BRIEFING PAPER Number 0651, 24 April 2020

Employment rights and By Lorraine Conway

Daniel Ferguson

Contents: 1. Payments covered by the State 2. Insolvency 3. Large scale redundancies

www.parliament.uk/commons-library | intranet.parliament.uk/commons-library | [email protected] | @commonslibrary 2 Employment rights and insolvency

Contents

Summary 3 1. Payments covered by the State 4 1.1 Redundancy Payments Service 4 1.2 Redundancy – payments by Secretary of State 6 1.3 Payments covered by HM Revenue and Customs 7 1.4 Pension contributions 7 1.5 The Pension Protection Fund 7 2. Insolvency 9 2.1 When is an employer insolvent? 9 2.2 10 The procedure 10 Administrator’s statutory objectives 11 What happens to employment contracts? 12 What happens to employment contracts if the company is sold on by the administrator? 13 Where does that leave the employee? 13 2.3 14 The procedure 14 What happens to employment contracts? 14 2.4 Statutory order of payment of 15 Preferential debts owed to employees 16 Reform of preferential status after 1 December 2020 17 3. Large scale redundancies 18 3.1 Overview 18 3.2 Collective consultation requirements 18 3.3 Insolvency Service: a call for evidence 18

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3 Commons Library Briefing, 24 April 2020

Summary

The Employment Rights Act 1996 (ERA 1996) and the Insolvency Act 1986 (IA 1986) provide two routes by which an employee might seek payment of debts owed to him or her by an insolvent employer. First, the Secretary of State must pay certain debts to employees, effected via the Redundancy Payments Service. Aside from in the case of unpaid redundancy pay, the Redundancy Payments Service will only pay these debts if the employer has become formally insolvent. Second, employees may seek payment from the company’s assets through insolvency proceedings or via administrators. In outline, the options open to the employee may be summarised as follows: • The ERA1996 requires the Secretary of State to pay certain debts owed to employees, including arrears of pay and unpaid redundancy pay. This is paid out from the National Insurance Fund via the Redundancy Payments Service.1 • Statutory payments such as statutory sick pay and maternity, paternity or adoption pay may be covered by HMRC. • The State may also cover unpaid employer’s contributions for employees who belongs to occupational pension schemes, and, under the Pensions Act 2004, pension schemes may be protected by the Pension Protection Fund. • If an employer is put into administration, employees may have claims against the administrator/administrative receiver. • If the employer is put into liquidation, employees may have claims against the insolvent estate. • Employees are treated as preferential creditors under the IA 1986 in respect of unpaid wages owed in the four months prior to the insolvency order (subject to an £800 limit), and in respect of the total amount of unpaid holiday pay. This House of Commons briefing provides detailed information about each of these options. The law discussed applies to the whole UK. This paper has been updated during the COVID-19 emergency. Many UK businesses are confronting serious commercial consequences, including a fall in consumer demand, delays in delivery of essential supplies, and cashflow difficulties. Some businesses (e.g. retail and hospitality) have been forced to stop trading altogether because of the nationwide lockdown. Despite government measures to protect businesses and jobs, the fear is that some businesses will inevitably fail, particularly those already in financial difficulty before the outbreak.

1 Certain categories of employee are excluded. The rights are not available to merchant seamen, share fishermen, employees of the Crown or parliamentary staff. 4 Employment rights and insolvency

1. Payments covered by the State 1.1 Redundancy Payments Service Under the ERA1996 the Secretary of State must pay to employees, certain debts owed to them by their insolvent employer. The material parts of the Act implement Directive 2008/94/EC. The Secretary of State must pay employees out of the National Insurance Fund. Payment is arranged by the Redundancy Payments Service, part of the Insolvency Service. The debts covered are set out below.2 • Statutory redundancy payments. Employees with two years’ continuous employment have a right to redundancy pay, based on their weekly pay (subject to a statutory cap, currently £538). The payment is calculated by multiplying a week’s pay (or multiple thereof – see below) by the number of years of employment, reckoned backwards from the date of dismissal, up to a maximum of 20 years. The relevant multiple for any given year of employment is determined by the employee’s age during that year: ─ 0.5x a week’s pay for each full year of service where age during the year is less than 22 ─ 1x a week’s pay for each full year of service where age during the year is 22 or above, but less than 41 ─ 1.5x a weeks’ pay for each full year of service where age during the year is 41+ • Arrears of pay up to £538 a week for a maximum of eight weeks, including guarantee payments for workless days; payments for time off for union duties; remuneration for suspension on medical or maternity grounds; and redundancy protective awards. • A payment for failure to give statutory notice, up to a weekly limit of £538. • Holiday pay for unused holidays and for holidays actually taken but not paid, up to a weekly limit of £538 for a maximum of six weeks. Holiday pay may include holiday carried over from the previous year if the contract of employment allows this. • An unpaid basic award made by an employment of compensation for unfair dismissal. Complaints about the Secretary of State’s failure to make such payments are dealt with by employment .3 Aside from in the special case of redundancy payments (see below under “Redundancy – payments by Secretary of State”) the State guaranteed payments apply only if the employer has become formally insolvent, as defined in section 183 of the ERA1996. Where the

