Insolvency and employees' rights: 2
The second of our two-part series on insolvency looks at the claims that employees of insolvent companies may make for statutory payments from the Government, as well as the statutory employment rights that may be enforced against an insolvent company.
In part one of this Guidance Note we saw that employees of insolvent companies have rights to certain payments from the insolvent employer, and that although the majority of these claims are unsecured, the Insolvency Act 1986 gives preferential status to some of them. By virtue of this status, those claims "jump the queue" and achieve a higher ranking in the hierarchy of claims. They then become payable out of the company's assets in priority to most other claims.
Further protection is afforded to employees of insolvent companies by the Directive on employees' rights on insolvency (No.80/987/EEC). This requires Member States to protect their employees in the event of their employer's insolvency by, for example, providing a guarantee of payment of employees' outstanding claims (article 3). The Directive specifies the period in relation to which pay should be guaranteed, but it allows Member States to set a ceiling on the liability of guarantee institutions to meet the claims (article 4).
To a large extent, this obligation is satisfied by Part VII (ss.122-127) of the Employment Protection (Consolidation) Act 1978 (the EP(C)A). These provisions give employees rights to receive certain guaranteed payments from the state rather than from the insolvent employer, in a limited class of claims. Moreover, ss.106-108 of the EP(C)A enable employees to claim statutory redundancy payments from the state.
The main points discussed in this Guidance Note are set out in the box opposite.
Claims against the National Insurance Fund
The right to a payment out of the Fund applies only to employees, and not to the self-employed.
The insolvency of the employer is another prerequisite for payment from the Fund (ss.106(1)(b) and 122(1)(a) of the EP(C)A). (However, a claim for a statutory redundancy payment may also be made by an employee for reasons other than insolvency, namely, on the ground that the employee has taken all reasonable steps, other than legal proceedings, to recover a payment from the employer, but has been unsuccessful (s.106(1)(a).)
Sections 106(5) and 127(1)(c) state that a company is insolvent if any of the insolvency procedures of liquidation, receivership, administration order or a voluntary arrangement have been applied to it. But note that the Directive may go further, as its provisions apply to a business which has been established as having "definitively closed down". This suggests that a mere cessation of trading on the company's part may be sufficient to invoke its protection.
Claims for payments from the Fund
The rights under ss.122-127 of the EP(C)A are available only to an employee of an insolvent employer whose employment has been terminated, and who has made an application in writing to the Secretary of State that on "the relevant date" he or she was entitled, under the provisions, to be paid a debt which remains unpaid.
The right to a payment does not apply to: a "master" or crew member engaged in share fishing paid solely by a share of the catch; an employee who ordinarily works outside the territory of the Member States of the European Communities (s.141(2A) of the EP(C)A); or a "merchant seaman".
However, the rights do not depend upon any qualifying period of continuous employment.
By s.122(5) the total amount payable in respect of any of the claims listed below must not exceed the limit applicable to claims under the EP(C)A. The current limit is £205 per week (or £41 a day for a five-day-a-week worker). This limit is subject to review by the Secretary of State and it is applied by reference to the relevant date. Debts over the limit (with the exception of apprentices' or articled clerks' fees) will not be paid by the Employment Department. The employee must proceed against the insolvent employer in the usual way.
The claims which an employee may make on the Fund under these provisions are: arrears of pay; payment for a failure to give the minimum statutory notice required under s.49 of the EP(C)A; holiday pay; the basic award of unfair dismissal compensation; and reimbursement of fees or premiums paid by an apprentice or articled clerk.
Arrears of pay. Section 122(3)(a) of the EP(C)A provides that an employee may claim from the Fund up to a maximum of eight weeks' pay. Arrears of pay include: guarantee payments; medical suspension payments under s.19 of the EP(C)A; payments for time off under ss.31(3) or 31A(4) of the EP(C)A, or under s.169 of the Trade Union and Labour Relations (Consolidation) Act 1992 (the TULR(C)A); maternity suspension payments under s.47 of the EP(C)A; and remuneration under a protective award under s.189 of the TULR(C)A.
In the case of Secretary of State for Employment v Forster, the EAT held that an employee who drew no salary but gave it as a loan to the company in which she was managing director and majority shareholder was entitled to notice pay and holiday pay from the Fund. But on the question of whether she could also claim the maximum eight weeks' arrears of salary from the Fund, the EAT held that that debt was not arrears of salary, but a loan, and so s.122 did not "bite" on it.
The relevant date for the purposes of claiming arrears of pay is the date on which the employer became insolvent.
Claims for notice pay. Section 122(3)(b) of the EP(C)A states that an employee may claim from the Fund "any amount which the employer is liable to pay the employee for the period of notice required by s.49(1) or (2) or for any failure of the employer to give the period of notice required by s.49(1)".
Subject to certain exceptions, statutory minimum periods of notice are required for the termination of a contract of employment. Section 49(1) provides that employees who have been continuously employed for a month or more but less than two years are entitled to not less than a week's notice; continuous employment of two or more years up to 12 years entitles an employee to not less than one week's notice for each year of continuous employment; and employees with 12 or more years' continuous employment must be given not less than 12 weeks' notice.
