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On 13 April 2020, Mr Justice Snowden released his judgment in the matter of Carluccio’s Limited (in administration) and handed down declarations and directions to the joint administrators of the company. The directions set out the legal basis upon which the joint administrators could place a large number of the company’s employees on furlough, pursuant to the government’s Coronavirus Job Retention Scheme (furlough scheme).
This is an important decision for illustrating the circumstances in which the furlough scheme can potentially apply in relation to companies in administration and the potential hurdles to overcome.
Facts
The company operates a chain of Italian restaurants. It has over 70 branches and around 2,000 employees. All of the company’s branches have been closed since 16 March 2020 (following the prime minister’s advice that all restaurants should close as part of the government strategy for combatting the COVID-19 outbreak).
An administration order was made on 30 March 2020 by ICC Judge Mullen. The intended administration strategy is to “mothball” the company’s business and in parallel seek a sale of the business in order to achieve a better return for creditors than would otherwise be achieved if the company were wound up (administration strategy). As part of this administration strategy, the joint administrators wanted to retain the company’s employees rather than make them redundant.
Coronavirus Job Retention Scheme and inter-relation with insolvency legislation
However, the company had no money to pay the continuing wages of its employees. Unless the company was able to utilise the furlough scheme, the joint administrators faced the prospect of making the workforce redundant. It was submitted by the joint administrators that redundancy would have a manifestly prejudicial effect on the employees and the value of the company’s business which the joint administrators are hoping to sell.
Why did the court have to make directions on this issue?
The application was necessary because the government has provided no precise details of the furlough scheme’s legal structure, in particular, its operation in tandem with the insolvency legislation. Under the Insolvency Act 1986, the joint administrators had 14 days to make their decisions on retaining the employees, namely on or before Easter Monday. Hence the application was also urgent.
The furlough scheme and its application to company in administration
The joint administrators provided evidence that there is a reasonable likelihood of achieving a sale of the business whereby all willing employees would be TUPE transferred to the buyer and resume work (after the COVID-19 restrictions are lifted). On this basis the judge agreed with the joint administrators that the furlough scheme ought to be available to the company in respect of furloughed employees.
Variation of employment contracts (prior to 14 day time period)
Shortly after their appointment, the joint administrators wrote to all of the company’s employees who were not immediately required to assist with the administration strategy offering to continue to employ them on varied terms so as to take advantage of the furlough scheme arrangements for pay (variation letter). The overwhelming majority of the employees accepted that offer (consenting employees), some indicated that they preferred to be made redundant and retire (objecting employees) and a small number had not responded to the offer (non-responding employees).
As highlighted by the judgment, the furlough scheme is not clear as to how it is to operate in an insolvency process. The furlough scheme guidance indicates that:
- It is a claim made by the employer.
- The government will pay any grant monies to the employer.
- The grant monies will be paid into the employer’s bank account and is to be accounted for as income by the employer.
This would mean that such grant of monies would constitute assets of the company in administration. Assets of a company in administration must be distributed in accordance with the statutory order of priorities for payment prescribed by the insolvency legislation and cannot otherwise be freely disposed of by the joint administrators.
Although the furlough scheme guidance indicates that employers must pay the employee all the grant monies they received for their gross pay, it makes no reference to the grant monies being impressed with a trust (in favour of the employee), such that the monies are not assets of the company to be dealt with in accordance with the statutory order of priorities. The grant monies are merely to be paid into the employer’s UK bank account without any requirement for those funds to be segregated from the company’s general funds. However, as indicated in the judgment, this issue is equally pertinent to companies not in administration.
Accordingly, a mechanism had to be found under the insolvency legislation to justify the payment of wages in priority to other claims against the company. In the Judge’s view the only realistic candidates were paragraphs 99 and 66 of Schedule B1 to the Insolvency Act 1986.
Paragraph 99 of Schedule B1 deals with charges and liabilities on an administrator’s vacation from office. The effect of the paragraph is that liabilities for wages or salary arising out of contracts of employment adopted by an administrator are payable out of the assets held by the administrator in priority to the administrator’s remuneration and expenses. This is the so called “super priority” payment status, and is the effect of paragraph 99 (5).
The judge rejected an argument that paragraph 99 (5) was limited to cases where “services” are actually rendered to the company before these provisions can be engaged, on the basis that if Parliament had wanted to limit super-priority for wages and salary to such circumstances, it could have expressly done so. Furthermore, the judge indicated that it was clear from subsisting case law, that promotion of rescue culture is an important consideration when interpreting the Insolvency Act.
