When furlough meets administration
11 May 2020
The current global health emergency has brought with it unprecedented legal issues of far-reaching practical and financial effect for both insolvency practitioners acting as administrators and employees of insolvent companies. The judgment of Snowden J in the matter of Carluccio’s Limited (in administration)  EWHC 886 (Ch) on directions, sought urgently by the administrators of Carluccio’s (the administrators), in respect of furlough arrangements with employees provides reassuring clarity and direction in uncertain times. The hearing itself took place by remote video hearing. At , Snowden J stated:
‘Accordingly, I considered that the court should do what it could to give a view of legal issues to assist the administrators. The COVID-19 pandemic is a critical situation that carries serious risks to the economy and jobs in addition to the obvious dangers to health. I think that it is right that, wherever possible, the courts should work constructively together with the insolvency profession to implement the government’s unprecedented response to the crisis in a similarly innovative manner.’
The urgency arose due to the 14-day period of grace under paragraph 99(5)(a) of schedule B1 of the Insolvency Act 1986 (the Act). Action taken within the period of 14 days after an administrator’s appointment shall not be taken to amount or contribute to the adoption of a contract. If an employment contract is ‘adopted’ by a former administrator, it attracts super-priority over (a) a former administrator’s remuneration and expenses and (b) over a floating charge, under paragraph 99(3) and (4) of schedule B1 of the Insolvency Act 1986.
Two key issues arose in Carluccio’s:
- How could the administrators lawfully give effect to furlough arrangements with employees who had agreed to vary their contract of employment by going on furlough leave and accepting a reduction in their contractual pay?
- Whether the administrators would be able to avoid incurring liabilities by adoption of the unvaried contracts of employees who had not responded to the letter from the administrators regarding the furlough scheme, so that they were not forced to make all those employees redundant before the end of the first 14 days of the administration?
Carluccio’s, which operates a chain of Italian restaurants, has over 70 branches and around 2,000 employees. As a result of the COVID-19 outbreak, all of the company’s branches have been closed since 16 March 2020. An administration order was made on 30 March 2020. In the absence of sufficient funds to pay the continuing wages of its employees, unless the company could take advantage of the coronavirus job retention scheme and limit its liability for wages to the amount that it would be able to obtain under the scheme, the administrators would be forced to make the workforce redundant.
Shortly after their appointment, the administrators wrote to the company’s employees and offered to continue to employ them on varied terms so as to take advantage of the scheme. The letter sought the agreement of the employees to the terms of the letter and to go on furlough leave. There were three categories of response: those employees who accepted the offer (consenting employees), those who indicated they would prefer to be made redundant and retire (objecting employees”), and those who had not yet responded (non-responding employees).
Although the government has published online guidance see here, no detail has been provided as to how the scheme is intended to operate consistently with the insolvency legislation. The administrators therefore sought a number of determinations of questions of law, which would assure them that if they act on the basis of those determinations they could not be accused of having acted inappropriately in dealing with the employees and making applications under the scheme.
There was also evidence before the court that the administrators had received several expressions of interest in respect of some or all of the company’s business such that they took the view that there was a reasonable likelihood of achieving a sale of the business. The administrators had considered the scheme guidance, which states that the expectation was that an administrator would only access the scheme if ‘there is a reasonable likelihood of rehiring the workers’ and believed that the scheme ought to be available to the company in respect of furloughed employees.
Three possible legal routes were considered:
- A trust of grant monies (see eg Barclays Bank v Quistclose Investments Limited  AC 567). However, the relevant scheme guidance did not distinguish on this issue between companies in administration and solvent companies. Moreover, the administrators were required to make their decision before the legislation and regulations giving effect to the scheme were drafted and published.
- Making a payment under the powers in paragraph 66 of schedule B1 of the Act. However, by contrast with paragraph 99, paragraph 66 is in general terms (compare Re Allders Department Stores  ICR 867 at ).
