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BRIEFING PAPER

Number SN00651, 9 June 2017

Employment rights and insolvency

By Doug Pyper and Lorraine Conway

Inside: 1. Payments covered by the

State 2. Administration and

liquidation proceedings

Number SN00651, 9 June 2017 2

Contents Summary 3

1. Payments covered by the State 4 1.1 Redundancy Payments Service 4 1.2 Redundancy – payments by Secretary of State 6 1.3 Payments covered by HM Revenue and Customs 7 1.4 Pensions 7

Pension contributions 7 The Pension Protection Fund 7

2. Administration and liquidation proceedings 8 2.1 Administration and contracts of employment 8 2.2 Liquidation proceedings 9 2.3 Payment of creditors’ claims 9

Preferential debts owed to employees 10

Cover page image copyright: Total stock liquidation … by Mark. Licensed under CC BY 2.0

3 Employment rights and insolvency

Summary The Employment Rights Act 1996 and Insolvency Act 1986 provide a number of avenues via which an employee might seek payment of debts owed to him or her by an insolvent employer. The avenues fall into two broad categories. First, the Secretary of State must pay certain debts to employees, effected via the Redundancy Payments Service. Aside from in the case of unpaid redundancy pay, the Redundancy Payments Service will only pay these debts if the employer has become formally insolvent. Second, employees may seek payment from the company’s assets through insolvency proceedings or via administrators.

The options open to the employee may be summarised as follows:

• The Employment Rights Act 1996 requires the Secretary of State to pay certain debts owed to employees, including arrears of pay and unpaid redundancy pay. This is paid out from the National Insurance Fund via the Redundancy Payments Service.1

• Statutory payments such as statutory sick pay and maternity, paternity or adoption pay may be covered by HMRC.

• The State may also cover unpaid employer’s contributions for employees who belongs to occupational pension schemes, and, under the Pensions Act 2004, pension schemes may be protected by the Pension Protection Fund.

• If an employer is put into administration, employees may have claims against the administrator/administrative receiver.

• If the employer is put into liquidation, employees may have claims against the insolvent estate.

• Employees are treated as preferential creditors under the Insolvency Act 1986 in respect of unpaid wages owed in the four months prior to the insolvency order (subject to an £800 limit), and in respect of the total amount of unpaid holiday pay.

This briefing provides further details about each of these. The law discussed applies to the whole UK.

1 Certain categories of employee are excluded. The rights are not available to merchant seamen, share

fishermen, employees of the Crown or parliamentary staff.

Number SN00651, 9 June 2017 4

1. Payments covered by the State

1.1 Redundancy Payments Service Under the Employment Rights Act 1996 the Secretary of State must pay to employees certain debts owed to them by their insolvent employer. The material parts of the Act implement EU Directive 2008/94/EC. The Secretary of State must pay employees out of the National Insurance Fund. Payment is arranged by the Redundancy Payments Service, part of the Insolvency Service. The debts covered are set out below.2

Statutory redundancy payments. Employees with two years’ continuous employment have a right to redundancy pay, based on their weekly pay (subject to a statutory cap, currently £489). The payment is calculated by multiplying a week’s pay (or multiple thereof – see below) by the number of years of employment, reckoned backwards from the date of dismissal, up to a maximum of 20 years. The relevant multiple for any given year of employment is determined by the employee’s age during that year:

─ 0.5x a week’s pay for each full year of service where age during the year is less than 22

─ 1x a week’s pay for each full year of service where age during the year is 22 or above, but less than 41

─ 1.5x a weeks’ pay for each full year of service where age during the year is 41+

• Arrears of pay up to £489 a week for a maximum of eight weeks, including guarantee payments for workless days; payments for time off for union duties; remuneration for suspension on medical or maternity grounds; and redundancy protective awards.

• A payment for failure to give statutory notice, up to a weekly limit of £489.

• Holiday pay for unused holidays and for holidays actually taken but not paid, up to a weekly limit of £489 for a maximum of six weeks. Holiday pay may include holiday carried over from the previous year if the contract of employment allows this.

• An unpaid basic award made by an employment tribunal of compensation for unfair dismissal.

