Dealing with distress: business restructuring and rescue
Businesses in every sector and geography are having to transition to new ways of operating within a rapidly changing and increasingly uncertain legal and regulatory landscape.
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The COVID 19 crisis (“Crisis”) has led to an unprecedented slowdown of business in the UK, as in the rest of the world, and to the announcement of extensive government support packages for businesses and individuals in the UK introduced at high speed to provide urgent support to businesses to avoid insolvencies on a large scale.
As businesses explore, apply for, and then evaluate the impact of the government funding packages available to them, the number of insolvency filings has actually fallen in the last couple of months. An increased number of formal insolvencies are expected as the lock down in the UK eases and as businesses have difficulties in funding the re-start of operations.
There have been several judicial decisions in the last month relating to the interaction of the government schemes and the UK insolvency processes. These decisions evidence the desire of the judiciary to support the efforts of the government to save businesses and jobs as part of the rescue culture, evidenced by the speedy manner in which the judiciary has dealt with the hearing of the applications and the handing down of decisions to the applicants, given the urgency of the situation.
At the same time the government has introduced a bill setting out new insolvency legislation including two new restructuring procedures: first the ability for directors to apply for a standalone moratorium in order to facilitate the rescue of the business. This would allow the company to continue to trade under the supervision of a monitor (who needs to be a qualified insolvency practitioner) for an initial period of 20 business days which can be extended for a further 20 days, and with court/creditor approval for up to a year. A new reorganisation plan is also to be introduced similar to the existing Scheme of Arrangement but with the ability to cram down dissenting classes of creditors if approved by the court. There is also a prohibition on serving statutory demands and the making of winding up orders for businesses affected by the Crisis until 30 June 2020 or 30 days from the coming into force of the new legislation. These measures are expected to become law very quickly in July 2020 to assist with the rescue of businesses in the Crisis.
The JRS was introduced by the government as a temporary scheme to support businesses whose operations have been severely affected by the Crisis and to prevent mass redundancies in light of the Crisis. It allows businesses affected by the Crisis to furlough employees for periods of at least 21 days, and to apply for a payment of 80 percent of an employee’s “reference pay” up to a maximum payment of £2,500 per month for the furlough period, on the basis that the employer agrees that he will not make the employee redundant during that period.
Guidance on the operation of the JRS was first issued by the government on 26 March 2020 and has been revised on many subsequent occasions (“Guidance”).
In addition the HMRC issued a Directive on 15 April 2020 (“Directive”) which sets out the operational mechanics of the JRS. Frustratingly, the Directive contradicted the Guidance in a number of ways, although the ongoing revisions of the Guidance have since dealt with many of these issues, in particular as regards whether the employee needs to consent to the furlough, and the treatment of holiday pay and sick pay. It is necessary to continually review the revisions to the Guidance to understand the way in which the JRS is evolving.
In terms of consent to the furlough, the Guidance is now that formal consent is not required but the confirmation of furlough needs to be in written form, for example by e mail from the employer. Employees can take holiday when furloughed, but holiday pay is at pre-furlough entitlement under their contract of employment, so an Administrator would need to top up the payment unless the terms of employment were varied by consent. As regards sick pay, the Guidance now states that the employer cannot claim statutory sick pay and under the JRS at the same time.
The JRS was originally available for a three month period from 1 March 2020. It was then extended for a further month to 30 June 2020 and then to October 2020, in light of the phased exit from lockdown. The extensions are to support businesses which are initially unable to operate fully or at all in the initial phases of the relaxation of the lock down process. The government has said that businesses will need to contribute to the cost of the scheme from August 2020 onwards and draft proposals setting out how this will work will be published shortly. This is likely to result in the need for employers to enter into restructuring discussions or a restructuring or insolvency process if they are unable to pay the required contributions.
The Guidance says that the JRS is available to Administrators and says:
“We would expect the administrator only to access the scheme if there is a reasonable likelihood of rehiring the workers. For instance, this could be as a result of an administration and pursuit of a sale of the business”
The Guidance does not specifically mention the use of the JRS in other insolvency procedures such as liquidation, company voluntary arrangements, and bankruptcy. Given the comments regarding the access to be on the basis that there needs to be a “reasonable likelihood of rehiring” the employee, it would not be available in insolvency procedures where the business is likely to be closed down. Businesses are sometimes continued by a provisional liquidator or a liquidator in a compulsory liquidation, or by the supervisor of a company voluntary arrangement or CVA, so it may be that they would be able to make a successful application to the JRS on the basis that their role is analogous to an administrator seeking to sell or save a business, but that would depend on whether there was a reasonably likelihood of a further period of ongoing trading in the future involving the furloughed employee.
