The story continues: Debenhams and the application of furlough schemes to companies in administration

In a judgment handed down by the Court of Appeal on 6 May, an appeal by the joint administrators of Debenhams Retail Ltd has been dismissed.

On 15 April 2020, the joint administrators of Debenhams Retail Ltd made an application for directions to Mr Justice Trower on the COVID-19 furlough scheme. In particular, they sought clarification on whether their furloughed employee contracts would be deemed ‘adopted’ if the employees remained furloughed and no further action was taken in relation to these employees, save for paying all amounts due via the scheme.

In line with the Carluccio’s decision, Mr Justice Trower found that the joint administrators had adopted the furloughed employee contracts. They appealed the decision, which was heard by the Court of Appeal on 24 April 2020. On 6 May judgment was handed down and the appeal was dismissed. 

Furlough prior to administration

The company is part of a group which operates 142 department stores in the UK and is the largest such retailer in the country. Prior to the COVID-19 pandemic the Group was experiencing financial difficulties. This led to the holding company of the Group (Debenhams Plc) entering administration in April 2019.

Between 25 March and 9 April 2020, the company wrote to just under 14,000 employees informing them that they were being furloughed until further notice with effect from the following day. Employees were informed that they would not receive any pay above that payable under the furlough scheme.

Joint administrators were appointed by the company directors on 9 April 2020. They considered that retaining the company workforce would help to ensure the viability of the business and future continued trading of the company. However, the employees had not been asked by their employer if they consented to the furlough scheme arrangements.

The joint administrators therefore sought such consent from the furloughed employees to avoid any doubt as to their agreement to all terms and received over 12,700 consents.

Joint administrators’ concerns

The joint administrators intended to pay each furloughed employee 80% of their salary up to the £2,500 monthly cap from the company’s cash reserves on the basis that the company would then be reimbursed via the furlough scheme. However, they were concerned they would be deemed to have “adopted” the relevant employment contracts as a result of this course of action. In those circumstances, super priority would apply to employee wages/sick pay and all benefits over and above the amounts reimbursed to the company via the furlough scheme.

The potential extent of the 20% shortfall which could be payable as a super priority administration expense was estimated to be over £3 million a month. Additionally, many of these costs would be payable ahead of the majority of the costs and expenses of the administration itself. Accordingly, the joint administrators considered they may have no alternative but to dismiss the furloughed employees.

They were also concerned that this would have an adverse impact on the rescue culture underlying the administration regime.

High Court finding of adoption

Mr Justice Trower disagreed with the joint administrator’s arguments, especially the argument that the scheme could not be applied in a manner consistent with Paragraph 99. In finding that the joint administrators had adopted the employee contracts, Mr Justice Trower:

  1. Determined that the joint administrators will be engaging in “positive conduct” which presupposes that the furloughed employee contracts continue to exist
  2. Disagreed that the absence of services being provided under the employment contract was of itself good reason why those contracts should not be treated as being adopted
  3. Considered it appropriate to identify Paragraph 99 as the source of the obligation to pay wages as a super priority administration expense
  4. Considered that the acts of participation and payment (in relation to the furlough scheme) were consistent not just with the joint administrators treating the contracts of employment as continuing but also with the company in administration having continuing liabilities under them. Those liabilities are entitled to the super priority payment status for which Paragraph 99 (5) provides.

Appeal issues and outcome

The key issue addressed (as confirmed in the Court of Appeal authority of Re Paramount Airways Ltd [1995]) was whether the administrator has “continued” the employment of the relevant employees. If so, super-priority payment status for the liabilities would be due under the contracts of employment. By contrast, doing nothing involves no continuation by the administrators of the employment.

The Court of Appeal found that the joint administrators had “continued” the employment of the furloughed employees for the following reasons:-

  • The joint administrators will continue to pay wages/salaries of the furloughed employees up to the furlough scheme cap;
  • The furloughed employees who have agreed to continue their employment on these revised terms will remain bound by their contracts of employment (save for the obligation to be available for work during the furlough);
  • In continuing to pay the furloughed employees, the joint administrators are acting with the objective of rescuing the company as a going concern.

The appeal court was also satisfied that the joint administrators had adopted the furloughed employee contracts for the purposes of Paragraph 99. It therefore dismissed the appeal.

Comment

The appeal court also addressed the potential financial impact of the adoption. Due to the terms agreed with the vast majority of the company’s employees (as outlined above), it determined that wages or salary in excess of the amounts payable under the furlough scheme would not enjoy super-priority payment status.

However, entitlements to full holiday pay may enjoy super-priority payment status. If that applies here, over a three month period, the excess holiday pay not covered under the furlough scheme would amount to some £1.28 million.

The judgment will leave administrators facing a hard decision. Should employees be retained after the initial 14 day appointment period if substantive super priority payments may arise and cannot be met by the administration estate?

This surely undermines the rescue culture intended not only by the furlough scheme, but the intended purpose of many administrations, where the objective is to seek to rescue the business as a going concern.

The judgment concluded that “.. there may be good policy reasons for excluding action restricted to implementation of the Scheme from the scope of “adoption” under Paragraph 99 but noted that such exclusion cannot be accommodated under the law as it stands.”

The message to the government is clear. Either the terms of the furlough scheme itself needs to be clarified and/or emergency legislative changes need to be put in place to address these super-priority payment issues.

It was notable that no representative of government attended the appeal hearing to address any of these issues. It will be interesting to see whether government will now take action in this regard in light of this further judgment.

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