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Legal update: insolvency and furloughed employees

Covid-19-furlough-and-insolvency

The financial distress caused by Covid-19 has led several companies into administration including Debenhams, Laura Ashley, Oasis and Warehouse, BrightHouse and Carluccio’s. 

The government’s furlough scheme was one of the lifelines extended to help such companies stay afloat and avoid going bust. However, use of the government’s novel furlough scheme by companies entering into administration has brought into question how some of the pre-existing administration procedure rules regarding rights of employees would play out.

Two recent cases have shed light on this intersection between the new and pre-existing provisions, namely Re Carluccio’s Ltd and Re Debenhams Ltd. Both cases clarify which actions taken by a company may amount to ‘adoption’ of an employees’ contract of employment as per para 99 of Schedule B1 to the Insolvency Act 1986. However, the latter in particular demonstrates how adopting the contracts of furloughed employees could amount to substantial costs accruing on a company in administration. 

14 days within administration, the administrator can ‘adopt’ employees’ contracts. If contracts are adopted, then payments in the form of salaries or wages owed to employees will have priority over the company’s other creditors and employees are still considered employed by that company. If, however, employees’ contracts are not adopted, then salaries or wages owed by the company will be treated as debts of a normal creditor with no priority attached. In effect these employees would be made redundant. 

In Re Debenhams Ltd. the question for the court was whether Debenhams would be considered as having adopted its employees’ contracts without doing anything further than furloughing their employees sometime before entering into administration. 

The court held that the company, by continuing to honour its obligations to employees up to the limits of the furlough scheme and acting with the objective of rescuing Debenhams as a going concern, is considered to have adopted the employees’ contracts. This was so even though the decision will mean that Debenhams accrues a substantial sum to be paid to employees in respect to their annual leave over the 3-month administration period, amounting to 1.28m, which potentially hinders the prospect of rescuing the company.

Thus, this result can be seen as contrary to both, the aim of the furlough scheme, which is meant to relieve employers of paying employees’ salaries, and the rescue culture that the administration procedure is meant to facilitate. 

Such a decision may have resulted from the absence of any guidance provided by the government as to how the furlough scheme is supposed to be executed alongside the provisions of the insolvency legislation. 

As such, such inconsistencies between policy and practice may be a portion of the price to be paid by companies in return for the government’s emergency provisions aimed at limiting their financial distress. In such a context, clarity from the courts can be seen as a welcome clarification for troubled companies planning their next move in a time-sensitive context.

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