Employers’ guide: what are your responsibilities to employees on insolvency?

Last updated: 10 June 2021

Estimated reading time: 7 minutes

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What are your legal obligations towards employees if your business becomes insolvent? Below is some guidance on this topic which should assist. For more specific or in-depth advice on a particular insolvency employment issue, please contact our employment solicitors.

Jump to:

  1. What do we have to pay employees?
    1. Administration
    2. Administrative receivership
    3. Pre-pack sale
    4. Company Voluntary Arrangements (CVAs)
  2. Administrators and adopting employment contracts
  3. Compulsory liquidation
  4. Redundancy pay and liquidation
  5. Protective awards
  6. Pregnancy or parental leave and insolvency
  7. Corporate Insolvency and Governance Act 2020

What do we have to pay employees?

Administration

When an administrator has been appointed to try and rescue a company, the employer does not change, and the contract of employment remains the responsibility of the employer.

However, an employer in administration may not be able to afford to pay all employees, so what happens in these circumstances?

The first 14 days are crucial, if the employee is made redundant by the company during that time the employee will become an ‘ordinary creditor’, and will rank equally with all other unsecured creditors in the order of creditors owed money by the company. Whereas, if an employee remains employed by the company beyond that time, the employee will be a ‘preferential creditor’, and have priority over ‘ordinary creditors’.

Preferential creditor employees are entitled to:

  • arrears of salary and commission for up to four months prior to the company entering administration, and with a maximum limit of £800 per employee
  • up to six weeks’ holiday pay
  • some occupational pension payments

This will not necessarily cover all monies owed to employees and anything else owed will need to be claimed as an ‘ordinary creditor’, using money generated by the sale of assets. If there is still not enough after the sale of assets, the monies will come from the National Insurance Fund (NIF), as long as the employees make a claim from the company within six months of their dismissal. Payments from the NIF will have a weekly cap which is currently £538 per week and could include: 

  • up to eight weeks’ wages
  • arrears of holiday pay for a period of up to six weeks
  • payment for any statutory notice period that was worked but not paid (up to 12 weeks maximum)
  • unpaid pension contributions; and
  • the basic award for unfair dismissal

For more information about employees and insolvency, see our guide on who gets paid first on insolvency?

Administrators will be able to ask employees to take a pay cut or defer pay to try and help the company survive.

If the business is purchased by a new company, TUPE legislation applies. But if the old company is liquidated, employees may only receive a proportion of their wages and other payments.

Administrative receivership

A administrative receivership refers to a formal insolvency process whereby an organisation, such as a bank that holds a floating charge, employs the services of a receiver with the aim of recovering the debt owed, usually by selling company assets that are subject to the floating charge. This process usually ends in liquidation and dissolution of the company.

If it is deemed by the administrative receiver that the company is unlikely to be able to be rescued, it is likely that employees will be dismissed. After 14 days of appointment the administrative receiver is personally liable under the contract of employment to pay ‘qualifying liabilities’, such as wages and holiday pay.

Employees are not immediately affected by the appointment of an administrative receiver and there is no automatic termination of contracts unless:

  • the appointment is accompanied by an immediate sale of the business (except a TUPE transfer)
  • simultaneously or soon after the appointment, the administrative receiver and employees enter into a new contract which contradicts the old contract; or
  • the continuation of employment of a particular employee would be inconsistent with the role and functions of the administrative receiver.

Pre-pack sale

The rights of employees during a Pre-pack sale of a company are governed by TUPE. This means that all the old company employees must be transferred to the new company under the same employment terms and conditions and be paid salary and benefits, as normal.

If redundancies are required by the new company, the redundancy process must consider all the rights that employees have accumulated since the beginning of their continuous employment with the old company. If full service is not considered, the employee may have grounds to bring a claim against the new company for unfair dismissal.

Company Voluntary Arrangements (CVAs)

Again, CVAs do not immediately affect contracts of employment, because the idea of them is to try to save the company as a going concern. An exception to this might be where a CVA occurs with an administration or a liquidation when distributing the company’s assets to unsecured creditors. Where that happens, whether employment contracts terminate or not depends on the type of process the company enters after that point, but a CVA on its own is unlikely to bring about any changes in the amount you pay employees, in the short term.