The question of the application of the JRS in administration has been considered in two recent cases involving the administration of the restaurant chain Carluccio’s and the retailer Debenhams.
In the Carluccio’s case, the Administrators were appointed prior to the furloughing of any employees. The Administrators made an application to court for directions regarding the application of the JRS and the furlough process. Judgment was handed down by the Honourable Mr Justice Snowden on 13 April 2020.1
The position in Debenhams was different as the employees were already on furlough at the time of the appointment of the Administrators. The Administrators applied for directions regarding the application of monies received from the government in relation to the JRS, and regarding a number of other matters including whether the contacts of employment of the employees on furlough were adopted by the Administrators. Judgement was handed down by the Honourable Mr Justice Trower on 17 April 2020.2 The decision was then appealed, and the decision of the Court of Appeal was handed down on 6 May 2020 with judgement being given by Lord Justice David Richards.
In both the Carluccio’s case and the Debenhams Case the key issue before the court was whether the Administrators would be considered to have adopted the contract of employment of the employee if an application to the JRS was made and/or a payment was made to the employee of monies received by the company as a grant under the JRS during the administration. This was important in light of the fact that if the contract of employment was adopted, the payment under the JRS would be of 80 percent of the employees “reference pay” up to a cap of £2,500 a month, leaving 20 percent of that “reference pay” and any additional amounts payable in excess of the cap, unpaid, with those amounts being a potential super priority claims in the administration in accordance with Paragraph 99 of Schedule B1 Insolvency Act 1986, unless the employee agreed to a variation of their contract of employment. As a result, in both cases, the Administrators sought the agreement of the employee to limit any payments accruing in the administration in the furlough period under the contract of employment to any amount paid by the government under the JRS by way of a grant to the company in administration.
In both cases the Administrators argued that if the employment contracts were found to be adopted, any potential exposure of the company in administration to make further payments in addition to the amounts received from the JRS, was likely to lead to a decision to make more employees redundant, thus undermining the rescue culture.
The leading decision in which the legal issues relating to the adoption of contracts of employment were considered in detail by the Court of Appeal and the House of Lords is the case of Powdrill v Watson: Re Paramount Airways No 3 1994.3 The Court of Appeal found that the Administrators had adopted the contracts of employment as a result of their conduct. They could not limit their liability by sending letters to the employees and could not pick and choose the liabilities that they would be responsible for paying as super priority claims during the administration period. The company in administration was therefore required to pay all amounts accruing under the employment contracts since the appointment of the Administrators. This decision was seriously damaging to the use of administration as a rescue procedure, and immediate changes to insolvency law were introduced to limit the categories of payments under the employment contract which would attract super priority. Adoption requires some conduct by the Administrators, which amounts to an election to treat the contract of employment with the company as giving rise to a separate liability in the administration. Importantly, adoption does not amount to assumption of personal liability by the Administrators.
Following the Paramount case and the consideration of similar issues arising in administrative receiverships, the insolvency legislation was amended by the introduction of Section 19(5) Insolvency Act 1986 which is now Paragraph 99(5) Schedule B1. This provides that Administrators have 14 days to decide whether or not to adopt a contact of employment and their conduct in that period cannot amount to adoption. Following the expiry of the 14 day period, if the contract is adopted, amounts in respect of holiday pay, sick pay, contribution to pension schemes and wages under the contract are payable during the period of employment in the administration. Other claims under the employment contract are preferential claims, for example for arrears of wages or holiday pay, and claims for notice and redundancy pay are unsecured claims. The decision was upheld by the Honourable Mr Justice Laddie in Re Antal International Limited 20034 where the Judge found that conduct is required to amount to an election to treat the contracts of employment as continuing even after the 14 day period has expired, so there is no automatic adoption on the 15th day if the employee is not made redundant.
Carluccio’s went into administration on 30 March 2020, and at that time no employees had been furloughed. The company operated 70 restaurants across the UK and had around 2000 employees. The Administrators had decided on their appointment to “mothball” the business during the lockdown period and at the same time seek to sell the business to achieve purpose (b) in Paragraph 3(1) Schedule B1 Insolvency Act, and received expressions of interest in the business. The Administrators sought various directions on the consequences for them as Administrators if they were to make applications under the JRS in relation to the employees of the company. Directions were given by the Honourable Mr Justice Snowden on 13 April 2020.
