EWHC 921 (Ch) which had been decided on 15 April 2020.  The Court of Appeal held that the administrators of Debenhams had “adopted” the contracts of employment of furloughed employees.  To put the rapidity of development of jurisprudence in this area in context, this followed the Court of Appeal announcing at the hearing on 24 April 2020 that it was dismissing the appeal.  This followed the first instance decision of Snowden J in In the matter of Carluccio’s Limited (in administration) [2020] EWHC 886 (Ch), days earlier on 13 April 2020.

The legal issue may seem narrow and specific, namely whether a contract of employment of a “furloughed employee” has been “adopted” by an administrator.  However, in financial terms, the effect of “adoption” of a contract of employment on the priority of liabilities under an employment contract is significant.  If “adopted”, certain liabilities under a contract of employment are elevated from the general body of unsecured creditors and obtain “super-priority”.  The “wages or salary” (which are defined by paragraph 99(6) to include holiday pay and sick pay) enjoy priority over (a) the administrators’ remuneration and (b) over a floating charge, under paragraph 99(3) and (4) of Schedule B1 of the Insolvency Act 1986.

Issue

The issue before the Court of Appeal was whether the administrators had “adopted” the contracts of employment of furloughed employees within paragraph 99(5) of Schedule B1 to the Insolvency Act 1986 (“the Act”) by paying only the amounts which may be claimed under the Scheme to employees while they are “furloughed” under the Scheme and therefore not permitted to work for the Company.

Analysis

The administrators contended (at [47]) that there had to be:

• words or conduct on their part of the administrators
• which, objectively construed evidences an election on the part of the administrator;
• 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 House of Lords considered and followed the leading House of Lords’ decision of Powdrill v Watson, Re Paramount Airways Ltd [1995] 2 AC 394 (“Paramount”).

David Richards LJ 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, a furloughed employee, must be instructed to cease all work under the Scheme for 21 days or more (at [22]).

At [39], David Richards LJ stated that Lord Browne-Wilkinson in Paramount dispelled the notion that it was necessary, to avoid adoption, for the officeholder to give notice of termination before expiry of the 14 days after appointment or at all. David Richards LJ continued that the question is “not whether the employment continues, but whether the officeholder has adopted the employment contract”.

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 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 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 tenure of office.’

At [53], David Richards LJ noted that as Lord Browne Wilkinson repeatedly said ‘the issue is whether the officeholder has “continued” the employment of the relevant employees’. The essence of the test was identified as whether ‘the officeholder 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’.

Laddie J summarised the effect of Paramount 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’.

The court confirmed at [54] that it agreed with Laddie J’s summary of the effect of Paramount.

“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:

1. 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’.
2. 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].
3. 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 [60]:

1. Firstly, that the employees ‘are not and will not be providing any services to the company’. Whilst 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].
2. Secondly, that the employees’ remuneration is limited to that which is covered by the Scheme. 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].
3. 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 have 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 wither during the administration or on its successful conclusion’ [64].

The court was therefore satisfied that, having taken these competing factors into consideration, the administrators have 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

At [71], David Richards LJ noted the difficulties which may face administrators in deciding whether to take the necessary steps to retain furloughed employees, or to place employees on furlough, where that will involve adoption of the employment contracts. The commercial impact of the decision had been reduced by the time of the appeal because of terms agreed with the vast majority of employees of the Company such that it was only in respect of 20% of holiday pay that super-priority may arise (see [31]).

The new factual issues raised by the Scheme have led to fresh review and consideration of long-established case law, most notably the House of Lords decision in Powdrill v Watson, Re Paramount Airways Ltd [1995] 2 AC 394 (“Paramount”).  While the judgment of the Court of Appeal in Re Debenhams is concerned with the Scheme, it is very likely it will be of wider and enduring effect on the issue of when a contract is “adopted” by an administrator.  This is more probable as terms in contracts of employment evolve in light of both economic factors and a new approach to “the workplace”, precipitated by the coronavirus pandemic.

A full copy of the judgment is here.

The writers’ previous articles on the first instance decisions of Snowden J in Re Carluccio’s and Trower J in Re Debenhams are here.

Lisa Linklater is a barrister specialist in all aspects of commercial litigation including insolvency and company law. She is recommended in both Legal 500 UK Bar Guide 2020 (commercial, banking, insolvency and Chancery law) and Chambers UK Bar Guide 2020 (Chancery and insolvency).

Harriet Hartshorn is a versatile junior who has developed a strong commercial and insolvency practice encompassing a range of personal and corporate insolvency matters.