2 Employment Rights Act 1996, sections 166 and 184 3 Employment Rights Act 1996, section 188 5 Commons Library Briefing, 24 April 2020

employer is a company (including charitable incorporated organisations) section183 will be satisfied: • if a winding up order has been made, or a resolution for voluntary winding up has been passed, with respect to the company; • if the company is in administration for the purposes of the IA 1986; • if a receiver or (in England and Wales only) a manager of the company's undertaking has been duly appointed, or (in England and Wales only) possession has been taken, by or on behalf of the holders of any debentures secured by a , of any property of the company comprised in or subject to the charge; or • if a voluntary arrangement proposed in the case of the company for the purposes of Part I of the IA 1986 has been approved under that Part of that Act.4 Where the employer is an individual, section 183 will be satisfied in England and Wales if— • a moratorium period under a debt relief order applies in relation to him • he has been made bankrupt or has made a composition or arrangement with his creditors; or • he has died and his estate falls to be administered in accordance with an order under section 421 of the IA 1986. in Scotland if— • sequestration of his estate has been awarded or he has executed a trust deed for his creditors or has entered into a composition contract; or • he has died and a judicial factor appointed under section 11A of the Judicial Factors (Scotland) Act 1889 is required by that section to divide his insolvent estate among his creditors.5 Where the employer is a limited liability partnership section 183 will be satisfied: • if a winding-up order, an administration order or a determination for a voluntary winding-up has been made with respect to the limited liability partnership; • if a receiver or (in England and Wales only) a manager of the undertaking of the limited liability partnership has been duly appointed, or (in England and Wales only) possession has been taken, by or on behalf of the holders of any debentures secured by a floating charge, of any property of the limited liability partnership comprised in or subject to the charge; or if a voluntary arrangement proposed in the case of the limited liability partnership for the purposes of Part I of the IA1986 has been approved under that Part of that Act.

4 Employment Rights Act 1996, section 183(1), (3) 5 Employment Rights Act 1996, section 183(1), (2) 6 Employment rights and insolvency

Ex-employees wishing to make a claim under these provisions should apply to their employer’s representative (for example, the receiver, or trustee) for an application form (RP1). The completed form should be sent to the Redundancy Payments Service. The various forms and supporting fact sheets are available from the Gov.uk website.6 The RP1 fact sheet provides a basic guide for employees.7 Employees who have outstanding claims which are not covered by this scheme may submit a claim to the employer’s representative who will consider it separately as part of the insolvency proceedings (see section 2 of this briefing).

1.2 Redundancy – payments by Secretary of State The ERA1996 contains specific provisions on state-guaranteed redundancy payments, separate from the Act’s treatment of other state- backed payments. A redundant employee may apply to the Redundancy Payments Service if his employer is liable to pay him a statutory redundancy payment and the employer: • is insolvent; or • refuses to pay and the employee has “taken all reasonable steps, other than legal proceedings, to recover the payment”.8 As such, in the case of claiming an unpaid redundancy payment from the Redundancy Payments Service, there is no absolute need for the employer to have become insolvent. In order to qualify for a statutory redundancy payment, the employee must have been dismissed by reason of redundancy and have two years’ continuous employment with the employer. What constitutes “all reasonable steps” will depend on the circumstances, but it will generally involve a requirement to obtain judgment against the employer in the employment tribunal.9

6 Redundancy payment forms, Gov.uk 7 Insolvency Service, “Redundancy payments: help for claimants”, 24 July 2015, [online] (accessed 7 April 2020) 8 Employment Rights Act 1996, section 166(1) 9 While section 166(1) of the ERA1996 stipulates a requirement to take all reasonable steps “other than legal proceedings”, section 166(4) qualifies this, somewhat counter- intuitively, by providing that the definition of legal proceedings “does not include any proceedings before an employment tribunal” (although does include tribunal proceedings to enforce a tribunal award). The effect of this is that section 166 contemplates the possibility of obtaining judgment in the tribunal as being a “reasonable step” which a redundant employee may be expected to take prior to applying to the Redundancy Payments Service. 7 Commons Library Briefing, 24 April 2020

