Debenhams and administration: Court of Appeal clarification on furloughed employees

On 6 May 2020, the Court of Appeal handed down judgment in the case of Re Debenhams Retail Ltd.  As in the Carluccio’s case, discussed here, the appeal considered the relationship between the  Coronavirus Job Retention Scheme (the Scheme) and the adoption of employment contracts by administrators under the Insolvency Act 1986 (the Act).

Background

On 25 March 2020, Debenhams Retail Ltd (the Company) wrote to approximately 13,000 employees informing them that they were being placed on furlough leave. On 9 April 2020, administrators were appointed by the directors of the Company under Schedule B1 of the Act. The purpose of the administration was to seek to rescue the Company as a going concern, with the aim of resuming trade once lockdown measures had been lifted.

Judgment of the High Court

The administrators of the Company applied to Court, under paragraph 63 of Schedule B1, for a direction that they would not be deemed to have adopted the furloughed employees’ contracts by participating in the Scheme. The distinction in this case, as compared to the Carluccio’s case, was that the majority of employees had been placed on furlough either prior to the appointment of administrators or within the first 14 days of their appointment.

Mr Justice Trower refused to grant the direction sought. It was held that, by making an application under the Scheme and by paying furlough monies to employees, the administrators would be deemed to have elected to treat the furloughed employees’ contracts as adopted. And pursuant to paragraph 99(4) of Schedule B1, the liabilities under the relevant employment contracts would accordingly enjoy “super-priority”.

Judgment of the Court of Appeal

The administrators appealed the High Court decision, submitting that, before it could be concluded that the employment contracts had been adopted, there must have been words or conduct on their part which, objectively construed, evidenced their election to treat the liabilities arising under the employment contracts as enjoying super-priority. The Court of Appeal considered a number of issues in turn:

  • The meaning of “adoption”

As the Act has no definition of “adoption” of an employment contract by an administrator, the Court of Appeal applied the House of Lords decision of Powdrill v Watson & Anor (Paramount Airways Ltd). In this case, the court concluded that if the conduct of an administrator constituted adoption, there was nothing they could unilaterally say to qualify or exclude it. A contract of employment would inevitably be adopted if the administrator caused the company to continue the employment for more than 14 days after their appointment, which would in turn give rise to super-priority. There was no requirement for the administrators to actually evidence an election; the question instead was a wholly objective one as to whether the administrator had continued the employment of the relevant employees.

  • Adoption of employment contracts in the present case

The issue before the Court of Appeal, therefore, was whether the administrators had continued the employment of the furloughed employees. Following the approach adopted by Snowden J in Carluccio’s, it was held that they had. The Court of Appeal identified three facts to support this conclusion.

The first was that the administrators were to continue to pay the salaries of the furloughed employees, albeit only up to the limits of the Scheme. The Court of Appeal noted that the employees’ entitlement to those payments derived exclusively from their contracts of employment. The second was that all furloughed employees who expressly consented to the continuation of their employment on the terms specified would remain bound by their contracts of employment, save as to the obligation to be available for work during the furlough period. The third was that, in continuing to pay the furloughed employees, the administrators were acting with the objective of rescuing the Company as a going concern and in the interests of the Company’s creditors as a whole.

The administrators relied upon three grounds to oppose this conclusion. The first was that the employees were not permitted to carry out any work for the Company whilst on furlough. Although significant, the Court of Appeal held that this was not sufficient in itself and had to be balanced against the continued performance of the employment contracts in all other aspects. The second was that salaries were limited to the amount provided by the Scheme. The Court of Appeal held this fact to be neutral as far as the administration was concerned. The third and final ground was that any decision regarding the termination of the employment contracts would take place only after the Scheme had ended. The Court of Appeal held that, as a matter of law, it was not possible to simply “suspend” the employment contracts. The contracts would remain in existence until a decision on termination had been reached.

Having considered the competing factors, the Court of Appeal declined to make the declaration sought and held that the administrators had indeed adopted the contracts of those employees who had consented to be furloughed. The appeal was dismissed.

Practical considerations

The decision of the Court of Appeal has made clear that administrators do not necessarily have to take significant or proactive action, other than to pass on payment of salaries received through the Scheme, to be deemed to have adopted employment contacts. The implications of this decision will be great and will affect administrators nationwide. They cannot simply furlough employees and delay decisions about redundancies. Administrators that have furloughed employees will now be faced with increased employee costs, ranking ahead of unsecured liabilities, as well as other costs and expenses of the administration.

What the Government has provided by way of financial assistance for businesses to help retain workforces, appears to have been taken away, in part, by the judiciary at a time when such businesses are at their most fragile and in the midst of a rescue procedure.

Employees of such businesses may well be relieved that their employee costs – such as sick pay, holiday and, for those that did not consent to being placed on the Scheme, the 20% balance of their salary – have essentially been pushed to the front of the queue to be paid as a “super-priority”. By contrast, administrators may well be asking how they can be expected to rescue a struggling business in these unprecedented times without further support from the Government.

Whilst the Court of Appeal appears to have prioritised the protection of employees in the waterfall of payments, the strain that will now be placed on administrators to manage already restricted finances may well have the undesirable consequence of pushing a number of struggling businesses from administration into liquidation. Alternatively, administrators may well instead be faced with difficult decisions as to whether employees that would otherwise have been candidates for the Scheme, will now be candidates for redundancy. Both consequences, seemingly, undermining the purpose of the Scheme and serving no long-term benefit to employees.

If you have any questions about this subject please contact Simeon Gilchrist, Sophia Bompas, Linky Trott or any member of the Business Protection Team.

Anonymous