At the time of the application the Guidance had been published (it has since been revised a number of times), but the Directive was not in place. The application was unopposed and in the time available there was no time to join a representative employee, but some submissions were made in writing by Counsel instructed by one of the unions representing some of the employees.
The Administrators sought a direction that they would not be adopting the contracts of employments of the employees by making the application to the JRS, and the payments to the employees under the JRS. A key submission made to the court was that there was no adoption as no services were being provided by the employees to the company whilst on furlough, so the facts were very different to the Paramount case, where services were provided to the company in administration.
The Administrators also asked for directions regarding the mechanism for making payments to the employees in accordance with the provisions of the Insolvency Act and Rules.
The Administrators had sent letters to the employees following their appointment, informing them that they were to be put on furlough and asking them to agree to a variation of their terms of employment to accept “such portion of your regular wages with the grant [from the JRS] will cover” as their contractual entitlement for the period of the furlough leave. The letter also made clear that the company would only be able to pay the employees when it got the grant from the government, and that if the employee did not consent to the variation within a short period of time, the Administrators would need to consider making the employee redundant.
As a matter of employment law, the employee needs to agree such a variation to their terms of employment, and absent such agreement, the company in administration had a potential exposure to pay the balance of the entitlements under the contracts of employment which were not covered by a grant from the JRS, to the employees as super priority claims in the administration. Further, if there was no consent from an employee to any variation to the terms of his employment to reduce wages, then this would be an unlawful deduction under the Employment Rights Act 1986. Subsequent consent by the employee cannot alter the position in relation to deductions from wages made prior to the consent being given.
The Judge referred to the analysis of adoption by Lord Brown Wilkinson in the Paramount case. He considered whether the fact that no services were being provided by the employees during the furlough period meant that Paragraph 99(5) could not apply. He commented that the employees were still available for work and would return to work in the event that a buyer was found. The employees would also continue to be bound by the terms of the contract of employment during the furlough period, including any restrictive covenants which would, for example, prevent them from working for a competitor, which could be valuable for a potential purchaser of the business. He found that Paragraph 99(5) could therefore be interpreted to permit the JRS to be given effect and to support the rescue culture.
As to the question of adoption, the Judge found that there was sufficient conduct by the Administrators to constitute adoption of the contracts of employment as a result of them acting upon the varied contracts of employment, (for the employees who had consented to the variations), or the existing contract of employment, (for those who had not responded), on the earlier of:
In terms of the payment mechanism for the monies received from the JRS, the Judge considered that the monies could be paid to the employee using Paragraph 66 or Paragraph 99(5) of Schedule B1 Insolvency 1ct 1986. His finding was that Paragraph 99 was the preferable mechanism for payment in light of his findings on adoption.
Debenhams operated 142 stores in the UK and went into administration in 2019 and then into a CVA to compromise payments under leases with the various landlords and to implement a store closure programme. The CVA was continued in operation until the Crisis. On March 25 2020 prior to the administration the company wrote to 13,000 store-based employees informing them that the government required them to close the stores and they were being furloughed until further notice from the next day. The letter said that they would receive 80 percent of their usual monthly wages up to a cap of £2,500, and the company would not pay any additional amounts accruing under their contracts of employment. A further 867 employees were placed on furlough in the period from March 26 2020 to the date of the administration.
On April 9 2020 the Administrators were appointed, with significant numbers of employees already furloughed. Immediately following their appointment the Administrators sought the express consent of the employees to the furloughing and the pay reduction in letters sent by email to employees on April 10 2020. As at the date of hearing there were 12,700 consents, 4 objections and 359 employees had not responded. Further consents were coming in all the time to the Administrators.
The Administrators sought a number of directions in relation to the employees and the JRS.
As in the Carluccio’s case the concern of the Administrators was that the additional potential super priority claims for the 20 percent of salary, salary above the monthly cap of £2,500 and holiday pay payable at the original rates in the employment contracts, for the employees who had not consented to the variation of their contracts of employment, would not be covered by the grant from the JRS. Prior to the hearing, these claims were estimated to amounted to about £3 million, and would be payable as super priority claims as administration expenses prior payment of the Administrators’ fees.
The Administrators submitted that the decision on adoption should wait until the furlough period had ended. The Administrators argued that to support the rescue culture and to enable the business to be rescued there should be no adoption as that could result in more redundancies if the Administrators were potentially exposed to make payments of additional amounts under the contracts of employment.