1.3 Payments covered by HM Revenue and Customs HMRC is liable to make the following payments to an employee if the employee cannot obtain payment from her/his employer due to insolvency: • statutory maternity pay,10 • statutory paternity pay,11 • statutory adoption pay,12 and • statutory sick pay.13 1.4 Pension contributions Under section 124 of the Pension Schemes Act 1993 the trustees of an occupational pension scheme or personal pension scheme may apply in writing to the Secretary of State claiming that an insolvent employer has failed to pay pension contributions (either on their own account or on behalf of the employee if deducted from the employee’s pay) into the scheme during the 12 months preceding the date on which the employer became insolvent. The Secretary of State is obliged to meet these liabilities subject to the limitations and maximum amounts set out in sections 124-125 of the 1993 Act. If the Secretary of State has failed to make any such payment or the payment is less than the amount which should have been paid, the trustees may complain to the employment tribunal.14

1.5 The Pension Protection Fund The Pensions Protection Fund (PPF) was set up under the Pensions Act 2004 to provide compensation to members of defined benefit pension schemes (i.e. workplace pension schemes that provide benefits based on salary and length of service) where they wind up underfunded on the insolvency of the employer. PPF compensation is not always equal to what the scheme would have provided, particularly for those below pension age when their scheme entered the PPF (unless they were in receipt of an ill-health or survivors’ pension). Where an insolvency event occurs, the appointed is obliged to notify the PPF. The scheme enters an assessment period, during which the PPF decides whether it should take responsibility for the scheme. It only does so if the scheme does not have sufficient assets to pay at least PPF levels of compensation and cannot otherwise be

10 Statutory Maternity Pay (General) Regulations 1986 (SI 1986/1960), regulations 7(3), 7(4) and 30 11 Statutory Paternity Pay and Statutory Adoption Pay (General) Regulations 2002 (SI 2002/2822) 12 Ibid 13 Statutory Sick Pay (General) Regulations 1982 (SI 1982/894), reg 9B 14 Pension Schemes Act 1993, section 126 8 Employment rights and insolvency

rescued. The PPF is funded by a levy on eligible pension schemes. Its operation is discussed in this Library briefing.15

15 “Pension Protection Fund”, Library briefing (CBP 3917, Jan 2020) 9 Commons Library Briefing, 24 April 2020

2. Insolvency

To seek payment of debts owed by an insolvent employer, an employee must make a claim in the insolvency. This section of the paper will consider the two most common forms of insolvency procedure affecting employees: administration and liquidation.16

2.1 When is an employer insolvent? An employing company is said to be insolvent when it has insufficient assets to meet all its debts or is unable to pay its debts as and when they fall due. It is the director’s responsibility to know whether the company is insolvent. They must consider not only the company’s balance sheet (and balance sheet solvency) but also the company’s ability (actual and expected) to pay its debts. Depending on the exact circumstances there are various insolvency procedures open to a company, including: • administration;17 • liquidation or winding-up;18 • administrative ;19 and • company voluntary arrangement (CVA)20 • schemes of arrangement;21 There is a distinct difference between an insolvent company entering administration and liquidation. At its heart, administration is a company rescue procedure designed to help restructure a still viable company and save jobs if possible. If, in carrying out his duties, an appointed administrator does not dismiss an employee within the first 14 days of

16 Due to changes in the law, administrative receivership has been largely replaced by administration 17 Administration is a collective corporate rescue procedure run for the benefit of all creditors, under which a statutory moratorium protects company assets against any form of creditor action while a rescue plan is worked out. The administrator has the power to “trade on” the business whilst seeking a buyer for it. 18 Liquidation occurs when a company is wound up by an order of the court, usually on the petition of a creditor. The role of the appointed liquidator is to collect in and realise company assets and distribute the proceeds to creditors in accordance with a hierarchy set out in legislation. At the end of the liquidation, the company is dissolved, and its name removed from the Companies Register. 19 Administrative receivership is a process under which the holder of a floating charge (usually a bank) against the assets of the company (which pre-dates 15 September 2003) appoints a receiver-manager to collect in and sell the company’s assets to pay off its secured debt. Crucially, administrative receivers are not authorised to pay unsecured creditors (unless they have court approval). To pay unsecured creditors, the company must pass into liquidation. 20 A company voluntary arrangement (CVA) is a legally binding agreement between a company and its creditors. Under a CVA, creditors will typically agree to a reduced or rescheduled debt arrangement which will allow the company to survive. CVAs are supervised by insolvency practitioners and are sometimes used in conjunction with the administration procedure. 21 Schemes of arrangement is a court approved legal arrangement between a company and its creditors. The process is more complicated than a CVA, and for this reason is usually only used by large companies and those with a significant number of classes of creditor or shareholder. 10 Employment rights and insolvency