For qualifying employees - that is, those with more than one month's continuous service - the statutory provisions override any contractual provisions for shorter notice (s.49(3)). Nevertheless, either party may waive his or her right to notice, or to accept pay in lieu. A claim for notice pay does not include recovery for other claims to which the employee was contractually entitled during the notice period.
The employee's claim under these provisions is treated as compensation for the employer's breach of contract for failing to pay notice pay. Therefore, the assessment of the employer's liability for such notice pay will take account of the employee's common law duty to take reasonable steps to mitigate his or her loss. In Westwood v Secretary of State for Employment, the House of Lords upheld the Secretary of State's entitlement to deduct unemployment benefit from the payment due to an employee under s.122 of the EP(C)A. However, this was only to the extent that there had been a net gain to the employee which he would not have had but for the breach of contract. Similarly, in Secretary of State for Employment v Wilson, the EAT held that there had been no loss to an employee who started a new job immediately after he had been dismissed without notice. Therefore, the employee could not recover a payment from the Secretary of State under s.122.
An award made by the Secretary of State under s.122 will be subject to the tax which would have been deducted if the employee had been paid wages by the employer during the relevant period (Munday v Secretary of State for Employment).
The relevant date for claiming notice pay is the date on which the employer became insolvent, or the date of termination, whichever is the later.
Holiday pay. Section 122(3) of the EP(C)A states that holiday pay of up to six weeks for holidays which accrued during the 12 months before the relevant date may be claimed from the Fund. Holiday pay means pay in respect of a holiday that is actually taken, or any accrued holiday pay owing to the employee by virtue of the contract of employment in respect of a holiday he or she would have been entitled to if the employment had continued (s.127(3)).
The relevant date for the purposes of claiming holiday pay is the date on which the employer became insolvent.
Basic award. For the purpose of claiming the basic award of unfair dismissal compensation, the relevant date is the date on which the employer became insolvent, or the date on which the employee's contract was terminated, or the date of the tribunal award, whichever is the later.
Pensions contributions. Sections 123-125 of the Pensions Scheme Act 1993 (the PSA) (which repealed s.123 of the EP(C)A) provide that upon application to the Secretary of State by the administrator of the relevant occupational or personal pension scheme, the Secretary shall make a payment into that pension scheme. The conditions which must be satisfied for such a payment to be made are that the employer has become insolvent as defined, and that at that time, there remained unpaid relevant contributions that the employer should have made to the scheme.
Section 124(2) of the PSA defines "relevant contributions" as those either payable by an employer to an occupational or personal pension scheme on its own account, or those so payable on behalf of an employee. For the latter purpose, the amount must have been deducted from the employee's pay by the employer.
SMP and SSP. Liability for statutory maternity pay after the employer becomes insolvent passes on to the Secretary of State under reg. 7(3) of the Statutory Maternity Pay (General) Regulations 1986. This is the same for statutory sick pay under reg. 9B of the Statutory Sick Pay (General) Regulations 1982.
For the period before insolvency, liability for either of these payments remains a debt of the insolvent employer, and will be preferential up to the maximum limit of £800. However, both sets of Regulations provide for the Secretary of State to assume liability for such claims if an adjudication officer has determined that the employer was liable to make either of those payments to the employee.
Claims for a statutory redundancy payment
Section 106 of the EP(C)A gives an employee the right to apply to the Secretary of State for "a payment" out of the National Insurance Fund upon the insolvency of his or her employer, if an "employer's payment" owed to the employee remains wholly or partly unpaid. First, the employee must have applied in writing to the employer for a payment before the end of a period of six months beginning with "the relevant date" - that is, for example, the date on which notice expired or termination took effect (ss.101 and 90).
An "employer's payment" is defined in s.106(1A) as a statutory redundancy payment, or a termination payment due under an agreement covered by a s.96 order (that is, a collective agreement ratified by the Secretary of State as replacing the statutory scheme).
The Secretary of State will investigate the employee's entitlement to this payment. This investigation may involve serving a notice in writing to the employer for information and relevant documentation (s.107(1)). A failure, without reasonable excuse, to respond to this notice is a criminal offence, punishable upon summary conviction by a fine (s.107(2)). Providing the Secretary of State with false information or falsified documentation is also a criminal offence punishable upon summary conviction by a fine and/or imprisonment (s.107(3) and (4)).
Claims relating to payments under s.106 may be referred to industrial tribunals by the Secretary of State under s.108 for a decision on any question as to the liability of the employer to make that payment, or as to the amount of redundancy pay payable.
If the Secretary of State is satisfied of the merits of the employee's claim, including that the employee is entitled to statutory redundancy pay and that the employer is insolvent, a payment is made out of the Fund to the employee. The sum due is calculated in accordance with Schedule 7 to the EP(C)A. This contains specific provisions dealing with payments due under a s.96 order, and situations where an industrial tribunal has found that an employer is liable to pay any part of the redundancy payment.