Judgement was given by the Honourable Mr Justice Trower. He did not accept that consent of the employees who had not responded in a short time frame to a potentially significant change in terms of employment could be inferred/deemed from silence.
The Judge found that the acts of participation in the JRS and the payment to the furloughed employees constituted an election in the form described by Lord Browne Wilkinson. The Administrators could not possibly procure the Company to participate in the JRS without procuring it to pay the equivalent amount to the employee. The obligation to do so arises under the continued contract of employment which the Company in administration is required to honour as a condition of participation in the JRS.
The Court of Appeal found that there was adoption, in light of the actions taken by the Administrators, but was concerned that the finding of adoption would mean that Administrators may consider they have to make redundancies in order not to incur liabilities not covered by the JRS.
The court considered that it as an objective test as to whether there was adoption, and the intention of the Administrators was irrelevant. They endorsed the decision of the Honourable Mr Justice Laddie in Re Antal 2003 which referred to the need for conduct on behalf of the Administrator:
“which could be treated as an election or could be regarded as him exercising a choice as to whether or not the contracts of employment were to be adopted…..”
Lord Justice David Richards commented:
“It is necessary to look at the facts and decide.”
The Court of Appeal considered the relevant facts here were as follows:
“that it is likely to assist achievement of the purpose of administration”
The Court of Appeal considered that the fact that the furloughed employees were not carrying on work was a significant fact, but not sufficient of itself to mean there was no adoption. The JRS had been devised by the government to provide for a payment by the company and not a payment direct to the employee, so:
“the legal consequences of the Scheme must be decided by reference to its actual terms”
The Court of Appeal said:
“We can see that there may be good reasons of policy for excluding action restricted to implementation of the Scheme from the scope of “adoption” under paragraph 99 but such exclusion cannot be accommodated under the law as it stands”.
So in effect, the conclusion is that law reform is needed to exclude the JRS from the scope of adoption, but this seems unlikely, given that the government is trying to reduce the reliance on the JRS in the coming months.
In terms of comments on the mechanism for payment under the Insolvency Act, the Court of Appeal disagreed with the Honourable Mr Justice Snowden that paragraph 99 should be interpreted to include the contract of furloughed employees. It accepted the submission by Counsel for the Administrators that Paragraph 66 is more appropriate and
“the most obvious source of authority for these payments”,
as the steps that the administrators are taking are “likely to assist achieving of the purpose of administration”.
“In contrast paragraph 99 operates only where a person ceases to be the administrator, although it may well be the case, as Trower J observed that authority can also be derived from Paragraph 99”
When the JRS is withdrawn, or the employee comes off furlough, the obligations of the employer to make payments under the adopted employment contracts will resume. In the alternative, the Administrators will need to make the employee redundant with no notice, with their claims for redundancy and notice being treated in accordance with the provisions of the Insolvency Act as preferential or unsecured claims. The Guidance does suggest that notice pay can be paid to employees on furlough, however this would be at odds with the obligation on the Administrator only to use the JRS if there is a reasonable likelihood to rehire the employee, and could expose the Administrator to potential liability for additional notice pay not covered by the grant from the JRS, if that were provided for in the contract of employment.
The consultation obligations re redundancy under TUPE and UK employment legislation remain notwithstanding the fact that the employees are on furlough. These sit uneasily with the Administrators indicating that it is reasonably likely that the employee will be rehired, and with the way in which Administrators seek to achieve the purpose of administration and rescue or sale of the business.
Practically it will be difficult to consult with employees on furlough if they are not contactable on email on by telephone. The Administrator should make reasonable efforts in the circumstances to consult with the employees on possible redundancies. It is also important to remember that there is potential criminal liability for failure to file collective consultation form HR1.
One practical suggestion would be to use the initial letter to the employees informing them of their appointment, the furlough, and requesting consent to variation of the terms of employment, as also referring to consultation and beginning the consultation process.
Claims for inadequate or lack of consultation can result in the making of a protective award against the company which is an unsecured claim.
The current focus in the UK is on saving businesses and rescuing companies. The JRS is forming a large part of this effort, by the government currently supporting the wage payments of over seven million employees in over one million businesses under the JRS.
It is to be hoped that the government makes an exception for companies in administration from the contribution obligations to be introduced later in the year, as otherwise this could significantly affect the number of businesses which survive and are restructured or sold using the administration process in the coming months.
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