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Furlough or forlorn? Employee issues post insolvency

View profile for Tim Francis
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A great deal of uncertainty has been created in recent weeks as a result of the unprecedented measures employed to aid businesses in their response to the novel Coronavirus. Among the most notable is the Coronavirus Job Retention Scheme (JRS), which allows employers to place staff on temporary leave, or ‘furlough’, in the knowledge the government will guarantee 80% of their salary for the duration of ‘lockdown’.

A significant problem, though, appears to stem from the fact companies themselves are having to satisfy payments toward wages of furloughed staff until the government scheme is finalised and JRS wage payments begin reaching businesses. Whilst companies will indeed be able to claim back this expense later down the line, many sectors are entirely unable to trade due to social distancing. Banks appear inundated with an untenable amount of Business Interruption Loan applications and 1 in 3 UK companies have furloughed between 75 and 100% of their staff. Ultimately, it seems none of this finance is arriving fast enough, as some of the largest entities with the most significant salary outlays are placed into administration and, doubtless, many more will follow suit as wages fall due at the end of the month.

The most high-profile examples, Debenhams and Carluccios, have seen appointments in recent days. What remains unclear, and is likely to be particularly pressing for employees, is how the JRS is likely to interact with the administration provisions in Schedule B1 of the Insolvency Act. Crucially, paragraph 99 provides for salary payments under contracts of employment ‘adopted’ by the administrators to be given super-priority in an administration, ranking before expenses and secured creditors. The decision as to whether to adopt these contracts is ordinarily made during a 14-day grace period after appointment. Alternatively, administrators have the ability to make such staff redundant. The question, then, is whether administrators are deemed to be ‘adopting’ staff through funding interim JRS payments?

Debenhams

This week, FRP Advisory applied to the Court for a declaration that interim wage payments in the superstore’s administration would not serve to ‘adopt’ pre-existing contracts pursuant to paragraph 99, or, in the alternative, that wage liabilities adopted would not exceed the sum that would later be covered and repaid under the scheme. In the April 15 hearing, however, Justice Trower declined to approve either of these points, stating that “the payment of equivalent amounts to furloughed employees [within the JRS]… means… contracts of employment… will have been adopted by the administrators.”

Seemingly, then, practitioners will be faced with a catch-22. Super-priority liability for interim payments up to the amount reimbursed would doubtless create enough of a strain on many administrations, given the limited funds often available to IPs. To put this in perspective, the Court heard that Debenhams has estimated salary outlays of £18m per month. Now forced to decide between providing uncapped interim salaries to furloughed employees or making these individuals redundant to enable long-term rescue, it seems clear administrators will choose the latter. It remains to be seen whether FRP will be appealing this decision. However, it appears to provide wholly unnecessary incentives for asset sales, redundancies and destruction of long-term human capital synergies at a time when a great many entities are likely to be entering the administration process with an equally large number of furloughed staff.

Carluccios

Whilst failing to resolve the resulting problems from the Debenhams judgment, a seemingly more positive direction was provided in a similar case presented with respect to Italian restaurant chain Carluccios, also managed by FRP Advisory. This judgment confirms that ‘adoption’ within the meaning of paragraph 99 will only occur upon a payment being made to a furloughed employee. Consequently, this decision provides much-needed breathing space to administrators in the coming weeks, absolving them of the standard 14-day ‘adoption’ grace period ordinarily permitted under paragraph 99.

However, this will be of scant reassurance to employees. In stark contrast to the intention of the scheme and, indeed, the administration rescue process more broadly, IPs appear to be best off withholding payments to furloughed staff. As the JRS does not offer any support whatsoever to redundant employees, it seems that the policy imperative of protecting short-term individual liquidity is decidedly absent from both of these judgments. Interestingly, the Business Secretary announced on 16 April an extension of the JRS, backdating the scheme to cover a significant number more employees. This will likely be of limited assistance, though, if funds under the system do not become available in extremely short order, incentives toward redundancies and suspension of salary payment are not addressed and Business Interruption Loans do not begin to reach distressed companies.

For further guidance on insolvency matters, please contact Tim Francis.