his appointment, he is deemed to have adopted their employment contract. He will also have incurred a “super priority” liability. In contrast, liquidation is for terminal cases, where there is no hope of saving the business; it signifies the end of the business with the unavoidable loss of jobs for all employees. Either way, employees have a right to claim monies owed to them by the insolvent company. There is a statutory order of priority for paying creditors (see Box 1 below). Employees are treated as preferential creditors under the IA 1986 in respect of unpaid wages owed in the four months prior to the insolvency order (subject to an £800 limit), and in respect of the total amount of unpaid holiday pay. Preferential claims rank for dividend ahead of any creditors with floating charges and unsecured creditors. Further detailed information is provided below.

2.2 Administration Recently, administration has been in the “limelight” due to the large number of high-profile administrations on the high street. An outline of the procedure is set out below. Detailed information is provided in two separate Library briefing papers, “Insolvency: company administration” (4915)22 and “Pre-pack administrations” (CBP 5035). The procedure Company administration is an insolvency procedure by which a company is placed under the direct control of an “administrator” (an insolvency practitioner). The procedure is set out in the IA 1986 having been extensively reformed by the Enterprise Act 2002 to make it more accessible. There are two routes into administration: • by a court order made at a formal hearing, usually on an application made by one or more creditors of the company or the company itself;23 or • by certain parties lodging a series of prescribed documents at court (the simple out-of-court route). A company can be put into administration if a “notice of appointment” is filed at court by either: the company acting either through its directors or shareholders (in both cases by passing a valid resolution); or a

22 Library paper 4915 considers the main characteristics and objectives of the administration process, including pre-packaged administrations known as pre-packs, and the distinctive role of the administrator 23 An application might also be made by a liquidator or a supervisor of a company voluntary arrangement (CVA) (effectively to replace the liquidation order or CVA with an administration order), or under section 359 of the Financial Services and Markets Act 2000 or section 87A of the Magistrates’ Courts Act 1980. 11 Commons Library Briefing, 24 April 2020

qualifying floating charge holder24 (i.e. a bank or other commercial lender).25 Importantly, a company cannot go into administration unless it is insolvent or is likely to become insolvent (but is not already subject to a winding up petition or in liquidation and has not already been in administration or a CVA26 within the previous 12 months). In addition, the company must first give 5 day’s prior notice to any qualifying floating charge holder. Administrator’s statutory objectives Once in administration, the company is placed under the day-to-day control and management of the appointed administrator. The administrator must perform his functions with the objective of either: • rescuing the company as a going concern (i.e. with as much of its business as possible); or • achieving a better result for creditors than would be likely if the company were wound up without first being in administration; or • realising company assets in order to make a distribution to one or more secured or preferential creditors. In other words, there is a statutory hierarchy of objectives. First and foremost, administration is designed to hold a business together while plans are formed to put in place a financial to rescue the company so that it can continue trading. If the rescue of the company is impossible, the administrator must aim to achieve a better result for all creditors through a more orderly winding down of the company’s affairs than would be possible in liquidation. For example, a better return may result from trading on for a period whilst seeking to sell off the business and or assets. If this objective is impossible, the administrator must sell company property to make a distribution to its creditors. In trying to implement these statutory objectives, the administrator has the benefit of a “moratorium” (sometimes described as a “protective cloak”) by which creditors and others are prohibited from taking or pursuing legal proceedings against the company while it is in administration. It is important to note that for the duration of the administration, the administrator is required to act in the best interests of the general body of creditors, including employees.