Note that redundancy claims under s.106 are not preferential. They are guaranteed out of the Fund up to the limit imposed, and any excess must be claimed from the insolvent employer in the usual way - that is, as an unsecured claim.
Subrogation
Once the sums due to the employee have been paid out of the Fund, the Secretary of State becomes subrogated to the employee's claim against the insolvent employer (ss.106(3) and 125 of the EP(C)A). (Subrogation in the case of payments out of the Fund into an occupational or personal pension scheme is provided for in s.124 of the PSA.) Subrogation means that all rights and remedies of the employee in relation to the debt in question are transferred to and vest in the Secretary of State, and any tribunal decision in favour of the employee in respect of that payment, becomes, in effect, a decision in favour of the Secretary of State. Where an employee's claim is a preferential debt, the Secretary of State's claim against the employer will also be preferential. Monies recovered under this provision are paid back into the Fund.
Applying for payment from the Fund
An employee with a claim on the National Insurance Fund under ss.122-127 of the EP(C)A should ask the insolvency practitioner for an application form IP1, which should be completed and returned to the insolvency practitioner as soon as possible after the termination. (For compensatory payment for the lack of proper notice, the appropriate application form is IP2, which should be completed and returned to the insolvency practitioner as soon as the statutory notice period ends.) The forms should not be sent to the Employment Department unless an official of the Department says otherwise.
Upon receiving the completed forms, the insolvency practitioner calculates the payments due. The employee is asked to sign a statement saying that the amount of the claim is agreed, and that his or her rights concerning the debt are subrogated to the Secretary of State. The statement is then sent to the Secretary of State.
A payment will not usually be made unless the Secretary of State has received this statement from the insolvency practitioner that the amount claimed is owed to the employee. However, if the Secretary of State is satisfied that a statement is not needed in order to determine the amount owed on the relevant date and that it remains unpaid, the payment due may be made without the statement.
The Secretary of State has similar powers of investigation of claims as in redundancy pay claims (s.126 of the EP(C)A). If it is satisfied of the merits of the claim, the Employment Department will send the amounts due to the insolvency practitioner for payment to the employee. Payments in respect of notice are sent direct to the employee. Income tax, NI contributions and any contributions due to an occupational pension scheme are deducted from arrears of pay and holiday pay and paid on the employee's behalf.
If the Employment Department rejects a claim or fails to make payment to the employee, or pays the employee less than the amounts claimed, the employee may complain to an industrial tribunal under s.124 of the EP(C)A. The claim should be made on a form IT1 and must be presented within three months beginning with the date when the Secretary of State's decision was communicated to the employee, or "within such further period as is reasonable", if it was not reasonably practicable for the complaint to be brought within the normal time limit. The form should show the Secretary of State as the respondent. If the tribunal finds the employee's claim well-founded, it must make a declaration to that effect, and must also state the amount which the Secretary of State should pay.
Rights as employees
The statutory employment protection rights of employees remain alive during the insolvency of their employer and are available against the insolvent company and/or the insolvency practitioner.
Termination by operation of law
Where the appointment of the insolvency practitioner causes the automatic termination of all contracts of employment, a termination by operation of law arises. Section 93(1) of the EP(C)A provides that "where in accordance with any enactment or rule of law - (a) any act on the part of an employer, or (b) any event affecting an employer (including, in the case of an individual, his death), operates so as to terminate a contract under which an employee is employed by him, that act or event shall ... be treated as a termination of the contract by the employer ..."
Acts of, or events affecting, the employer which result in the automatic termination of contracts are therefore deemed to be dismissals. Examples of such acts or events, apart from the death of individual employers, include where a court liquidation or compulsory winding-up order, and also a court-appointed receiver, are in place. The automatic terminations caused by these appointments are treated as dismissals of the employees under s.93(1). An order for the compulsory winding up of a company itself serves as notice of dismissal to employees.
But note that the effect of s.93(1) is not to bring about a dismissal for unfair dismissal purposes, but for redundancy purposes. It would therefore appear that employees automatically dismissed as a result of a court liquidation or court receivership are precluded from bringing unfair dismissal claims, and must put in claims for redundancy payments. In practice, however, and as the authors of Harvey on industrial relations and employment law1 suggest, "they are not really cases of termination by operation of law, but are usually treated as cases of wrongful dismissal by the employer, presumably on the ground that the employer has put it out of his power to continue the employment and so is in breach of contract, the employee having no option but to accept that the contract is discharged by the breach."
Wrongful dismissal
A wrongful dismissal entitles an employee to bring an action at common law for damages for breach of contract. Such a dismissal arises where the employee is dismissed without any or full contractual notice or a payment in lieu, and also without justification - that is, the employee is not dismissed for being in repudiatory breach of contract.
