Employment contracts of employees furloughed prior to the commencement of administration are adopted by administrators if they keep the employees in the scheme (Re Debenhams Retail Limited)

Dispute Resolution analysis: This case confirms that the contracts of furloughed employees are adopted by administrators of companies pursuant to paragraph 99(5) of Schedule B1 to the Insolvency Act 1986 if those employees are kept in the furlough scheme even where those employees were furloughed before the administration commenced. The administrators are thereby liable to pay the shortfall between the 80% reimbursed under the scheme and the sums due under the employment contract and these wages enjoy a super priority in the administration.

In the matter of Debenhams Retail Limited [2020] EWHC 921 (Ch)

What are the practical implications of this case?

This case demonstrates a number of potential problems and even perverse incentives which arise from the relationship between the Government’s attempts to protect the economy and companies from the restrictions imposed during the COVID-19 pandemic and the existing insolvency legislation. Trower J concluded that if employees are kept furloughed by the administrators after their appointment, the administrators are taken to have adopted the employment contracts. This makes the company liable for the shortfall between the sums reimbursed under the scheme and the salary payments due in the employment contract. In some cases, this shortfall may be very significant. In this case, it meant a liability to the company of around £3 million per month and perversely may have fatally undermined the administrators’ ability to rescue the business. Once the details of the furlough scheme are made into law, efforts may be made to mitigate this effect which appears essentially at odds with the underlying purpose of the scheme.

What was the background?

The administrators applied to the High Court for directions in relation to the question of whether contracts of employees who had been furloughed pursuant to the Government’s Coronavirus Job Retention Scheme (“JRS”) prior to their appointment would be adopted by the administrators under paragraph 99(5) of Schedule B1 to the Insolvency Act 1986 if they took no further action in relation to them, save for the payment to those employees of sums to be reimbursed to the Company under the JRS. It was accepted that if the contracts had been adopted, the wages of the employees would enjoy a super priority in the administration. The joint administrators argued that the contracts had not been adopted and asserted that a finding against them would have a serious impact upon the ability to rescue the business through the administration. The application for directions was heard on an urgent basis, without a named Respondent or submissions adverse to those of the administrators two days after Snowden J had considered a similar (though by no means identical) application from the administrators of the restaurant chain, Carluccio’s (Re Carluccio’s [2020] EWHC 886 (Ch)).

What did the court decide?

At the urgent hearing, Trower J indicated that he would not give the directions sought by the administrators. Instead, he directed that the administrators would 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 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.

In a written judgment handed down two days later, Trower J explained that whilst he was sympathetic to the position of the administrators and appreciated the impact which the adoption of the employment contracts might have on the ability to rescue the business of the company, he had little hesitation in endorsing the reasoning of Snowden J in Re Carluccio’s. The adoption thereby further burdened the Company with liability to pay the shortfall between the 80% (subject to cap) reimbursed under the scheme and the sums due under the employment contract. These wages enjoy a super priority in the administration.

Case details

• Court: High Court, Business and Property Courts, Insolvency and Companies List (ChD)
• Judge: Mr Justice Trower
• Date of judgment: 17 April 2020

This article was first published by Lexis PSL on 21 April 2020.