24 A floating charge is a charge taken over all the assets or a class of assets owned by a company from time to time as security for borrowings or other indebtedness. The advantage of a floating charge is that before insolvency it allows the charged assets to be bought and sold during the course of the company’s business without reference to the charge holder. The floating charge “crystallises” if there is a or similar event. At that stage, the floating charge is converted to a fixed charge over the assets which it covers at that time. 25 The floating charge must meet the requirements of paragraph 14(2) of Schedule B1 to the Insolvency Act1986 26 For a definition of a CVA, see footnote 20 12 Employment rights and insolvency

What happens to employment contracts? Employment contracts do not automatically terminate when a company enters administration.27 This is because the administrator is regarded as an agent of the company, there to promote (if possible) the rescue of the company as a “going concern”, as such, his appointment does not amount to a change of employer. Crucially, nothing which an administrator does or omits to do in the first The 14-day 14 days of their appointment will cause contracts of employment to be adoption window taken as “adopted”.28 This provision is intended to give a breathing space to administrators in order to understand the business and decide which employees the business needs (and can afford) to retain. In the landmark case of Re Paramount Airways Ltd (1995)29, the House of Lords held that an administrator adopts an employment contract if, in substance, they continue after the statutory 14 days to employ the person and pay them in accordance with their previous contract (unless the contract is genuinely re-negotiated). In effect, the adoption rules allow the administrator to dismiss employees within the first 14 days of his appointment without incurring a “super priority” liability (see below). If, in carrying out his duties, the administrator retains an employee beyond this 14-day cut-off point, he is deemed to have adopted their employment contract. Crucially, the adoption rules determine how employee claims rank against other debts of the insolvent company and who is liable to pay them. In accordance with the statutory order of priority for paying creditors (see Box 1), The expenses of an administrator have priority over a debt secured by a floating charge.30 But debts or liabilities arising out of a contract entered into by the administrator (including a contract of employment) have priority (sometimes called a “super priority”) over the administrator’s own remuneration and expenses.31 It follows from this that there is every incentive for the administrator to discharge such liabilities while in office. The following important points should be noted: • A sum payable under a contract of employment “adopted” by the administrator has super-priority except to the extent to which it refers to anything done or occurring before the contract was adopted.32 • Only certain “qualifying liabilities” arising out of the employment contract have super-priority under this provision. They are limited to “wages and salary” and include holiday pay,

27 Paragraph 69, Schedule B1, Insolvency Act 1986 28 Paragraph 99, Schedule B1, Insolvency Act 1986 and sections 37 and 44 29 Re Paramount Airways Ltd (No 3) [1995] 2 AC 394 30 Schedule B1, paragraph 99, Insolvency Act 1986 31 Schedule B1 paragraph 99(3) & (4), Insolvency Act 1986 32 Schedule B1, paragraph 99(5), Insolvency Act 1986 13 Commons Library Briefing, 24 April 2020

sick pay, payments in lieu of holiday and contributions to occupational pension schemes.33 • Administrators do not incur personal liability for “qualifying liabilities” in relation to contracts adopted by them.34 What happens to employment contracts if the company is sold on by the administrator? At the end of the administration process, employment contracts may be transferred if a new company has purchased the business. In this instance, employment rights may be protected by the Transfer of Undertakings (Protection of Employment) Regulations 2006 (known as TUPE). Where does that leave the employee? From the above narrative, it should be clear that an employee’s rights will largely depend on the administrator’s plans for the company in administration. There are various possible scenarios, for example: • To rescue the business, the administrator might agree a company voluntary Arrangement (CVA) with the company’s creditors.35 If the company goes into a CVA, employees may or may not retain their job, much would depend on how the company is to be restructure. Employee rights can be affected by a CVA. • If the administrator can immediately find a buyer to take over all or part of the business as a “going concern” some jobs may be saved (although there may still be redundancies). Employment contracts may be transferred to the new buyer, with the employees’ rights protected under rules that apply to the transfer of undertakings (TUPE). • Alternatively, the administrator might decide to continue the operation of the business for a period in the hope of selling it later as a “going concern”, this would necessitate the retention of employees. If this option is pursued, the administrator will incur “super priority” liabilities under those adopted employment contracts (e.g. wages or salary or contributions to occupational pension schemes).36 • If the business is later sold on, the employment rights adopted by the administrator may be transferred to the new buyer – this is known as TUPE or transfer of an undertaking of employment rights.37 It is worth noting that the potential liability which may be inherited by a buyer under TUPE will frequently be a primary consideration in assessing whether to buy an insolvent business. • If it cannot be saved, the business will simply and quickly move from administration into liquidation, resulting in redundancies.38

33 Paragraph 99(5), Insolvency Act 1986 34 This is in direct contrast to administrative receivers who do incur personal liability 35 For a definition of a CVA, see footnote 20 36 Insolvency Act 1986, Schedule B1, para 99 37 Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246) (TUPE) 38 It should be noted that there is a separate largely abolished process whereby an “administrative receiver” may be appointed by the holders of debentures (debt instruments not secured on physical assets) crated before 15 September 2003 14 Employment rights and insolvency

Whether employees will recover all that is owed to them will depend, in part on the value of the insolvent company’s assets.