Normally, the assessment of an employee's damages for breach of contract aims to put the employee in the position he or she would have been in, as far as money can do so, had the contract been performed. Therefore, the claim would normally include wages or salary payable during the notice period or the unexpired balance of the fixed term, as well as the value of any other contractual benefits which the employee would have received during that period, and which can be given a financial value.
In reality, it may be practically impossible to have this claim met in full by an insolvent employer, as damages under this head fall to be paid only as an unsecured claim on the company's assets. However, as we have seen, payments due in respect of the minimum statutory notice periods (s.49 of the EP(C)A) are payable from the National Insurance Fund.
Unfair dismissal
In addition to a claim for wrongful dismissal, employees may also be able to bring a complaint of unfair dismissal under the EP(C)A.
A claim for unfair "constructive" dismissal may arise where the insolvency practitioner's conduct constitutes a repudiatory breach of the contract of employment entitling the employee to leave without notice - as for example, where the insolvency practitioner fails to pay employees their due wages. But the majority of unfair dismissal complaints will arise in connection with procedural faults relating to redundancy, such as unfair selection or lack of consultation.
Note, however, that while the basic award of compensation is a statutorily guaranteed payment which may be met from the National Insurance Fund, the compensatory award is not statutorily guaranteed, and so employees may find that they are unable to recover the full compensation due to them.
Redundancy
Clearly, most dismissals upon insolvency will be by reason of redundancy. Section 57(2)(c) of the EP(C)A makes this a potentially fair reason for dismissal, but, as always, the tribunal must be satisfied of the reasonableness of the decision to dismiss under s.57(3). (Certain redundancy dismissals are deemed to be automatically unfair - s.59 of the EP(C)A and s.153 of the TULR(C)A.)
Section 91(2) of the EP(C)A presumes that a dismissed employee is, in the absence of evidence pointing to some other reason, dismissed by reason of redundancy. This presumption of redundancy means that it is up to the employer who seeks to escape liability for a redundancy payment to point to some other reason for the dismissal.
In Doegar v Herbert Mueller Ltd (in receivership) and Secretary of State for Employment, the company became insolvent and the administrative receiver who was appointed dismissed all employees and informed them of their entitlement to redundancy payments. However, no letter of termination was sent to Mrs Doegar, a director of the company who also claimed to be an employee. This was because the receiver did not know that she was an employee, although it knew of her directorship. When Mrs Doegar later wrote demanding her salary, the receiver, without accepting her claim to be a full-time manager of the company, responded by terminating her alleged employment.
The industrial tribunal to which Mrs Doegar complained held that because the administrative receiver had not known of the existence of Mrs Doegar's contract of employment, he could not be held personally liable for any claim for a redundancy payment (and neither could he be held to have adopted the alleged contract of employment when he failed to take steps to terminate an employment he had not been aware of).
Section 81(2) of the EP(C)A provides the definition of redundancy for these purposes. It states that a dismissed employee shall be taken to have been dismissed "by reason of redundancy" if the reason for dismissal is that: (a) the employer has ceased, or intends to cease, to carry on the business either generally or at the employee's particular workplace; or (b) the requirements of the business for employees to carry out work of a particular kind, either generally or at the employee's particular workplace, have ceased or diminished or are expected to cease or diminish.
It will not be difficult for insolvency practitioners to establish that a redundancy situation has occurred. But they must also prove that any dismissals are genuinely due to the redundancy. In most cases, an industrial tribunal will not inquire into the reason or justification for a cessation of work causing redundancy (see, for example, Moon and others v Homeworthy Furniture (Northern) Ltd), but it will nevertheless apply the standard of reasonableness in s.57(3) to the dismissal to see whether it was fair or unfair (Bessenden Properties Ltd v Corness).
Following proper procedures. Despite the doubts expressed by Mr Justice Kilner-Brown (as he then was) in Fox Brothers (Clothes) Ltd v Bryant (a voluntary winding-up case) as to whether "there can be an unfair dismissal in the case of a properly conducted entry into liquidation" the correct position must be taken to be as set out in Polkey v A E Dayton Services Ltd. It will be remembered that Polkey confirmed the importance of following the appropriate procedures before dismissing an employee for redundancy, if an employer is to be held to have acted reasonably in treating the reason for dismissal as sufficient reason. However, an employer may be found to have acted reasonably, if it could reasonably have concluded in the light of the circumstances known to it at the time of dismissal that following the proper procedures would be utterly useless, and so dispensed with them.
Consulting trade unions on redundancies. One important aspect of the procedural framework within which an employer is expected to operate in handling redundancies is the statutory obligation to inform and consult with recognised trade unions, and to notify the Employment Department of proposed redundancies before they take place.
These duties are set out in ss.188 and 193 of the TULR(C)A. In Pambakian v Brentford Nylons Ltd, the EAT held that not even the need for secrecy required in negotiations of takeover deals could exclude the necessity for consultation. The EAT said that receivers and managers needed to be as much aware of the requirement of good industrial relations with regard to consultation as employers.
