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Coronavirus: Court confirms administrators may adopt contracts of furloughed employees

In the first decision concerning the government’s proposed Coronavirus Job Retention Scheme (the “Scheme”), the court has held that an administrator can adopt the contracts of employees who agree to be furloughed and that their wages guaranteed by the government can be paid in priority to other creditors.

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Background

Under the Scheme, furloughed employees, whose services cannot be used due to the current COVID-19 pandemic, will not be permitted to work for their employer during the period of furlough but the employer will be able to apply for a grant from the government to cover the cost of continuing to pay the employees 80% of their salary up to a cap of £2,500 per month.

The Court had to decide whether administrators of a company could apply to the government under the Scheme and receive funds to continue to make payments to employees in priority to other creditors. If it were not possible for the administrators to take advantage of the Scheme and pay employees in priority, those employees would have to be made redundant.

Facts

Administrators were appointed to Carluccio’s Limited on 30 March 2020 and wished to take advantage of the Scheme in order to continue to pay employees and avoid making redundancies. The administrators wrote to all of the company’s employees offering to continue to employ them if they agreed to vary the terms of their contracts and be furloughed under the Scheme. The overwhelming majority of the employees agreed to the variation of their contracts. A very small number of employees rejected the variation and a number of others had not responded by the time the administrators applied to the court.

The administrators sought directions from the court as to whether they could pay the furloughed employees in priority to other creditors. Their concern was that a claim under the scheme is made by the employer and not the employee and the government will pay monies to the employer and not the employee. Any money received from the government will therefore constitute assets of the company in administration. Administrators are required to dispose of assets of the company in administration in accordance with the order of priorities prescribed in the insolvency legislation. Administrators therefore feel confident that they were entitled to pay the wages of the furloughed employees in priority to other claims against the company.

Under paragraph 99(5) of schedule B1 to the Insolvency Act 1986, a liability arising under a contract of employment which is adopted by an administrator is payable in priority to the administrator’s own remuneration and expenses, which in turn have priority over the claims of floating charge creditors and unsecured creditors. This is subject to the condition that no act taken within the first 14 days following the administrator’s appointment shall be taken to be an adoption of a contract. The administrators therefore needed directions before the expiry of the 14 day period on 13 April 2020.

Analysis of the Paramount decision

Snowden J analysed the decision of the leading case on the meaning of adoption in the context of paragraph 99(5), (Powdrill v Watson and Another (Paramount Airways Limited) [1995] 2 AC 394 (“Paramount”).

In considering how the adoption of contracts applied in the context of the Scheme, Snowden J clarified the principles set out in the Paramount decision as follows:

  • the appointment of an administrator does not terminate a contract of employment;
  • where a contract is not terminated within 14 days, the mere continuance of the contract after the expiry of 14 days does not mean it is automatically adopted;
  • in order for a contract of employment to be adopted, there must be some conduct by the administrator which amounts to an election to adopt;
  • usually the payment for services rendered by an employee would amount to an adoption, but in the case of furloughed employees, the fact that they are not rendering any services would not prevent their contracts being adopted;
  • in this case, adoption will take place when the administrators apply to the government for a grant under the Scheme or make payments to the employees under their varied contacts;
  • once the contracts had been adopted, funds paid to the employees may be paid in priority either using the funds received from the government under the Scheme or from funds of the company which would be reimbursed by the Government;
  • in respect of employees who declined to agree to vary their contracts and be furloughed, their contracts would not be adopted but terminated and they would be made redundant; and
  • in respect of employees who only responded to the furlough offer more than 14 day following administration, their contracts would be adopted if they subsequently accepted the offer or, alternatively, their contracts would be terminated if they declined the offer.

Comment

This is an important decision for two reasons. In the immediate term, it provides certainty for administrators in allowing them to take advantage of the Scheme and to pay employees who would otherwise be made redundant. It is to be welcomed that even though the Scheme has not been formalised by legislation, which means that the court’s decision cannot actually bind any of the affected employees or the government, Snowden J decided the best course was to assist the administrators by giving his view as to the legal issues. He said that the courts should work constructively together with the insolvency profession to implement the government’s unprecedented response to the crisis.

More broadly, the decision is of interest generally with regard to the meaning of “adoption” of employment contracts under paragraph 99(5) of Schedule B1 to the Act, so that it is clear that (1) failing to terminate a contract within 14 days following administration does not in itself constitute adoption of the contract (2) adoption requires some conduct by the administrator amounting to an election to adopt and (3) payment for services rendered by an employee would amount to an adoption.

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