2.3 Liquidation The procedure Compulsory liquidation (or winding up) is a legal process by which a liquidator (a licenced insolvency practitioner) is appointed by the court to wind-up the affairs of an insolvent company. Detailed information on is provided in a separate Library briefing paper, Compulsory liquidation of a company (CBP 4937). In outline, a company may be forced into liquidation by one or more creditors with an unpaid “statutory demand”.39 Once a liquidation order has been made by the court, the company immediately stops trading, redundancies are made, and company assets are sold to pay off its debts (often, creditors are not paid in full). At the end of the process the company will be dissolved – it will no longer legally exist. How long winding-up a company takes will depend on the complexity of the case. All creditors (including employees) must formally register their claim in the insolvency (known as a “proof of debt”). This is done by notifying the liquidator of their claim in writing (supported by evidence of the debt if required). In , generally all debts are provable, this means that the liquidator will “admit” the claim provided he is satisfied that the debt is owed. The body of creditors (including employees) are entitled to receive reports on the progress of the liquidation from the liquidator. They can also form a liquidation committee with at least two other creditors, to help the liquidator fulfil his functions. What happens to employment contracts? In most cases, the effect of compulsory liquidation is to automatically terminate all employee contracts with immediate effect from the date of the order. As outlined in section 1 of this paper, under the Employment Rights Act 1996 (ERA 1996) and the IA1986, an employee can seek payment of debts owed to him/her by: • making a claim to the Secretary of State pays via the Redundancy Payments Service; and • making a claim to the liquidator in the insolvency proceedings (where the employee will rank as a preferential creditor, see below). Three important points should be noted: • In a compulsory liquidation, there is a moratorium (or “stop”) on legal proceedings against the insolvent company. This moratorium would need to be lifted before an employee could bring legal proceedings against the company (e.g. for wrongful dismissal).

39 A statutory demand is a formal written demand for payment of a debt within 21 days. If the does not pay within the 21 days and fails to apply to restrain the creditor from presenting a winding-up petition, the creditor can use the statutory demand as grounds to present a petition to the court for a winding-up order. 15 Commons Library Briefing, 24 April 2020

• A liquidator wishing to retain some employees must enter into new employment contracts (unless they have previously agreed that no termination will take place and employment with the company will continue, with continuity of service being preserved). Debts owed to employees will be the liability of the insolvent company and not of the insolvent practitioner personally.40

2.4 Statutory order of payment of creditors Generally, assets of an insolvent company are collected in and sold, the proceeds used to pay the company’s debts. An insolvency practitioner, whether acting as an administrator or as a liquidator, has an overriding duty to act in the interests of all creditors. Typically, this means maximising returns to creditors. How much creditors will receive will depend on many factors including, the value of company assets and the total number of creditors. Creditors are paid in accordance with a strict order of priority (see Box 1 below), as set out in Schedule 6 of the IA 1986 and the Insolvency (England and Wales) Rules 2016. Each class of creditor must be paid in full before the insolvency practitioner can distribute funds to the next class. In many cases, there is rarely enough money to pay all those owed money. It follows from this that the lower a creditor’s position in the priority order, the less they are likely to receive. It is often the case that the dividend to unsecured creditors is just a few pence in the pound or is nothing at all.

Box 1: Current order of asset distribution in insolvency The current order of distribution is set out in Schedule 6 of the Insolvency Act 1986 and the Insolvency (England and Wales) Rules 2016. Broadly, asset realisations are paid out in the following order:

• Fixed charge holder (also known as a ). Fixed charge holders (often banks and other asset-based lenders), hold security over a specific asset (such as a building, plant, machinery or vehicles etc). When a fixed charge is provided to the lender, the borrower loses the right to sell or trade the item. If the business enters formal insolvency, the fixed charge holder can sell the secured asset to recover payment of the debt.

• Expenses of the liquidation. In addition to the insolvency practitioner’s remuneration, costs are incurred in administering the liquidation. For example, costs and expenses can be incurred when realising assets, distributing funds, providing accounts and reports, and investigating the conduct of directors.

• Preferential creditors. Preferential creditors have unsecured debts which, by statute, are to be paid in priority to all other unsecured debts. They are split into two classes: ordinary preferential creditors and secondary preferential creditors.