The duty to consult with trade unions arises when an employer, or insolvency practitioner, is "proposing to dismiss as redundant an employee of a description in respect of which an independent trade union is recognised ..." Note that the definition of redundancy for these purposes is different to that applicable in other circumstances. Section 195(1) of the TULR(C)A provides that a redundancy is "a dismissal for a reason not related to the individual concerned or for a number of reasons all of which are not so related". For these purposes also, it is presumed that a dismissal is by reason of redundancy, unless the contrary is proved.
The stage at which an employer can be said to be proposing to dismiss is crucial because, as was expressed in USDAW v Leancut Bacon Ltd, no matter how desperate an employer's economic situation is, if it has not yet considered redundancies, it is not bound to consult with anybody.
In Association of Patternmakers & Allied Craftsmen v Kirvin Ltd, a financially troubled employer being subsidised by the Government decided to sell the company. The industrial tribunal found that right up until the last moment, there had been a real prospect of a purchaser being found. But when the last potential purchaser disappeared, the employer had been forced to call in the receiver, who immediately gave notice of redundancy to the entire workforce.
According to the union, an employer "proposed to dismiss" not at the date when it decided to take the action of making employees redundant, but at the earlier date when such a possibility entered or should reasonably have entered its contemplation. But the EAT disagreed, holding that a proposal to dismiss goes beyond a mere contemplation of a possible event, and connotes "a state of mind directed to a planned or proposed course of events". The employer must have formed a view as to the number of employees to be dismissed, when dismissal would take place and how it was to be carried out. The EAT said that clearly in this case, neither the employer nor the union had grasped the seriousness of the situation, and there had been no proposal to dismiss employees as redundant until the date the receiver was appointed.
Note, however, that the redundancy consultation provisions were enacted to comply with the "Collective Redundancies" Directive (No.75/129/EEC). Article 2(1) of this provides that: "where an employer is contemplating collective redundancies he shall begin consultations with workers' representatives" (our emphasis). In Re Hartlebury Printers Ltd and others (in liquidation) the question arose as to whether the word "contemplating" in the Directive meant that the obligation to consult should commence at an earlier stage than suggested by "proposing to dismiss".
The High Court resolved this by saying that "contemplation" referred to "something less than intention. Nevertheless, the range of mental states included within the word is wide. It would extend from merely 'thinking about' to 'having in view or expecting'. In the latter sense, but not the former, the word would equate with the verb 'to propose'." According to the High Court, the phrase "an employer proposing to dismiss as redundant" excluded one which was "merely thinking about the possibility of redundancies". Therefore, the word "proposing" could not be construed as embracing the full range of possible meaning of the word "contemplating", although the latter could be construed in a sense equivalent to the former.
Similarly, article 3(1) of the Directive, which corresponds with the TULR(C)A's notification obligations, provides that "employers shall notify the competent public authority in writing of any projected collective redundancies" (our emphasis). Again, the High Court said that the word "projected" was used in the sense of "then intended", after the processes of consultation with the union have been completed. And therefore it held that the statutory redundancy provisions did comply with the Directive.
Consultation must begin "at the earliest opportunity" and, in any event, 90 days before the first of the dismissals of 100 or more employees within a 90-day period takes effect, or 30 days before the first of the dismissals of between 10 and 99 employees within a 30-day period takes effect (s.188(2) of the TULR(C)A).
Consultation requires disclosing the following matters in writing to trade union representatives: the reasons for the proposals to dismiss; the numbers and descriptions of employees whom it is proposed to dismiss; the total numbers of employees of that description employed at the establishment in question; the proposed method of selection; the proposed method by which the dismissals will be carried out, with due regard to any agreed procedure; the period over which the dismissals will take effect; and the method of calculation of any non-statutory redundancy payments (s.188(4) of the TULR(C)A).
Section 188(6) provides that consultation must include consultation about ways of avoiding the dismissals, reducing the numbers of employees to be dismissed, and mitigating the consequences of the dismissals. Moreover, the consultation must be undertaken a view to reaching agreement" with the trade union.
Notifying the Employment Department. Section 193 of the TULR(C)A states that an employer who is proposing to dismiss as redundant between 10 and 99 employees at one establishment within a 30-day period, must notify the Department in writing of this proposal at least 30 days before the first dismissal takes effect, and similarly for 100 or more employees within a 90-day period, at least 90 days before the first dismissal.
Protective awards. The failure to consult with recognised trade unions before dismissing or proposing to dismiss employees as redundant entitles a trade union to present a complaint to an industrial tribunal under s.189 of the TULR(C)A. Section 189(2) provides that if the industrial tribunal finds the complaint well-founded, "it shall make a declaration to that effect and may also make a protective award".
A failure to adhere strictly to any of the requirements under s.188 will expose an employer or insolvency practitioner to a complaint by a recognised trade union under s.189. The complaint must be presented to the tribunal before the proposed dismissal takes effect, or within three months beginning with the date the dismissal takes effect, unless it was not reasonably practicable for it to be presented within that time, in which case it may be any further period that the tribunal considers reasonable (s.189(5)).