Complaints about the Secretary of State’s failure to make such payments are dealt with by employment tribunals.3

Aside from in the special case of redundancy payments (see below under “Redundancy – payments by Secretary of State”) the State guaranteed payments apply only if the employer has become formally insolvent, as defined in section 183 of the 1996 Act. Where the

2 Employment Rights Act 1996, sections 166 and 184 3 Employment Rights Act 1996, section 188

5 Employment rights and insolvency

employer is a company (including charitable incorporated organisations) section183 will be satisfied

• if a winding up order has been made, or a resolution for voluntary winding up has been passed, with respect to the company;

• if the company is in administration for the purposes of the Insolvency Act 1986;

• if a receiver or (in England and Wales only) a manager of the company's undertaking has been duly appointed, or (in England and Wales only) possession has been taken, by or on behalf of the holders of any debentures secured by a floating charge, of any property of the company comprised in or subject to the charge; or

• if a voluntary arrangement proposed in the case of the company for the purposes of Part I of the Insolvency Act 1986 has been approved under that Part of that Act.4

Where the employer is an individual, section 183 will be satisfied

in England and Wales if—

• a moratorium period under a debt relief order applies in relation to him

• he has been made bankrupt or has made a composition or arrangement with his creditors; or

• he has died and his estate falls to be administered in accordance with an order under section 421 of the Insolvency Act 1986

in Scotland if—

• sequestration of his estate has been awarded or he has executed a trust deed for his creditors or has entered into a composition contract; or

• he has died and a judicial factor appointed under section 11A of the Judicial Factors (Scotland) Act 1889 is required by that section to divide his insolvent estate among his creditors.5

Where the employer is a limited liability partnership section 183 will be satisfied

• if a winding-up order, an administration order or a determination for a voluntary winding-up has been made with respect to the limited liability partnership;

• if a receiver or (in England and Wales only) a manager of the undertaking of the limited liability partnership has been duly appointed, or (in England and Wales only) possession has been taken, by or on behalf of the holders of any debentures secured by a floating charge, of any property of the limited liability partnership comprised in or subject to the charge; or

• if a voluntary arrangement proposed in the case of the limited liability partnership for the purposes of Part I of the

4 Employment Rights Act 1996, section 183(1), (3) 5 Employment Rights Act 1996, section 183(1), (2)

Number SN00651, 9 June 2017 6

Insolvency Act 1986 has been approved under that Part of that Act.

Ex-employees wishing to make a claim under these provisions should apply to their employer’s representative (for example, the receiver, liquidator or trustee) for an application form (RP1). The completed form should be sent to the Redundancy Payments Service. The various forms and supporting fact sheets are available from the Gov.uk website, here.6 The RP1 fact sheet provides a basic guide for employees.

Employees who have outstanding claims which are not covered by this scheme may submit a claim to the employer’s representative who will consider it separately as part of the insolvency proceedings (see section 2 of this briefing).

1.2 Redundancy – payments by Secretary of State

The Employment Rights Act 1996 contains specific provisions on State-guaranteed redundancy payments, separate from the Act’s treatment of other State-backed payments. A redundant employee may apply to the Redundancy Payments Service if his employer is liable to pay him a statutory redundancy payment and the employer:

• is insolvent; or • refuses to pay and the employee has “taken all reasonable steps,

other than legal proceedings, to recover the payment”.7

As such, in the case of claiming an unpaid redundancy payment from the Redundancy Payments Service, there is no absolute need for the employer to have become insolvent.

In order to qualify for a statutory redundancy payment the employee must have been dismissed by reason of redundancy and have two years’ continuous employment with the employer.

What constitutes “all reasonable steps” will depend on the circumstances, but it will generally involve a requirement to obtain judgment against the employer in the employment tribunal.8

6 Redundancy payment forms, Gov.uk 7 Employment Rights Act 1996, section 166(1). 8 While section 166(1) of the 1996 Act stipulates a requirement to take all reasonable

steps “other than legal proceedings”, section 166(4) qualifies this, somewhat counter-intuitively, by providing that the definition of legal proceedings “does not include any proceedings before an employment tribunal” (although does include tribunal proceedings to enforce a tribunal award). The effect of this is that section 166 contemplates the possibility of obtaining judgment in the tribunal as being a “reasonable step” which a redundant employee may be expected to take prior to applying to the Redundancy Payments Service.