40 The exception being the special rules relating to “qualifying liabilities” for administrative receivership (in relation to which the administrative receiver has personal liability) and LPA receivership 16 Employment rights and insolvency

a) Ordinary preferential creditors include employees entitled to arrears of wages, accrued holiday pay, and other statutory payments up to a certain limit. This class also includes deposits that fall within the Financial Services Compensation Scheme (FSCS). The FSCS provides protection for customers of failed financial services firms. b) Secondary preferential creditors, who are only paid once ordinary preferential creditors are paid, currently include those parts of a deposit which do not fall within the protection of the FSCS.

• Prescribed part creditors: The law “ring-fences” a fund that is used by the appointed insolvency practitioner to pay a dividend to non-preferential creditors (i.e. unsecured creditors). The Prescribed Part is calculated as 50% of the first £10,000 available and 20% thereafter up to a maximum of £600,000. In August 2018, the government announced plans to increase the prescribed part cap to £800,000. In August 2018, the Government announced plans to increase the prescribed part to £800,000 (from £600,000).

• Secured creditors with a floating charge over assets. A floating charge holder (usually a bank) takes a floating charge as security for its financial exposure to the company. Unlike a fixed charge, a floating charge does not attach to a specific item of company property. Instead it is a charge on those company assets which are constantly changing (e.g. stock, raw materials, book debts and work in progress). Assets of this type can be traded in the normal course of business. On insolvency (or if the company defaults on the terms of the loan) then the floating charge is said to “crystallise”. At that stage the floating charge is converted to a fixed charge over the assets which it covers at that time.

• Unsecured creditors. Non-preferential unsecured creditors include trade creditors, suppliers, customers, contractors, and some staff claims. Unsecured creditors share equally in any available assets of the company in proportion to the debts due to them. In practice, this is likely to yield, at best, a few pence of every pound the company owes them.

• Shareholders or individuals: in a company insolvency, shareholders are the final group to be paid. They are not entitled to a distribution until all other creditor groups have been paid.

Preferential debts owed to employees It should be apparent from Box 1 that employees of an insolvent company have a degree of preference. As preferential creditors they rank third in the statutory order of priority. They are paid in full after fixed charges and the expenses of the insolvency41 and before holders of floating charges, the “prescribed part,” and all other unsecured creditors. As preferential creditors, employees can claim for: 42 • any arrears of wages (including any commission, overtime or contractual bonuses) for work done in the four months before the date of the insolvency order, up to a maximum of £800 in total;43 • accrued holiday pay of up to 6 weeks (uncapped);44

41 Sections 175, 386 and Schedule 6 of the Insolvency Act 1986 in relation to England and Wales and section 129 of the (Scotland) Act 2016 42 The current categories of preferential debt are listed in Schedule 6 of the Insolvency Act 1986 in respect of England and Wales and for Scotland, Schedule 3 of the Bankruptcy (Scotland) Act 2016 43 Paragraph 9, Schedule 6, Insolvency Act 1986 44 Paragraph 10, Schedule 6, Insolvency Act 1986 17 Commons Library Briefing, 24 April 2020

• pay in lieu of notice and redundancy pay. In addition, employees can claim for any unpaid contributions to occupational pension schemes and state scheme premiums, all within certain limits.45 The amount of pay in lieu of notice and redundancy pay due will be defined in an employee’s contract of employment. Whilst the contractual notice period may be a different period from the statutory notice period, most contracts of employment define redundancy pay to be commensurate with statutory redundancy pay. It is possible for an employee to rank as both a preferential creditor and an ordinary in the same liquidation. This is because debts payable by way of remuneration are treated as preferential only in respect of the whole (or any part of the period of) four months immediately preceding the insolvency and the extent of the preferential debt is capped at £800. It follows from this that an employee will rank as an unsecured creditor in respect of any debt in excess of the £800 cap/four-month period (i.e. the shortfall). If there are insufficient funds from the sale of company assets to pay all that is owed to the employee, he/she may have to submit a claim to the Redundancy Payments Service (RPS). As outlined in section 1 of this paper, the RPS covers payments such as redundancy, salary and holiday pay not recouped from the sale of company assets (up to certain limits). Reform of preferential creditor status after 1 December 2020 Currently, employees are “ordinary” preferential creditors in cases of insolvent liquidation and HM Revenue and Customs (HMRC) is an unsecured creditor in respect of all its debts. However, from 1st December 2020, HMRC will become a “secondary” preferential creditor in respect of certain taxes, namely, those taxes collected by business on their behalf, such as PAYE and VAT. HMRC will, however, remain an unsecured creditor for corporation tax and other taxes owed directly by a company. As HMRC is typically one of the largest creditors in an insolvent liquidation, its new creditor status in respect of some taxes will mean (as from 1 December) that unsecured creditors will recover reduced returns. Further information is provided in a separate Library’s briefing paper, “Insolvency: return of HMRC preferential creditor status” (CBP 8800).