The remedy is twofold: a declaration, which the tribunal is bound to make upon finding the complaint well-founded; and the discretionary power to order the insolvency practitioner to pay to the affected employees remuneration, called the "protective award", for a "protected period". We saw in part one of this Guidance Note that the protective award ranks as a preferential debt and that it is also guaranteed out of the National Insurance Fund.
Although a claim for a protective award must be made to an industrial tribunal, the union may find that where the claim is to a company in liquidation upon a winding-up order by a court, it may have to seek leave from the court under s.130(2) of the Insolvency Act 1986 for leave to commence and/or to continue proceedings against the company (Re Hartlebury Printers Ltd).
The "special circumstances" defence. There is a defence open to the insolvency practitioner under ss.188(7) and 193(7) of the TULR(C)A "if in any case there are special circumstances which render it not reasonably practicable for the employer to comply with a requirement of ... consultation or of notifying the Secretary of State ..." In either case, the insolvency practitioner "shall take all such steps towards compliance with that requirement as are reasonably practicable in those circumstances". The result of establishing a successful "special circumstances" defence is to block the tribunal from making either the declaration or the protective award.
However, the special circumstances defence is no longer available if the decision leading to the dismissals was that of a person controlling the employer (either directly or indirectly), and the failure to consult arose because that person failed to provide information to the employer.
There are two limbs to this defence which the insolvency practitioner must show. Firstly, there must be a circumstance which is special to the particular case. This will be a question of fact to be determined in each case. Secondly, the insolvency practitioner must show that despite those special circumstances, it did the best it practicably could to comply with its statutory duties.
Despite the EAT's observation in Association of Patternmakers & Allied Craftsmen v Kirvin Ltd - to the effect that the requirements of consultation seemed more in keeping with cases "involving limited redundancies which might be avoided or mitigated by timeous consultation with a ... trade union" than with others where liquidation or receivership compelled the wholesale redundancy of the entire workforce - an insolvency practitioner should not be tempted to assume that the mere fact of the insolvency entitles it to rely upon the "special circumstances" defence.
The industrial tribunal will look closely at the facts of the case, the nature and extent of the company's financial troubles, and the approach of the insolvency practitioner and/or the employer to the crisis.
As the Court of Appeal stressed in Bakers' Union v Clarks of Hove Ltd, it would be more inclined to find that special circumstances exist in the cases where severe problems suddenly befall a company forcing it to take drastic measures which may include insolvency. On the other hand, the circumstances may not be so special in situations where the seriousness of a steadily deteriorating financial situation is miscalculated and the company carries on trading at a loss until it is suddenly faced with insolvency and has to immediately dismiss the entire workforce.
In Clarks of Hove Ltd, the company fell into serious financial trouble which was identified in an auditor's report as a liquidity crisis due to substantial trading losses. The report called for immediate additional working capital if liquidation was to be avoided. The company sought to raise the capital through the sale of its shops, but all hopes of this were dashed when the last potential buyer declined to proceed with the transaction. At that moment the company put up notices of immediate dismissal of its entire workforce. Three days later, a receiver was appointed.
Despite the fact that the tribunal accepted that there was no chance of the company complying with the duty to consult at least 90 days before the dismissals took place, and that in any case the receiver would have summarily dismissed the whole workforce upon appointment, it held that the circumstances were not special in any way, and that the employer was in breach of its statutory obligations. It therefore made a protective award of 49 days' remuneration.
Upholding the tribunal's decision, the Court of Appeal said that the mere fact of insolvency was "neither here nor there. It may be a special circumstance, it may not be a special circumstance. It will depend entirely on the cause of the insolvency whether the circumstances can be described as special or not. If, for example, sudden disaster strikes a company, making it necessary to close the concern, then plainly, that would be a matter which was capable of being a special circumstance; and that is so whether the disaster is physical or financial. If the insolvency, however, was merely due to a gradual run-down of the company, as it was in this case, then those are facts on which the industrial tribunal can come to the conclusion that the circumstances were not special. In other words, to be special, the event must be something out of the ordinary, something uncommon; and that is the meaning of the word 'special' in the context of this Act."
In Hamish Armour v ASTMS, the EAT applied this definition of a special circumstance to find that it had not been reasonable for there to be compliance with the consultation requirements, where the troubled company was refused a further loan from the Government in circumstances where it had been reasonable to assume that this loan would be forthcoming.
Special circumstances were also found to exist in USDAW v Leancut Bacon Ltd, in a decision difficult to reconcile with the definition of "special" as something out of the ordinary. The company's half-yearly accounts painted such a poor picture that the prospective purchaser panicked and pulled out of the proposed sale, whereupon the bank immediately withdrew the company's credit facilities. Influenced more by the bank's sudden withdrawal of funds than by the gradual financial deterioration which preceded it, the EAT upheld the tribunal's decision that the circumstances were special.
