COVID-19 - Court of Appeal Rules on Status of Furloughed Employees

Many companies have entered administration in response to the COVID-19 crisis but have retained furloughed employees in the hope that they will emerge from lockdown to a brighter future. In a case which will have major consequences for vast numbers of such workers, the Court of Appeal has ruled on the legal consequences of such arrangements (In the Matter of Debenhams Retail Ltd (In Administration) v Rowley and Another).

The case concerned a high street retailer which appointed administrators and furloughed over 13,000 employees. Almost all of them accepted an effective pay cut, in that they would only receive 80 per cent of their wages, up to a maximum of £2,500 a month, in accordance with the government's furlough scheme. Their incomes would not be topped up by the administrators.

That gave rise to an issue as to whether the administrators had adopted the workers' employment contracts. The effect of such an adoption would ordinarily be that wages and salaries, together with some other amounts such as sick and holiday pay, would be payable as expenses of the administration. Satisfaction of those liabilities would thus take priority over the demands of unsecured creditors and many of the costs and expenses of the administration.

Following a hearing, a judge declined to make a final declaration as to whether the employment contracts had been adopted. However, he ruled that that was likely to be the case and authorised the administrators to act accordingly. The decision was of practical assistance to the administrators, in that it enabled them to proceed on the basis that adoption had occurred without fear of incurring personal liability to creditors and others for doing so.

In challenging the judge's ruling, the administrators pointed out that the employees were not providing, and were not permitted to provide, any services to the company whilst they were furloughed. Their remuneration was limited to the extent of available government funding and the retailer was merely acting as a conduit for that funding. Although it was hoped that the retailer would continue as a going concern when the lockdown was lifted, a decision could not be made as to whether to keep on the employees until after the furlough scheme ended.

Giving a definitive answer to the issue and dismissing the appeal, the Court found that the administrators had clearly adopted the contracts of the furloughed employees. Sums that they received under the scheme would be paid to them by the retailer and their entitlement to them derived exclusively from their employment contracts. They remained bound by their contracts, save that they were not obliged to be available for work during the furlough period, and they would be required to return to work when the retailer reopened its stores.

The tax position of both employees and retailer also indicated that the contracts had been adopted. Money that the employees received under the scheme would be subject to Income Tax which would be deducted at source under the PAYE system in the ordinary way. Such remuneration would be treated as an expense of the retailer's trade and payments that it received from the government under the scheme would be chargeable to Corporation Tax.

The Court noted that, given the agreement of the vast majority of the employees to accept part-payment of their wages whilst they are on furlough, the financial impact of its ruling on the retailer would be modest. It accepted that there might be good policy reasons why the administrators should not be taken to have adopted the employment contracts. However, such an outcome could not be accommodated under the law as it stands.