Hard cases and bad law: Insolvency and employment debts

Richard Parr

Richard Parr

This is one of those unfortunate cases…in which, it is, no doubt, a hardship upon the plaintiff to be without a remedy but by that consideration we ought not to be influenced.  Hard cases, it has frequently been observed, are apt to introduce bad law.”

Those were the words of Baron Rolfe J in Winterbottom –v- Wright , a case decided in 1842.  Surely, 170 years on, a little humanity has pervaded the judicial system?

Ask a lady called Ms Pengelly.  She would undoubtedly have something to say on the subject.

But first, a word about the dry topic of insolvent companies and the remedies available to an employee left high and dry by a company failure . . . . . .

Where an employer is insolvent and employment has been terminated, an employee is likely to be owed one or more of the following:

  • arrears of pay
  • notice pay
  • damages for any breach of contract occasioned by the termination
  • statutory redundancy pay
  • a protective award (for failure to inform and consult in relation to collective redundancies), and
  • an award for failure to inform and consult under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”).

Employees may be able to recover some of these debts from either:

  • the company (a topic on its own which this blog leaves for another day), or
  • National Insurance Fund (ie, you and me!).

Article 3 of the EU Directive 2008/94/EC  obliges member states to establish “guarantee institutions” to offer limited protection to employees whose employer becomes insolvent.  The Directive has been adopted in the UK by amendment to the Employment Rights Act 1996 (“ERA”) and through the creation of the National Insurance Fund (operated via the Redundancy Payments Office).

Aside from statutory redundancy pay which is dealt with separately in ERA 1996, the types of debt for which an employee may make a claim on the National Insurance Fund (Section 184 ERA 1996) are:

  • up to 8 weeks’ arrears of pay
  • pay during the minimum period of notice prescribed by Section 86 ERA 1996 (ie 1 week for each complete year of employment) or, alternatively, damages for failure to give that amount of notice
  • holiday pay for up to 6 weeks’ holiday to which the employee had an entitlement in the previous 12 months (this means pay to which an employee was entitled when he was on holiday, but which he did not receive, or pay in respect of holiday accrued, but untaken), and
  • a basic award for unfair dismissal and a protective award (for failure to consult in a collective redundancy situation).

Four further conditions must be satisfied, namely that:

  • The individual is an employee.  This point may seem obvious but it may be problematic as regards an individual who is a controlling shareholder (and probably also a director) of a small private limited company.  Following the decisions in Secretary of State v Neufeld [2009] EWCA Civ 280  and Nesbitt v Secretary of State UKEAT/0091/07 it is for the Employment Tribunal (or the Insolvency Service) to consider whether a controlling shareholder or director is an employee, and therefore eligible to claim.  However, the mere fact that an individual is both a majority shareholder and director should not automatically result in a finding that an employment status does not exist; instead, in order to undermine employment status, it must be shown that the contractual relationship between the company and the “employee” is a mere sham.
  • The employer must be insolvent within the meaning of ERA 1996 which means:
    • a winding-up order has been made, or a resolution for voluntary winding-up has been passed, or a company is in administration, or
    • a voluntary arrangement (ie a moratorium with creditors) has been proposed, or
    • a receiver has been appointed, or
    • a debenture holder has taken possession of property secured by the floating charge
    • employment must have terminated, and
    • the money must have been owed to the employee on “the appropriate date”.

This is where it gets really complicated – and you thought it was complicated already?

The “appropriate date” means:

  • in relation to arrears of pay and holiday pay, the date the employer became insolvent
  • in relation to a basic award or protective award, the latest of the date on which the company became insolvent, the date of termination of employment, and the date when the award was made.
  • for any other type of payment, the later of the date on which the company became insolvent and the date of termination of employment.

Still with me? Let’s bring in Ms Pengelly.

In June 2010 Woolston Manor Golf and Country Club Ltd entered into a company voluntary arrangement (“CVA”).  Ms Pengelly started work for the club two months later in August 2010.  She knew nothing of the CVA.

Seven months later, in February 2011, the club went into compulsory liquidation.  The liquidation resulted in Ms Pengelly’s automatic dismissal.  At the time of her dismissal Ms Pengelly was owed arrears of wages and holiday pay.  The debts accrued after the CVA had been entered into.

Ms Pengelly went to the National Insurance Fund for the arrears but the Fund denied liability.  The Fund argued that although Ms Pengelly was unaware of it, the Club was already insolvent when it entered into the CVA.  The Fund pointed to the first of the definitions of “appropriate date”, set out above.

Ms Pengelly issued a claim in the employment tribunal.  Her claim was upheld. The judge’s view was that parliament could not have intended to leave Ms Pengelly without a remedy.  But the problem for the judge was that Section 183 ERA defines insolvency to include a CVA – and, of course, the CVA preceded the liquidation.

The judge bravely argued that regard should be paid to the nature of the insolvency when deciding which of the two dates – the date of the CVA and date of compulsory liquidation – was to be chosen as the “appropriate date”.  The judge noted that the Club continued operating as a going concern following the start of CVA.  He argued the date of the CVA should not be the appropriate date.  He concluded that it was only when the Club went into compulsory liquidation that the appropriate date arose.

The Secretary of State for Business Innovation and Skills , as the operator of the Fund, appealed against the decision.  The Secretary of State argued that the appropriate date was the date of the CVA.  Accordingly, Ms Pengelly could not meet one of the preconditions for payment in section 182 – she was not owed anything when the CVA started.

The EAT held that for the purposes of section 182 ERA 1996 insolvency occurred when the CVA started.  Since no debts were owed to the Ms Pengelly at that time, she was not entitled to recover her arrears of wages and holiday pay from the Fund.

The EAT rejected the argument that the aim of the Directive was to guarantee, without limit, debts owed to employees by insolvent employers.  The EAT pointed out that there are several species of insolvency (detailed earlier in this blog), and that it would create uncertainty if the test or conditions for recovering employment debts differed with the type of insolvency.  But it has to be said that such “uncertainty” has for decades been part of UK insolvency law when it comes to secured, unsecured, and preferential debts – a point which apparently didn’t trouble the EAT.

The EAT admitted that the decision would produce a harsh result for Ms Pengelly – and leave her with no way of claiming her salary and holiday pay

So much for justice.

Lord Denning , where are you now when litigants like Ms Pengelly so badly need you?

Richard Parr
Employment Department 
0113 227 9246

This entry was posted in Employment Law. Bookmark the permalink.

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