It was argued in Re Hartlebury Printers Ltd that the statutory duty to consult and the duties imposed on administrators by the Insolvency Act 1986 "are so mutually repugnant that they cannot exist side by side", and that the Insolvency Act 1986 impliedly repealed or amended those statutory provisions so as to exclude an employer which is a company in administration. Moreover, the administrators argued that the fact of being in administration was sufficient by itself to constitute a special circumstance making it not reasonably practicable for an employer to comply with the consultation requirements. The High Court rejected this view, directing itself on the Clarks of Hove case. It also said that to uphold this argument would be to put the UK in breach of its obligations under the "Collective Redundancies" Directive.
Although the High Court refused to be persuaded to put a company in administration in any different position to any other employer, it held that, upon the facts of the case, the union's claim for a protective award failed. The administrators had not proposed the redundancies which took place. On the contrary, they had asked for more breathing space to carry out the objectives of the administration, but their request had been rejected by the Court which had then issued a winding-up order. This had led to the automatic termination of the employees' contracts, making redundancies inevitable.
Applying Clarks of Hove Ltd to another case, GMB v Rankin and Harrison, the EAT disagreed with an industrial tribunal's decision that a company in receivership with no orders and no buyers for the business, and which needed to shed workers to make the business more attractive to prospective purchasers, had a special circumstances defence.
The EAT said that the shedding of employees in order to make the sale of a business more attractive is not something special to a particular case, but is a common incident in any form of receivership or insolvency. And the facts that the business could not be sold and that there were no orders were common incidents of insolvencies and not special circumstances in the required sense. It found that by failing to follow the required procedures, and in the absence of any special circumstances, a protective award for 90 days should be granted.
Note: the European Court of Justice recently ruled that the UK is in breach of the "Collective Redundancies" Directive, by limiting information and consultation rights to recognised trade unions only, whereas the Directive provides for these rights to be accorded to "workers' representatives" (Commission of the European Communities v United Kingdom of Great Britain and Northern Ireland ). It is expected that legislation will be introduced in due course to bring the UK's law into line with the Directive, and the above discussion should be read in that light.
Employees' rights upon sale of the business
It will be the aim of most insolvency practitioners to sell the ailing business of the insolvent employer, or parts of it, if they can, as a going concern. As previously stated, the Insolvency Act 1986 is clearly in favour of this for public policy reasons. Moreover, this form of dealing with insolvencies has proved more advantageous financially than breaking up a company's assets for disposal, as the sale of a business as a going concern carries with it the valuable goodwill of the business.
Before 1982, employees had very few rights upon the transfer of their employer's businesses to new owners. Transfers operated to automatically terminate all contracts of employment. They were said to constitute a repudiatory breach of contract entitling the employee to compensation for unfair "constructive" dismissal, damages for wrongful dismissal or statutory redundancy pay. Employees did not transfer into employment with the new ownership, and the purchaser had no responsibilities towards the employees. The purchaser could therefore offer re-employment to some or all of the employees on whatever terms and conditions could be negotiated.
The "Business Transfers" Directive (No.77/187/EEC) changed this state of affairs. It preserved the rights of employees upon business transfers by imposing new and substantial obligations on vendors and purchasers of businesses. The most significant of these obligations is the principle of automatic transfer to the purchaser, along with the business, of employees and their terms and conditions of employment. The Transfer of Undertakings (Protection of Employment) Regulations 1982 implement this Directive in the UK.
The Regulations provide that on a business transfer, all existing employees automatically transfer into the purchaser's employment, together with their existing terms and conditions of employment (but not pensions), and accrued periods of continuous employment. The purchaser also inherits all the vendor's rights, powers, duties and liabilities connected with the transferred contracts. These provisions apply in respect of employees still in the vendor's employment at the moment of transfer. But if employees have been dismissed prior to this moment for a reason connected with the transfer which is not an economical, technical or organisational (ETO) reason entailing changes in the workforce, these employees are treated as having continued in employment up to the moment of transfer.
Unless there is an ETO reason, any dismissal of an employee in connection with a transfer is automatically unfair (reg.8(1)). Because trade union recognition rights are also automatically transferred to the purchaser, the obligations of consultation apply in respect of any proposed redundancies by the purchaser.
Rights upon dismissal. If employees are dismissed in connection with a business transfer by either the vendor or the purchaser, they have available to them their normal employment protection rights, including the right to a redundancy payment or unfair dismissal compensation. With regard to unfair dismissal, however, reg. 8(1) provides that a dismissal connected with a business transfer is automatically unfair. Liability for such dismissals is passed on to the purchaser (reg. 5).
Protection under reg. 8(1) is afforded to employees of both vendor and purchaser. It applies to dismissals whether effected at any time before or after the date of the transfer. However, the dismissal must be "connected" with the transfer. It is for the employee to prove that there is a connection. In looking at what amounts to sufficient connection, the ECJ said in P Bork International A/S v Foreningen af Arbejdsledere i Danmark and others that "account must be taken of the objective circumstances in which the dismissal occurred and, in particular ... the fact that it took place on a date close to that of the transfer and that the workers concerned were re-engaged by the transferee."