7 Employment rights and insolvency

1.3 Payments covered by HM Revenue and Customs

HMRC is liable to make the following payments to an employee if the employee cannot obtain payment from her/his employer due to insolvency:

• statutory maternity pay9 • statutory paternity pay10 • statutory adoption pay11 • statutory sick pay12

1.4 Pensions Pension contributions Under section 124 of the Pension Schemes Act 1993 the trustees of an occupational pension scheme or personal pension scheme may apply in writing to the Secretary of State claiming that an insolvent employer has failed to pay pension contributions (either on their own account or on behalf of the employee if deducted from the employee’s pay) into the scheme during the 12 months preceding the date on which the employer became insolvent. The Secretary of State is obliged to meet these liabilities subject to the limitations and maximum amounts set out in sections 124-125 of the 1993 Act. If the Secretary of State has failed to make any such payment or the payment is less than the amount which should have been paid, the trustees may complain to the employment tribunal.13

The Pension Protection Fund The Pensions Act 2004 established the Pensions Protection Fund, which may assume responsibility for compensating members of eligible pension schemes. Where an insolvency event occurs the insolvency practitioner is obliged to notify the PPF, following which the scheme enters a PPF assessment period. The operation of the PPF is set out in this Library briefing.14

9 Statutory Maternity Pay (General) Regulations 1986 (SI 1986/1960), regulations

7(3), 7(4) and 30 10 Statutory Paternity Pay and Statutory Adoption Pay (General) Regulations 2002 (SI

2002/2822) 11 Ibid. 12 Statutory Sick Pay (General) Regulations 1982 (SI 1982/894), reg 9B 13 Pension Schemes Act 1993, section 126 14 Thurley, D., Overview of the Pension Protection Fund, SN03917

Number SN00651, 9 June 2017 8

2. Administration and liquidation proceedings

Insolvency arises when individuals or businesses have insufficient assets to meet all their debts, or are unable to pay their debts as and when they fall due. Depending on the exact circumstances there are various insolvency procedures open to an insolvent business, including administration and liquidation.

2.1 Administration and contracts of employment

On a petition by the company, its directors or creditors, an administrator may be appointed. An administration order is an order directing that the affairs, business and property of a company shall be managed by a person appointed by the court.15 The primary objective of administration is to rescue the company as a ‘going concern’ (i.e. with as much of its business as possible). If the administrator can find a buyer to take over all or part of the business as a ‘going concern’ some jobs may be saved (although there may still be redundancies). Employment contracts may be transferred to the new buyer, with the employees’ rights protected under rules that apply to the transfer of undertakings. If the business cannot be saved, the administrator can perform his functions with the aim of achieving a better return for creditors than would be likely if the company were wound-up (liquidated) without first being in administration. It should also be noted that there is a separate largely abolished process whereby an ‘administrative receiver’ may be appointed by the holders of debentures (debt instruments not secured on physical assets) created before 15 September 2003.

Once in administration, the company is placed under the day-to-day control and management of an administrator, which may involve the continued operation of the business and retention of employees. Both administrators and administrative receivers will be taken to have adopted the company’s employment contracts after a period of 14 days. They may then be required to pay liabilities under those employment contracts in respect of wages or salary or contributions to occupational pension schemes. For administrators, these liabilities are paid out of the company’s assets and given priority over most other charges and securities on those assets, and are payable in priority to the administrator's remuneration and expenses.16 Administrative receivers are, by contrast, personally liable to pay wages or salary or contributions to occupational pension schemes where those sums are payable in respect of services rendered after the adoption of the contract.17

15 Insolvency Act 1986, section 8(2) 16 Insolvency Act 1986, Schedule B1, para 99 17 Insolvency Act 1986, section 44

9 Employment rights and insolvency

2.2 Liquidation proceedings An insolvent company may be forced into compulsory liquidation by one or more creditors. ‘Liquidation’ is the process by which the operations of a company are brought to an end; it will cease to exist. The assets and property of the company are used to pay off its debts. An insolvency practitioner (IP) will be appointed liquidator to manage the insolvent estate.

When a compulsory liquidation order is made against a company, all creditors (including employees) have to formally register their claim in the insolvency, which is done by notifying the liquidator (the IP ) of their claim in writing (using a ‘proof of debt’ form), backed by evidence if required. The liquidator may either accept a claim in whole or part or reject it.

