COVID-19: Furlough and administration

COVID-19: Furlough and administration

What should pubs and restaurants "takeaway" from the new temporary Use Class DA?

 It is now common knowledge that the Government has responded to the COVID-19 crisis with a number of protective measures, including the Coronavirus Job Retention Scheme (CJRS), which provides support to businesses that cannot maintain their current workforce because their operations have been severely affected by COVID-19.  Under the CJRS, employers can apply for a grant to cover 80% of the wages (up to £2,500 per month) of employees who are placed on furlough leave.

It is clear from HMRC guidance that the CJRS is available to companies in administration as well as solvent companies, providing another option for administrators faced with problems handling the workforce of an insolvent company. The CJRS is only to be used by administrators where there is a reasonable likelihood of the workers being retained – for example via a rescue or sale of the business. Without the CJRS, the administrators would likely be forced to retain minimal staff (those who were essential to enable a rescue or sale of the business or assets, which is a complex matter to determine) and to leave the remainder of the staff facing redundancy.

But how would administrators manage this balance with, for example, a casual dining business which would usually require a large number of staff across its sites – but where those sites are unable to operate due to lockdown? In a typical administration sale, a buyer would likely require at least some of the existing staff to transfer with the business in order to operate effectively post-sale. Therefore, making all staff redundant due to the restrictions of lockdown would render a sale of the business more difficult, and/or require a reduced selling price. This would be a worse outcome for the creditors of the business and the staff who have been made redundant than if COVID-19 had not forced the restaurants to close temporarily.

This is where the use of furlough leave by administrators could become crucial to protect both jobs and value in the business. Some administrators have therefore already been prepared to embrace this option, but have sought directions from the court in the absence of legislative clarity.

Given the lack of detail about the specifics of the CJRS, including the implications in an insolvency context, the administrators of restaurant chain Carluccio’s sought urgent directions from the High Court.

The administrators sought clarity as to whether they had adopted, or would adopt, the employment contracts of employees to whom furlough leave was offered. Employment contracts which are not adopted by administrators are typically terminated. The High Court held that employees who had agreed to be placed on furlough leave had varied their contracts and their varied contracts would be adopted by the administrators when they make a claim under the CJRS in respect of such employees, or pay employees sums received under the CJRS. The same would apply to the employment contracts of any employees who had not yet responded but later agree to vary their contracts and be placed on furlough leave.  The contracts of employees who choose not to consent to be placed on furlough leave would not be treated as adopted and would be terminated.

The administrators also required clarity from the court as to how any CJRS funds received from HMRC could be paid to the company’s employees, as the usual priority of payments in an insolvency context does not anticipate the payment of an amount to the company itself, which is destined for the employees under a scheme such as the CJRS. In the judgment, it was confirmed that the employees will have super-priority under the Insolvency Act 1986, ranking ahead of the fees and costs of the administrators, floating charge creditors and unsecured creditors. This means that the funds received by the company under the CJRS could be used to make payments to the employees as soon as they are received.

The situation was different for the administrators of Debenhams, which had placed the majority of its 22,000 employees are on furlough leave either prior to entering administration or within the first 14 days of the process.

The Debenhams administrators also looked to the court for directions, a mere two days after the administrators of Carluccio’s. Because the Debenhams staff were already largely on furlough leave, the administrators sought a direction from the court that they could operate the CJRS without having been deemed to formally adopt the contracts of employment of the furloughed employees. They raised arguments challenging the conclusions made by Mr Justice Snowden (the judge in the Carluccio’s case), but Mr Justice Trower agreed with his reasoning and was not prepared to give such a direction. Instead, he directed that:

“the Administrators be at liberty  to act on the basis that  they  will  be  taken  to  have  adopted  any  contract  of  employment  between  the Company  and  its  employees  in  circumstances  where,  in  respect  of  any  particular employee or employees, at any time after 14 days from the time of their appointment:

(1) the Joint Administrators cause the Company to make payments to such employee  or  employees  under  and  in  accordance  with  their  employment contracts including in respect of amounts which may be reimbursed to the Company by a grant under the JRS; or

(2) the Administrators make an application in respect of such employee or employees under the JRS.”

The implications of this are problematic for the administrators of Debenhams, as it greatly increases the amount of employee costs which would qualify for super-priority – staff who had not varied their contracts could be entitled to claim the 20% ‘balance’ of their pay, or any amount in excess of the £2,500 monthly cap, together with other employment benefits as expenses of the administration. This could jeopardise the very ability of the administrators to retain as complete a workforce as possible in the spirit of rescuing the business. The position is less problematic in Carluccio’s, because the administrators were in a position to implement a variation to the workforce’s employment contracts as part of the process of engaging with the CJRS.

The administrators of Debenhams appealed the High Court’s decision to the Court of Appeal. The judges on appeal held that that the administrators had, for the purposes of paragraph 99 (which sets out the super-priority of certain employee payments such as wages in insolvency distributions), adopted the contracts of those employees who have consented to be furloughed and accordingly dismissed the appeal. In the appeal judgment, Lord Justice David Richards noted that “there may be good reasons of policy for excluding action restricted to implementation of the [CJRS] from the scope of "adoption" under paragraph 99, but such exclusion cannot be accommodated under the law as it stands."

In these initial weeks of dealing with the COVID-19 pandemic, perhaps it is not surprising that there is little clarity on the detail – drafting and approving legislation takes time, whilst certain measures were required to take pretty much immediate effect. The devil, as ever, will be in the detail – we wait with bated breath to see what the new legislation will say as to the precise operation of CJRS. One area which will be interesting to see is whether legislation will ‘carve out’ placing staff on furlough from the actions which are taken to show an adoption of employment contracts – which could remove or mitigate the problem of super-priority facing the Debenhams administrators.

David Steinberg, co-head of Restructuring & Insolvency at Stevens & Bolton comments:

The availability of furlough leave to administrators may prove essential in retaining value for certain businesses, and indeed to enabling a sale. However, in the absence of detail as to precisely how the legislation will operate, administrators such as those appointed to Carluccio’s or Debenhams may find themselves needing to apply to court (which, of course, comes at a cost to the insolvency estate) to obtain urgent directions where there is an absence of clarity. This is made more complicated at a time when the courts are also dealing with the complexities of social distancing and operating via remote hearing wherever possible.

Whilst we can take some comfort from the pragmatic approach taken by the court in the Carluccio’s matter - which demonstrates a commitment to the core objectives of an administration and the spirit of trying to rescue the business or procure a better outcome for creditors than a liquidation, the implications of the Debenhams matter are more troublesome – although the reasoning is logical, the outcome is unfortunate. We await the anticipated legislation with interest.

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