Protective awards unprotected

The Court of Appeal decision on whether employees' protective awards are entitled to priority in an administration

The Journal, October 2005, page 46

Earlier this year (see May Journal, page 51, and correcting letter, June Journal, page 12) the Allders Department Stores [2005] EWHC 172 (Ch) decided that employee claims for redundancy payments or unfair dismissal compensation did not constitute expenses of an administration so as to attract priority for payment. Protective awards under section 189 of the Trade Union and Labour Relations (Consolidation) Act 1992 generated a further flurry of case law over the summer in relation to administrations, and with it much debate.

On 27 July 2005, in Re Huddersfield Fine Worsteds Ltd [2005] EWCA 1682 (Ch), Peter Smith J held that administrators of a company were obliged to pay protective awards and payments in lieu of notice to employees whose contracts of employment they had adopted, in priority to the expenses of the administration. However, in a judgment on the morning of 9 August in Re Ferrotech Ltd, Etherton J took the opposite view, holding that such payments did not have this priority. That afternoon, the Court of Appeal agreed to hear an appeal from both decisions (and decisions concerning two other companies including Granville Technology Group Ltd). The reason for the haste was that Granville’s administrators had to decide whether or not to dismiss over 150 Granville employees by the following morning and the outcome of the appeals would influence their decision. The appeal court overruled Peter Smith J, upheld Etherton J and held that protective awards and payments in lieu of notice are not payable as administration expenses. This decision put an end to some weeks of serious concern that administrations would in most cases not be viable, which in the view of some commentators threatened the demise of the “rescue culture”.

“Super priority”

The issue is not without its difficulties. Paragraph 99(3) of Schedule B1 to the Insolvency Act 1986 (inserted by the Enterprise Act 2002) provides that an administrator’s claim for remuneration and expenses should generally have priority over all the debts of the company. However, paragraph 99(4) then states that priority over the administrator’s claim (often referred to as “super priority”) is enjoyed by “a sum payable in respect of a debt or liability arising out of a contract entered into by the former administrator or a predecessor before [he ceases to be the company’s administrator]”.

Paragraph 99(5) applies this “super priority” to a liability arising under a contract of employment adopted by the administrator; for that purpose “(c) no account shall be taken of a liability to make a payment other than wages or salary”. By paragraph 99(6), “wages or salary” includes, among other things, holiday pay, sick pay, and “(d) in respect of a period a sum which would be treated as earnings for that period for the purposes of an enactment about social security”.

Adoption effectively occurs in respect of a contract of employment if the administrators do not dismiss the relevant employee within 14 days of taking office.

Protective awards arise under the 1992 Act where an employer fails to comply with the section 188 obligation to consult before dismissing more than 19 employees on the ground of redundancy. It has been held that insolvency per se does not amount to a special circumstance disapplying the duty. Although an employment tribunal complaint for failing to comply with this duty need only be raised by one employee, by section 190 a protective award by the tribunal is collective in the sense that it applies to all the employees who have not been properly consulted. The level of the protective award will be the amount of remuneration which the employer would have had to pay during the protective period. The redundant employees may also have claims for unfair dismissal.

The least unsatisfactory answer

The issue before the Court of Appeal was whether a protective award falls within paragraph 99(6)(d). In the words of Neuberger LJ, who delivered the opinion of the court, the provision appears “to give rise to difficulties on any view”. It was vigorously contended before the court that the paragraph extends to a protective award in the light of section 112(3)(c) of the Social Security Contributions and Benefits Act 1992, which states that regulations may provide that “a sum payable by way of remuneration in pursuance of a protective award… should be deemed to be earnings”, or alternatively that it refers to notional earnings as described in paragraph 4 of the Social Security Benefit (Computation of Earnings) Regulations 1996, under which in certain circumstances an employee who earns less than the norm for his particular job can be treated for social security purposes as earning the norm.