- Paragraph 99(5) of schedule B1 of the Act. At , Snowden J stated that paragraph 99(5) ‘should be interpreted to permit the scheme to be given effect, and thus support the rescue culture and the government’s efforts to deal with the economic consequences of the COVID-19 pandemic.’
The decision focuses on paragraph 99(5), while Snowden J notes at  that paragraph 66 of schedule B1 of the Act might be an appropriate way for the administrators to fill any gaps or deal on an ad hoc basis with particular issues of detail that might arise in relation to the implementation of the Scheme.
Having considered the decision of Lord Browne-Wilkinson in the leading case of Powdrill v. Watson & Anor (Paramount Airways Ltd) 1995] 2 AC 394 (Paramount) in detail, in particular the distinction between termination, continuation and adoption of a contract of employment, Snowden J held:
1 - In respect of the consenting employees:
- ‘as and when the administrators make an application under the scheme in respect of the consenting employees or make any payment to the employees under their varied contracts, this would amount to adoption of the varied contracts of employment. Alternatively, although this is not anticipated, if funds were unexpectedly to become available to the administrators to make payments of wages to the furloughed employees prior to the receipt of monies from the scheme, that too would amount to adoption of the varied contract’ (at ); and
- ‘such steps would enable super-priority payments to be made to the furloughed employees under paragraph 99(5) using the grant monies as and when received under the scheme; or in the alternative would enable payments to the employees to be made from other funds of the company, which would be reimbursed when the grant money was paid’ (at ).
- On the particular facts of the case, the inclusion of wording in the relevant letter to the effect that the administrators ‘will not be adopting, and will not at any future date adopt, your contract of employment’ was a mistake and did not detract from the conclusion that the contracts of employment of the consenting employees will be adopted under paragraph 99(5) of schedule B1 of the Act (at  – ).
2 - ‘The contracts of employment of the objecting employees will not either be varied or adopted by the administrators, but will be terminated and the employees in question will be made redundant’ (at ).
3 - A number of permutations arose in respect of the non-responding employees.
- If there was no change prior to the expiry of 14 days into administration, ‘I consider that applying the principles set out by Lord Browne-Wilkinson in Paramount that I have explained above, the administrators will not be treated as having adopted the unvaried contracts of employment of the non-responding employees by the mere failure to terminate those contracts prior to the expiry of the 14-day period. Moreover, although the unvaried contracts will continue in existence, the employees cannot attend for work, and there will be nothing done or said by the administrators that could amount to an election to treat those unvaried contracts as giving rise to super-priority liabilities in the administration. This is the crucial analysis that will enable the administrators to avoid having to take the precaution of dismissing the non-responding Employees prior to the expiry of 14 days into the administration’ (at ).
- Belated ‘acceptance of the variation letter after the expiry of 14 days will simply put the relevant employee into the same position as regards adoption as those who accepted the variation prior to the expiry of the 14 day period’ (at ).
- ‘Non-responding employees who continue not to respond to the variation letter will simply continue to be employed by the company on the terms of their unvaried contract unless and until it is terminated, but they will merely be an unsecured creditor in the administration in respect of any claim under the contract’ (at ).
Snowden J also considered whether the administrators were under a duty to apply under the scheme in respect of any of the employees to whom the letter was sent. An indication was given at  that the administrators would be under no such duty, ‘other than in respect of consenting employees or others who have agreed to the variation in their contracts in accordance with the variation letter.’
Ultimately, the conclusions reached ‘enable the administrators to proceed to implement their proposals for furloughing most of the employees of the company without fear that they will be criticised in the future for acting inappropriately’ (at ).
Administrators, employees and their advisers are currently operating in a fast-moving and often untested legal landscape that requires practical and often creative solutions within the existing legal framework. While the court is not there to act as ‘a bomb shelter’ for administrators (re T&D Industries plc  1 WLR 646, 657 per Neuberger J), there are undoubtedly further urgent and unprecedented issues arising for insolvency practitioners nationwide in the current COVID-19 crisis that will be appropriate for urgent applications for directions by remote hearing.