45 Paragraph 8, Schedule 6, Insolvency Act 1986 18 Employment rights and insolvency

3. Large scale redundancies 3.1 Overview Insolvency practitioners, as agents of the insolvent employer, are obliged to adhere to specific statutory requirements in respect of large-scale redundancies of more than 20 employees from a single company. Collective consultation must be undertaken, either with employees or with the union if there is one, otherwise former employees may be entitled to claim monies via employment tribunals (a “protective award”).46

3.2 Collective consultation requirements Under section 188(1) of the Trade Union and Labour Relations (Consolidation) Act 1992 (TULRCA), insolvency practitioners, as agents of the insolvent employer, are obliged to: • notify the Secretary of State in advance (within the specified time limits) of collective redundancy proposals;47 • comply with the requirement to consult when seeking to rescue or wind up a business; and • provide information on how to ensure legal compliance when electing employee representatives (in the absence of existing employee representatives). Specifically, the insolvency practitioner must “collectively consult where they propose to dismiss as redundant 20 or more employees at one establishment within a period of 90 days or less”. This includes compulsory liquidation where the contracts of employment are automatically terminated on the court order being made. Failure to comply with the obligation to “inform and consult” exposes the insolvent employer to pay affected employees a “protective award” of up to 90 days’ uncapped pay. There is a “special circumstances” defence for breach of these obligations, but it is well- established that insolvency is not of itself a special circumstance, although unforeseen circumstances may arise during an insolvency situation.48 It is also possible that an employer’s imminent insolvency may be a mitigating factor when calculating the amount of the protective award. Much would turn on the facts of each case.

3.3 Insolvency Service: a call for evidence In March 2015, the Insolvency Service published a call for evidence on how directors and insolvency practitioners comply, in insolvency, with

46 Protective awards made in respect of redundancies made after the appointment of the insolvency practitioner do not qualify for super priority in an administration and are not paid in priority to an administrator’s expenses. However, protective awards in relation to the period prior to the insolvency are preferential debts and so can be claimed from the insolvent estate (up to the applicable limits) in priority to most employment debts 47 Section 194(3) TULRCA 1992 48 Section 188(7) of TULRCA 1992 19 Commons Library Briefing, 24 April 2020

the requirement under section 188 of the TULRCA to consult employees about large-scale redundancies.49 On 20 November 2015, the Insolvency Service published responses to this call for evidence.50 In May 2018, a further response51 was published announcing a package of non- legislative measures including new guidance, “The Insolvency Service: New guidance to support staff engagement during ”. Going forward, the Insolvency Service has said it may consider additional measures if necessary.

49 Insolvency Service, Collective Redundancy Consultation for Employers facing Insolvency”, March 2015 [online] (accessed 7 April 2020) 50 Insolvency Service, Responses to Call for Evidence: Collective Redundancy Consultation for Employers facing Insolvency” November 2015 [online] (accessed 7 April 2020) 51 Insolvency Service, “Call for Evidence: Collective Redundancy Consultation for Employers Facing Insolvency – Government response”, April 2018 [online] (accessed 7 April 2020)

About the Library The House of Commons Library research service provides MPs and their staff with the impartial briefing and evidence base they need to do their work in scrutinising Government, proposing legislation, and supporting constituents. As well as providing MPs with a confidential service we publish open briefing papers, which are available on the Parliament website. Every effort is made to ensure that the information contained in these publicly available research briefings is correct at the time of publication. Readers should be aware however that briefings are not necessarily updated or otherwise amended to reflect subsequent changes. If you have any comments on our briefings please email [email protected]. Authors are available to discuss the content of this briefing only with Members and their staff. If you have any general questions about the work of the House of Commons you can email [email protected]. Disclaimer This information is provided to Members of Parliament in support of their parliamentary duties. It is a general briefing only and should not be relied on as a substitute for specific advice. The House of Commons or the author(s) shall not be liable for any errors or omissions, or for any loss or damage of any kind arising from its use, and may remove, vary or amend any information at any time without prior notice. The House of Commons accepts no responsibility for any references or links to, BRIEFING PAPER or the content of, information maintained by third parties. This information is Number 0651 provided subject to the conditions of the Open Parliament Licence. 24 April 2020