The court dismissed the first argument as, whilst it attributed an entirely natural meaning to the rest of the subparagraph, it gave no meaning to the words “in respect of a period” or “for that period”, and gave paragraph 99(6)(d) such a wide ambit that it rendered the rest of paragraph 99(6) otiose. It dismissed the second contention on the basis that it was somewhat fanciful to think that Parliament intended an employee, contractually entitled only to wages lower than the norm, to be entitled to demand super priority for wages at a higher level, at a time when the company was in administration and therefore subject to the “rescue culture”. Nor did the court see what machinery would be invoked to decide what the norm was, or whether a particular employee was being paid less. This contention also failed to explain the references to period.

The Attorney General, who had intervened in the Ferrotech and Granville cases in order to persuade Etherton J not to follow Peter Smith J, was unable to suggest any current statutory provision to which paragraph 99(6)(d) might refer. He argued that the references to “period” should in fact read “period of holiday”, as in section 19(10) of the Act which the paragraph effectively replaced. As Neuberger LJ said: “as must be clear from the number of possible interpretations that have been put forward, and the significant defects in each of these interpretations, paragraph 99(6)(d) is not merely opaque; it is a thoroughly unsatisfactory piece of drafting”. The Court of Appeal concluded that the least unsatisfactory construction was that “period” related to the period of holiday or absence through illness or other good cause, referred to in subparagraphs (a) and (b). A protective award did not appear to fall within paragraph 99(6)(d), was therefore outside the ambit of “wages or salary” and could not enjoy super priority.

Policy considerations

Their Lordships pointed out however that paragraph 99(5) contained a double gateway in that the liability (i) had to arise under a contract of employment and (ii) had to fall within the definition of “wages or salary” in paragraph 99(6). They went on to consider policy considerations relating to the “rescue culture”, which they considered legitimate in arriving at their decision. They put particular emphasis on evidence by one of the Ferrrotech administrators, who had explained that if protective awards were to have super priority, the need to make the entire workforce redundant within 14 days of the date of his appointment would have ruled out from the outset the possibility of achieving a sale of the business as a going concern. This would have general application owing to the increase in the costs of administration arising out of adopting contracts of employment. The court therefore concluded that this would seriously undermine the rescue culture which underlies the administration regime. Their final comment was that as the 1986 Act prior to 2002 did not accord super priority to protective awards, it would be surprising if the Enterprise Act amendments had that result unless there was some justification for it. They had found no trace of any relevant recommendation or proposal, and accordingly held that in light of the natural meaning of paragraph 99(5) and (6) as reinforced by practical and policy considerations, a protective award did not fall within the ambit of those provisions.

Payments in lieu of notice

They were able to deal with payments in lieu of notice rather more shortly, adopting the approach of Lord Browne-Wilkinson in Delaney v Staples [1992] 1 AC 687 where he categorised such payments.

The first category was where an employer gave proper notice of termination to the employee, told the employee that he did not need to work until termination date and gave him the wages attributable to the notice period. Payments in this category were wages within the normal meaning of that word and would therefore attract the paragraph 99(4) super priority.

Another category was where the employer and employee agreed that employment would terminate forthwith on payment of a sum in lieu of notice. The court held that, at least as a matter of ordinary language, such a payment could not be categorised as wages, nor could it be said to arise under a contract of employment. It took a similar view of the situation where, without the employee’s agreement, the employer summarily dismissed him and tendered a payment in lieu of notice. The court had more difficulty with the situation where the contract expressly provided that employment might be terminated, either by notice or on payment of a sum in lieu. It held that such a payment was not naturally within the meaning of wages, but saw some point in the argument that it would satisfy paragraph 99(6)(d). Ultimately, however, it decided that it would not, having already held that subparagraph (d) referred to payments in respect of holiday or sickness because of the reference to “period” relating back to subparagraphs (a) and (b). It also held that these were really “one off” payments not related to a particular period.

The “rescue culture” therefore survives for so long as these decisions are held to be good law – although, in light of the recent overturning by the House of Lords of long established case law, one wonders whether we have any real certainty in relation to the interpretation of the obscurely worded paragraph 99.

Alistair Burrow, Tods Murray LLP