Carluccio’s and administration: the High Court allows administrators to furlough employees

On 13 April 2020, in the first ruling of its kind, the High Court provided much needed clarity on the application of the Coronavirus Job Retention Scheme (the Scheme) for companies that have entered into administration.  The Court expressed a willingness to assist with the policy objectives of saving jobs, and this may be the first in a series of authorities curbing traditional vested interests in favour of collective processes.

Background

On 30 March 2020, as a result of the impact of the current Coronavirus restrictions, the Italian restaurant chain Carluccio’s (the Company) entered into administration. The evidence before the Court was that the Company had no money with which to pay the continuing wages of its employees whilst in administration. Given that the Administrators would have to make the employees redundant within fourteen days of their appointment or adopt by operation of law all of the employees’ contracts, the Administrators sought directions on their liability were they to take advantage of the Scheme; would the Court limit their liability for wages to the amount that they would be able to recover? The administrators hoped to “mothball” the business of the Company and preserve both value and employment; precisely the policy behind the Scheme.

Shortly after their appointment, the Administrators wrote to all employees (the Variation Letter), offering to continue to employ them on varied terms so as to take advantage of the Scheme. The overwhelming majority of employees accepted the offer, a small number rejected the offer (preferring to be made redundant) and the remaining employees did not respond. Given the lack of legislation and precise details of the Scheme, and the fact that the Administrators’ fourteen day “safe” period was almost up, the Administrators sought an urgent judgment of the High Court on the application of the Scheme and its intended operation in conjunction with the insolvency legislation.

Judgment of the High Court

Mr Justice Snowden considered a number of questions in turn.

• Was the Scheme available to the Company?

The first question was whether the Scheme was actually available to the Company, having entered into administration. The Court held that although the Scheme was manifestly intended to apply to companies which were not in an insolvency procedure, it could apply to companies in administration. The government guidance (the Guidance) states “Where a company is being taken under the management of an administrator, the administrator will be able to access the Job Retention Scheme. However, we would expect an administrator would only 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 question, therefore, is whether there is a reasonable likelihood of rehiring the workers. Given the fact that there had been several expressions of interest in respect of the sale of some or all of the business, the Court held that there was a reasonable likelihood of rehiring the workers and the Scheme was therefore available to the Company.

• Have the contracts of employment been varied?

The second question before the Court was in relation to the contracts of employment. The Variation Letter explained to employees that the Company was not in a position to meet the remaining portion of their usual wage. By agreeing to be furloughed, they would effectively be agreeing to a reduction in their pay. The Variation Letter also made it clear that the Company would only be able to pay employees once it had received the grant from the government. The issue to consider was whether the Variation Letter validly amended the contracts of employment of the employees to whom it was sent. For those employees who accepted the offer, it clearly did. For those employees who did not respond, the issue was less clear. Upon consideration of the principles in Abrahall v Nottingham CC, the Court held that the absence of a response could not give rise to a clear inference that the employee must have consented to the variation proposed. The current situation was very different to the one in Abrahall and the wording of the Variation Letter required some form of positive response from the employees. In addition to this, only a matter of days had passed since the Variation Letter had been sent and, although regarded as advantageous by the overwhelming majority of employees who accepted it, there were employees who had rejected the variation. This meant that unless employees subsequently agreed to the variations, those who did not respond would still be employed under their existing, un-amended employment contracts.

• How does the Scheme work in an insolvency process?

The third question before the Court was how the Scheme worked in an insolvency process, and in particular how the Administrators were to pay furloughed employees in accordance with the insolvency legislation. The Court held that it was clear from the Guidance that any grant monies would be paid into the employer’s bank account and accounted for as income by the employer. As such, the money would constitute assets of the company in administration. Administrators are not free to dispose of the assets of the company in administration as they see fit, but must do so in accordance with the order of priorities prescribed by Schedule B1 of the Insolvency Act 1986 (IA86). There are mechanisms available to ensure that monies for specific payments can be held on trust but, as Mr Justice Snowden explained, there is no mention of those in the current Guidance.

So what were the Administrators to do? The Court held that in order for the Administrators to be confident that they would be able to make payments to furloughed employees, they would have to find a mechanism to justify the payment of such wages in priority to other claims against the Company. There were two contenders: paragraphs 66 and 99 of Schedule B1. The first allows for payments out of the assets that might be necessary or incidental to the performance of an administrators’ functions. The Court did not consider that the provision could apply, perhaps because Paragraph 99 appeared more naturally suited to the issue: by this provision liabilities for wages or salary arising out of contracts of employment adopted by an administrator are payable out of the assets held by the administrator in priority to the administrator’s remuneration and expenses, which in turn have priority over the claims of floating charge creditors and unsecured creditors.

• What does “adoption” mean in the context of Paragraph 99?

Lastly, the Court considered the meaning of “adoption” in the context of Paragraph 99. Upon consideration of the decision of the House of Lords in Powdrill v Watson & Anor (Paramount Airways Ltd), the Court examined the distinction between termination, continuation and adoption of a contract of employment. For those who accepted the offer, the Court held that adoption would occur at the point at which the Administrators make an application under the Scheme in respect of that employee or make a payment to that employee under their varied contract. It is at this point that the Administrators would be doing an act which could only be explicable on the basis that they were electing to treat the varied contract as giving rise to liabilities which qualify for super-priority. For those who rejected the offer, the contracts of employment would neither be varied nor adopted but would be terminated and the employees in question made redundant.

Finally, for those who had not yet responded, the Court held that if they consented outside the fourteen day period, this would not amount to an adoption as the act would be by the employee rather than the Administrator. Those employees would instead be placed in the same position as those who had already accepted the offer, with adoption taking place on the Administrators making an application under the Scheme. Otherwise, and critically for administrators generally, the court held that the Administrators would have done nothing amounting to adoption; the unvaried contracts would not be adopted by the mere fact that they were not terminated prior to the expiry of the fourteen day period. Accordingly, those non-responding employees would be unsecured creditors of the Company in respect of any claim under the contract.

Practical Considerations: mothballing?

This judgment provides welcome and timely clarification of the Scheme, and its interaction with traditional administration as a restructuring tool. Whilst waiting on the arrival of the rumoured debtor in possession restructuring process, this judgment does more than answer the narrow point about administrators and furlough; it underlines that administration is not liquidation, and that administration can be a useful tool in achieving the business hibernation that is so clearly needed.  With other significant fixed costs such as rent not in issue in this judgment, the door may though now be open for other companies on the edge of administration to seek similar decisions in their bid to preserve employment. How long before an administrator seeks direction for a “light touch” administration ?

If you have any questions about this subject please contact Simeon Gilchrist, Ali Zaidi, Linky Trott, Lauren Murphy or any member of the Restructuring & Insolvency or Employment teams.

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