Administrators and adopting employment contracts

In the case of administration, the insolvency practitioner may keep some or all employees to carry on the insolvent business, and the insolvency practitioner is just the agent of the company for this purpose, the insolvent company remains as the employer. It is only where there is a court-appointed administrative receivership, the receiver is the principal of the company and so will become the employer. However, the insolvency practitioner will be running the business day to day and making employment related decisions.

In terms of ‘adoption’ of employment contracts, nothing an administrator or administrative receiver does or does not do within 14 days of their appointment will cause contracts of employment to be ‘adopted’. This gives insolvency practitioners a short period of time to familiarise themselves with the workings of the business and decide which employees the business needs to function and what the business can afford to pay those employees.

An administrator or administrative receiver adopts contracts of employment if, after the initial 14 days, they continue to employ staff and pay them as per their previous contracts of employment, unless the contracts are genuinely re-negotiated.

During the Coronavirus pandemic, the courts have looked at the relationship between the 14-day window and furloughing employees under the government’s Coronavirus Job Retention Scheme (CJRS). The Court of Appeal found that the administrators of Debenhams had adopted the employment contracts of staff by making payments to them in accordance with their contracts, even where these were only payments that were to be recovered by way of government grants under the CJRS.

Compulsory liquidation

Compulsory liquidation means that all employment contracts are automatically and immediately terminated from the date of publication of the winding up order of the company. In this case, the employee will usually have a claim for wrongful dismissal unless sufficient notice under their contract has been provided or paid in lieu (but there will be a moratorium in legal proceedings against the company which will need to be lifted before a claim can be brought by an employee). There is not usually a claim for unfair dismissal in these circumstances as ‘operation of law’ is the reason for the dismissal.

Where there is a compulsory liquidation, if the liquidator wishes to keep employees, they will have to either agree in advance that there will be no termination of employment or, alternatively, enter into new employment contracts maintaining continuity of service. This type of re-engagement can reduce liability by way of damages payable for any wrongful dismissal claims by employees after the original termination.

Redundancy pay and liquidation

If a company is being liquidated, payment or part-payment of redundancies may come from the insolvent business once it has sold its assets, but there is unlikely to be enough to cover all monies owed to the employee. If redundant employees do not receive their full redundancy pay entitlement from their employer, they may make a claim from the NIF, through the Redundancy Payments Service (RPS). These are usually dealt with by the liquidator or administrator first.

Whether a company liquidation is voluntary or compulsory, all employees are made redundant upon liquidation of a company, and those who qualify for a statutory redundancy payment will be able to claim through the RPS within six months of being made redundant. The liquidator should assist employees and provide them with Form RP1 so that they can claim redundancy pay from the NIF. Employees will then complete and return the form to the liquidator to forward on to the RPS.

Protective awards

Protective awards can be claimed and awarded by an Employment Tribunal, either where an employer does not consult properly when 20 or more employees are being made redundant at the same workplace at the same time (collective redundancy), or where there is a lack of consultation on a TUPE transfer to another employer.

The maximum protective award is generally up to 13 weeks’ pay. But where an employer is insolvent this will be paid by the government if required, for a maximum of 8 weeks’ pay capped at £538 per week, subject to income tax and National Insurance Contributions. If arrears of pay have been paid for the same time, the amount of that payment will be deducted from the protective award paid.

Pregnancy or parental leave and insolvency

If a company becomes insolvent after the start of the Qualifying Week and before the start of the employee’s pay period, HM Revenue and Customs (HMRC) will pay the employee’s Statutory Maternity Pay (SMP). In addition, if the company becomes insolvent during the SMP pay period, HMRC will pay SMP from the week the company became insolvent. The company or insolvency practitioner should assist the affected employee and ask them to contact the Statutory Payment Disputes Team and should contact HMRC on the employee’s behalf.

Arrears of statutory sick pay, maternity, paternity or adoption pay are not claimed from the NIF like other employee payments on insolvency, but through the Department for Work and Pensions, and HMRC.

Corporate Insolvency and Governance Act 2020

How the changes made to the Corporate Insolvency and Governance Act 2020 effect employment remain to be seen. But we would expect the measures to better protect employment in the short to medium term than if the changes had not been made.

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