On this basis, paragraph 99 (5) should be interpreted to permit the furlough scheme to be given effect and thus support the rescue culture and the government’s efforts to deal with the economic consequences of the COVID 19-pandemic.
Legal status of the variation of employment contracts
The consenting employees are employed on the basis of terms as varied by way of the variation letter. Those terms only require payment of wages and salary (i) at a level equal to the grant received under the furlough scheme in respect of the employee and (ii) only at a time when the grant had been received.
The judge determined that the variation letter validly amended the contracts of employment as regards the consenting employees. The variation letter indicated that the company cannot be liable for wages or salary in excess of the amount paid under the furlough scheme. Furthermore, it provided that the company is not obliged to pay the employee before receipt of the Furlough funds.
As and when the joint administrators make an application under the furlough scheme in respect of the consenting employees, or make any payment to the employees under their varied contracts, this would amount to an adoption of the varied contracts of employment. The judge held that such steps would enable super priority payments to be made to the furloughed employees under paragraph 99 (5) using grant monies when received, or, alternatively, it would enable payments to the employees to be made from other funds of the company, which would be reimbursed when the grant money was paid.
Notwithstanding the fact that the variation letters contained express wording to the effect that the joint administrators would not be and will not at any future date adopt the employees’ contract of employment, the judge did not consider that the wording should detract from the conclusion that the varied contracts of employment of the consenting employees will be adopted under paragraph 99 (5).
It was determined that the contracts of employment of the objecting employees will not either be varied or adopted by the joint administrators but they will be terminated and the employees in question made redundant.
The position of the non-responding employees was less clear as to whether or not they could be deemed to have accepted the terms of the variation letter. Subsisting case law did not assist the court in being able to reach a conclusion that they could be deemed to have accepted the variation letter terms. Furthermore, the court indicated that the furlough scheme guidance stated that furloughing should be done by agreement with employees.
The judgment confirmed that any non-responding employees who accepted the offer made in the variation letter prior to the expiry of the 14 days into the administration, would stand in the same position as the consenting employees.
For those non-responding employees that did not accept the variation letter offer prior to the expiry of 14 days into the administration, and on the basis that nothing else happens, then based on subsisting case law, the judge determined that the joint administrators would not be treated as having adopted the unvaried contracts of employment of those employees by the mere failure to terminate those contracts prior to the expiry of the 14 day period.
Those non-responding employees who continue to fail to respond to the variation letter would continue to be employed by the company on the terms of their unvaried contracts of employment, unless and until those terms are terminated.
In light of the determinations made by the court as to the application of paragraph 99 (5) to the circumstances of this case, the judge did not consider it necessary to express any views on the potential applicability of paragraph 66 to this matter.
Commentary
This judgment is a highly welcome decision providing practical guidance and detailed clarity on the circumstances in which the furlough scheme can potentially apply in relation to employees of a company in administration.
The important aspects for insolvency practitioners (IPs) to consider in determining whether or not an administration appointment they are dealing with can utilise the furlough scheme are:
- Consideration of the administration objective and/or strategy. Will this involve an intended sale of the business which would likely involve the re-engagement of the current employees by the purchaser?
- If so, is that administration strategy reasonably likely to be achieved?
- If so, it is important to engage with employees at the earliest opportunity in relation to these matters (crucially within the first 14 days of appointment) in order to canvass their approval for any proposed variation of their contractual terms as may be appropriate with reference to utilisation of the furlough scheme going forward.
It is important that administrators fully document their reasoning for undertaking any such approach in relation to attempting to utilise the furlough scheme with reference to these matters, whilst at the same time seeking to preserve any confidential terms of indicative offers of purchaser proposals for instance.
It will be interesting to see if the government’s guidance on the furlough scheme will be updated in light of the clarity provided by way of this judgment. In particular, whether the government will address any wording as to declarations of trust in favour of employees as regards payments made to employers under the scheme going forward.
If IPs need to consider the furlough scheme following publication of either further details of the legal structure behind it or further guidance, then they should take legal advice as to the application of the findings in this case to ensure that the understanding of the furlough scheme upon which this case is based has not been superceded.
The judgment also serves as a useful reminder to employees of the importance of keeping in touch with an appointed administrator during the course of their employer’s administration and making sure that they have up to date contact details and means of getting in touch with an employee promptly (such as mobile, telephone and emails address) so that the employee has the ability to secure advice early in relation to such proposals and is fully engaged in any decisions going forward.
United Kingdom