Despite this, the purchaser may be able to show that some event or occurrence has broken the connection, and that the dismissals in question fall outside reg. 8(1) - for example, the loss of a major customer, necessitating redundancies. Another way in which the purchaser may escape liability under reg. 8(1) is to show an ETO reason under reg. 8(2) as the principal reason for the dismissal. If successful, this operates to disapply reg. 8(1) to the dismissal.
This does not mean, however, that the dismissal becomes automatically fair. It simply reverts to the normal unfair dismissal rules, and the reason for dismissal becomes "some other substantial reason for dismissal" within s.57(1)(b) of the EP(C)A. The tribunal will need to be satisfied that the decision to dismiss for the ETO reason was reasonable in all the circumstances under s.57(3). This will also involve a consideration of the procedures applied before the dismissal.
Rights in a "hiving-down"
The automatic transfer principle applies in the event of a "hiving-down" of company assets.
In a sale to a potential purchaser of the business as a going concern, the insolvency practitioner may have to "hive down" the business in order to make it more attractive to the purchaser, who may be deterred from buying the company's assets where it would include liability for the entire workforce. "Hiving down" therefore refers to the complex practice of divorcing the assets of the business from the workforce, thereby creating two separate legal entities.
The insolvency practitioner transfers the business assets from the insolvent company into a wholly-owned subsidiary company. This leaves the employees virtually alone in the insolvent "asset-less" company. It is then arranged for the employees to provide services for the subsidiary under some new agreement such as a labour-supply agreement. Then the insolvency practitioner sells the shares of that subsidiary company to the purchaser free of the employees. If the insolvency practitioner is unable to find a purchaser for the parent company, the liquidator is called in and the entire workforce is dismissed by reason of redundancy. Any claims of the employees will be against the insolvent parent company in the normal way.
Clearly, such a practice would have been inconsistent with the very ethos of the Transfer Regulations had not special provision (reg. 4) been made for its preservation in some form. Regulation 4 applies where an insolvency practitioner transfers an undertaking to a wholly-owned subsidiary of the company. At that moment, reg. 4 operates to suspend the application of the Transfer Regulations to that transfer. The suspension continues until one of two things happens: (a) the parent insolvent company sells its shares in the subsidiary to a purchaser; or (b) the parent insolvent company sells the business of the subsidiary as a going concern (but not its shares).
At the moment that (a) happens, the employees in the parent insolvent company automatically transfer into the employment of the subsidiary, and they are therefore part of the subsidiary when its shares are bought by the purchaser. In situation (b), just a moment before the business transfer takes place, the employees are transferred into the employment of the subsidiary and automatically transfer into the employment of the purchaser.
Regulation 4 continues by saying that "the transfer of the relevant undertaking shall be taken to have been effected immediately before that date by one transaction only."
Regulation 4 aimed to prevent the application of reg. 5(1) to the transfer from the parent company to the subsidiary, so that the employees would not automatically transfer into the subsidiary, and from there into employment with the purchaser. The parent company could dismiss them before the sale of the subsidiary company to the purchaser to prevent their automatic transfer.
Since the House of Lords' decision in Litster and others v Forth Dry Dock & Engineering Co Ltd and another, however, the effect of reg. 4 has been much curtailed. Dismissals by the parent company "immediately before the transfer" under such circumstances will almost certainly be found to be sufficiently connected with the transfer, and so, unless they can be explained by an ETO reason, reg. 5 may still be held to apply.
Case list
Association of Patternmakers & Allied Craftsmen v Kirvin Ltd [1978] IRLR 318
Bakers' Union v Clarks of Hove Ltd [1978] IRLR 366
Bessenden Properties Ltd v Corness [1974] IRLR 338
Commission of the European Communities v UK [1994] IRLR 412
Doegar v Herbert Mueller Ltd (in receivership) and Secretary of State for Employment 9.5.94 EAT 867/93
Fox Brothers (Clothes) Ltd v Bryant [1978] IRLR 485
GMB v Rankin and Harrison [1992] IRLR 514
Hamish Armour v ASTMS [1979] IRLR 24
Hartlebury Printers Ltd and others (in liquidation), Re [1992] IRLR 516
Litster and others v Forth Dry Dock & Engineering Co Ltd and another [1989] IRLR 161
Moon and others v Homeworthy Furniture (Northern) Ltd [1976] IRLR 298
Munday v Secretary of State for Employment 6.11.89 EAT 618/88
P Bork International A/S v Foreningen af Arbejdsledere i Danmark and others [1989] IRLR 41
Pambakian v Brentford Nylons Ltd [1978] ICR 665
Polkey v A E Dayton Services Ltd [1987] IRLR 503
Secretary of State for Employment v Forster 7.7.87 EAT 220/87
Secretary of State for Employment v Wilson [1977] IRLR 483
USDAW v Leancut Bacon Ltd [1981] IRLR 295
Westwood v Secretary of State for Employment [1984] IRLR 209
Insolvency and employees' rights 2: the main points to note
1 Volume 1, III 250.