2.3 Payment of creditors’ claims Any creditor (including an employee) involved with a failed company, will want to know their position when it comes to the realisation and distribution of company assets to pay off debts. An IP, whether acting as an administrator or as a liquidator, has an overriding duty to act in the interests of the body of creditors as a whole. Typically, this means maximising returns to creditors who are owed money (theses creditors can include banks, employees, suppliers, etc.).

Generally, assets of an insolvent company are collected in and sold and the proceeds used to pay company debts. The IP must follow a strict order of priority, set out in Schedule 6 of the Insolvency Act 1986 (“IA 1986”), to distribute realisations to the various creditors. In an insolvency, there is rarely enough money to pay all those owed money. It follows from this that the lower a creditor’s position in the priority order, the less they are likely to receive.

The priority order is as follows:

• Any creditor holding a fixed charge over an asset (e.g. a mortgage)

• The fees and charges of the liquidation (it is important to note that expenses of the liquidation have priority over other claims except for those of fixed charge holders).

• Preferential debts (certain employee debts are preferential – see below)

• Any creditor holding a floating charge over an asset (e.g. a debenture)

• All unsecured creditors (also known as ordinary creditors) • In company cases, the shareholders

A secured creditor (usually a bank) will have security over company assets for amounts owed to them. Security tends to fall into two categories: fixed charge security and floating charge security.

Fixed charge security is a lien or mortgage over a specific asset such as land, a building, or machinery which is registered and remains in force until the debt is paid. A characteristic of fixed charge security is that a

Number SN00651, 9 June 2017 10

borrower would need the lender’s permission to sell a fixed charge asset. In the event of the borrower’s insolvency, the fixed charge holder will be paid out of the proceeds from the sale of the assets subject to the fixed charge, and before all other creditors (including preferential creditors).

Unlike a fixed charge, which will attach itself to an asset from the point of creation, a floating charge will ‘float’ above a changing pool of assets (e.g. stock, book debts and work in progress) until a specific event occurs (i.e. insolvency or a default under the loan) when it will attach. At that stage the floating charge is converted into a fixed charge over the assets which it covers at that time. However, a floating charge holder is only paid out once the following have been satisfied:

• holders of fixed charges; • expenses of the insolvent estate; and • preferential creditors (including, where relevant, employees; see

below)

For certain floating charges there may also be a percentage-based ring-fenced amount for the benefit of unsecured creditors.

Unsecured creditors, often referred to as ordinary creditors, are creditors who do not hold any security for the money owed to them. Unsecured creditors have no legal title to specified assets of the company and in insolvency proceedings are subordinate to secured creditors, preferential creditors and those with a floating charge.

Employees of an insolvent company have a degree of preference under the IA 1986, explained below.

Preferential debts owed to employees Preferential debts are unsecured debts which, by statute, are to be paid in priority to all other unsecured debts and debts secured by floating charges. The categories of preferential debts for all forms of insolvency are listed in Schedule 6 to the IA 1986. In respect of employees, preferential debts include:

• an amount payable “by way of remuneration” which is defined to include:

─ wages or salary (including commission)

─ a guarantee payment under Part III of the Employment Rights Act 1996, which entitles qualifying employees to guarantee payments if they are not provided with work in specified circumstances

─ payment owed for: time off work to look for work/training in the event of redundancy; time off for ante-natal care; time off for union duties

─ remuneration on suspension on medical or maternity grounds

─ a protective award made by an employment tribunal in respect of employers’ failure to undertake a proper redundancy consultation

11 Employment rights and insolvency

─ any remuneration payable by the debtor to a person in respect of a period of holiday or of absence from work through sickness

• an amount owed by way of accrued holiday remuneration; and • any amount which is ordered (whether before or after the

relevant date) to be paid by the debtor under the Reserve Forces (Safeguard of Employment) Act 1985.

Debts payable by way of remuneration are treated as preferential only in respect of the whole or any part of the period of four months immediately preceding the insolvency and the extent of the preferential debt is capped at £800. However, the amount owed by way of accrued holiday remuneration is uncapped. The cap is applied separately to any amount owed under the Reserve Forces (Safeguard of Employment) Act 1985.

When a liquidator comes to make a distribution from the insolvent company’s estate, amounts due in respect of preferential debts are paid after amounts secured by a fixed charge, and the expenses of the liquidation, but before all other liabilities. An employee will rank as an unsecured creditor in respect of any debt in excess of the £800 cap/four month period.

BRIEFING PAPER Number SN00651, 9 June 2017

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