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What are the legal implications of insolvency on an employer?

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The devastating compulsory liquidation of the travel agent Thomas Cook on 23 September 2019 has affected over 21,000 members of staff worldwide and 9,000 in the UK.

In this blog, we address the legal position for employers who might find themselves in a similar situation.

Compulsory liquidation

Generally speaking (there are some exceptions), the outcome of a compulsory liquidation is that the employees lose their jobs with immediate effect when the company enters liquidation.

An insolvency situation creates great concern for both the insolvent employer and its employees. Subject to potential buyers of the company showing interest quickly, it is possible for all or parts of the business to be purchased and “rescued”. Where this is the case, the employees within the business, or part in question, will be transferred to the new owner of the business under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (widely referred to as “TUPE” and pronounced “tew-pee”).

In order to assist with rescuing insolvent companies, TUPE operates in these situations so that a transferee will not inherit all the insolvent company’s debts in respect of the transferring employees and there will be scope to vary the terms of employment for the transferring employees. TUPE is a very complex area of law so specialist advice must always be sought. You can find out more about it by reading our blog ‘Understanding TUPE’.

If there are no willing buyers, compulsory liquidation will automatically terminate the employee’s employment contracts from the date of either the winding up order, or the date that a receiver is appointed. If there is a need for some employees to be retained whilst the liquidation process is underway, the employees will have to enter into new employment contracts, if continuation of their employment had not been agreed prior to the company ceasing trading.

Voluntary liquidation and administration

Voluntary liquidation and administration differ to compulsory liquidation, as these do not automatically terminate employment contracts.

Redundancy

In situations where insolvency practitioners are proposing to make 20 or more employees redundant within 90 days or less at one establishment, they must collectively consult with the employees in question. Case law suggests that this also includes compulsory liquidation, where employment contracts are automatically terminated. A failure to consult could result in the insolvent employer having to pay the employees a protective award of up to 90 days’ pay. Although insolvency is not deemed to amount to a ‘special circumstance’ defence, an employer’s imminent insolvency could be a mitigating factor when calculating the protective award.

Recovering debts

The insolvent employer remains liable for the debts owed to the employees, with the exception of the ‘qualifying liabilities’ rule for administrative and LPA receivership. An example of the type of debts include unpaid wages; notice pay; statutory redundancy pay; protective awards for failing to inform and consult for collective redundancies; failure to inform and consult under TUPE; and damages for breach of contract.

Employees can recover their ‘remuneration’ as a preferential debt, meaning that they rank third in priority following secured creditors and the expenses of the insolvency process. It is important to note that this is subject to a capped amount, so even when the employees recover the full amount of the cap, this is usually not the full amount owed to them. The other debts of employees are unsecured and rank second to last in priority, meaning that, in practice, employees are only likely to receive a small proportion of what is owed to them.

Insolvent employers very rarely have enough money remaining in the business to cover the above-mentioned debts in full. This requires payments to be made from the Government’s National Insurance Fund, who guarantee a basic minimum payment of specific debts owed to employees. The guaranteed debts include capped arrears of pay; statutory notice pay; and an ‘employment payment’; which is generally a statutory redundancy payment; payment due by way of settlement; or a termination payment under an agreement where an exemption order applies.

The three conditions that must be met to qualify for the payment are that the employer must have become insolvent; the employee’s employment must have been terminated; and on the appropriate date, the employee must have been entitled to be paid the whole, or part of, a specific debt. It is important to note that the appropriate date differs depending on the type of debt. In relation to pay arrears, the appropriate date is the date of insolvency. In relation to the basic or protective award, the appropriate date is the later of: the date of insolvency, the date of employment termination, or the date the award was made.

If an employee is transferred to a new employer before the former employer became insolvent, money cannot be claimed from the National Insurance Fund. However, if  an employee is transferred afterwards, claims can be made for statutory redundancy, statutory notice pay and other outstanding payments.

If the conditions are met, and the National Insurance Fund accepts the employee’s claim, the amount payable varies. In relation to the ‘employment payment’, the amount is calculated in accordance with the relevant statute. In relation to an employee debt, the amount is calculated based on the facts and up to a statutory cap of one week’s pay. The payments are usually paid within 14 days of the employee’s application.

If the whole of the employee’s claim is paid out of the National Insurance Fund, their claim against the insolvent employer is finalised. However, if the claim cannot be paid in full by the National Insurance Fund, the employee remains a creditor of the insolvent employer.

This blog touches on the basic interplay between insolvency and employment law. If you require any specialist advice, please contact our Employment Team.

Disclaimer: Anything posted on this blog is for general information only and is not intended to provide legal advice on any general or specific matter. Please refer to our terms and conditions for further information. Please contact the author of the blog if you would like to discuss the issues raised.