Landmark Holiday Pay Decision

As reported in our earlier briefing on 5 November 2014, the Employment Appeal Tribunal ("EAT") gave a very significant ruling regarding how holiday pay should be calculated for workers.  

Whilst the case gives some guidance regarding how holiday pay should be calculated, some key issues remain unresolved.  This means that employers may still face uncertainty about what they should do now to stay on the right side of the law and to head off potential claims from employees and other workers.

1. What were the facts of this case?

This case was an appeal to the EAT by three employers, all of whom had had judgments against them in the Employment Tribunal about how they had calculated holiday pay for their employees.  

Bear Scotland, which carries out road construction and the maintenance of Scottish roads, was appealing a decision by an Employment Judge in Glasgow who had ruled that they had made unlawful deductions from wages by failing to include overtime and other payments associated with their work when calculating the holiday pay owed to them.   

In the other two cases, Hertel (UK) Limited and Amec Group Limited were appealing a separate decision where an Employment Judge had ruled that they had made unlawful deductions from wages when they failed to include overtime in calculating their holiday pay. There was also an issue regard how their payment in lieu of notice was calculated on the termination of their employment.

As the cases dealt with the same central issues, they were heard together by the EAT during the summer.  Given the importance of the issues under discussion, the Secretary of State for Business, Innovation and Skills intervened in support of the arguments being put forward by the employers.

The Employees’ case

The employees argued that overtime payments had not been included in the calculation of the holiday pay they received, despite the fact that they worked overtime consistently.  This meant they received less pay when they were on holiday than they would have done had they been at work for the same period.  

In relation to Hertel and Amec, the overtime in dispute was overtime which the EAT described as “non-guaranteed”.   In other words, although there was no obligation to provide any overtime to the employees (and as such, it wasn’t “guaranteed”), if it was provided, the employees had a contractual obligation to work it.  (As such, the EAT distinguished it from truly “voluntary” overtime.)   In short, the employer wasn’t obliged to make overtime available but if it did the employee had to carry it out.

2.    What were the issues under appeal?

The appeal dealt with three main issues:

  • What constitutes “pay” during a period of annual leave under European law?
  • Could the Working Time Regulations ("the Regulations") be interpreted consistently with this?
  • If workers had been underpaid their holiday pay, how far back could their claims go?   

Issue 1 - How should pay be calculated?

The employers argued that holiday pay shouldn’t include any overtime payments made to these workers.  

The basic premise of their argument was that Article 7 of the Working Time Directive (which is the EU legislation from which the Regulations derive) doesn’t require holiday pay to be calculated as an average of the pay actually received by employees; instead payments should only be included if they were “intrinsically linked” to the work the employees were doing.  In practical terms, the employers said that including overtime payments would actually create an incentive for employees to work additional hours, because they would not only receive additional pay for the hours that they worked but also in relation to any subsequent holidays which they took.  They argued that this is in direct contravention of the general principle for ensuring workers’ health and safety at work.

The employees argued that there was clear European case law that meant that the courts had to apply a wide definition to “normal remuneration” to include not only basic salary but also any additional benefits (whether payable directly or indirectly) arising out of employment.  They cited recent European cases where “normal remuneration” had been calculated to include not only basic pay but also supplementary payments (for example the allowances for pilots that had been included in the Williams case and commission, which had been included in the Lock case).

Judge Langstaff sitting in the EAT reached the conclusion that it was quite clear that “normal pay” is that which is “normally received” by the employee.  He was clear that employees should not be at a disadvantage for taking holiday; employees should therefore be paid holiday pay so that they are put in the same position as if they had been at work during the same period.  

However, he did identify that there is a “time element” for identifying what is “normally” received by the employee.   He said that payments had to be made for a sufficient period of time to justify the label “normal”.   In this case, however, the employees’ working patterns were “settled” and did not vary and therefore he had no difficulties in identifying what was “normal” pay for the purposes of the European Directive.  

In the Hertel and Amec cases overtime was compulsory (although not guaranteed by the employers) and the EAT was satisfied that it was required regularly enough for it to be included in an assessment of what employees normally received.  The EAT therefore ruled that the Directive required the “non-guaranteed” overtime payments to be taken into account when calculating workers’ holiday pay.  

Issue 2 – What does this mean for the Regulations?

The Judge then went on to consider the Regulations.

He noted that it is a general principle of English law that national legislation must be interpreted in light of any European Directives (as far as possible) to achieve the purpose of the Directive.  Under the Regulations a “week’s pay” is calculated using the definition found in the Employment Rights Act 1996 (the “ERA”) as basic pay and nothing more. The Judge ruled that this is inconsistent with the way in which “normal remuneration” should be interpreted under the European Directive.  However, he held that the Regulations could be interpreted consistently with the Directive by simply dis-applying the provisions in the ERA.  The Judge argued that the intention of Parliament when it implemented the Working Time Regulations had been to fulfil its obligation under the Directives.  He said that “If, seen through a modern lens, the words do not achieve that, then to adopt a conforming interpretation is not doing violence to the intention of Parliament but instead respecting it”.  

However, he was clear that this re-writing of the Regulations only applied to the holiday rights that workers have gained as a result of the European Directive i.e. the basic four week leave period to which employees are entitled under Regulation 13 of the Regulations.  It did not apply in respect of the additional 1.6 weeks’ annual leave under Regulation 13(A) of the Working Time Regulations.  This additional period of annual leave was entirely a matter of domestic law and therefore how pay should be calculated in respect of that period was a matter for Parliament and Parliament alone.  As such, pay during this period would be calculated in accordance with the provisions of the ERA (and would therefore be limited to basic salary only).

The employers had argued that this interpretation couldn’t be right on the basis that it would create a dichotomy of rights depending on whether a particular period of holiday was being taken under Regulation 13 or Regulation 13(A) of the Working Time Regulations.  They argued that this would create serious practical consequences which could not be ignored.  The Judge acknowledged this point and the potential confusion that this might cause going forward.  However, this was a matter for Parliament to consider.

Issue 3 - Has there been a “series of deductions”?

The employees argued that the sums they should have received in holiday pay had been unlawfully deducted from them and that they could bring a complaint linking the underpayments as a “series of deductions”.   The Judge agreed that this was a possible claim open to them and therefore went on to look at what this claim would involve.

Firstly, he said that whether there had been a series of deductions was a question of fact.  He said there must be a sufficient similarity of subject matter so that each deduction is factually linked with the next.  However, he also accepted the employers’ submissions that there was also a time element to the series of deductions.  Under the normal principles for bringing a claim for unlawful deduction from wages, a claimant has a three month period to bring a claim in respect of any single deduction.  When applying this to a “series of deductions”, the Judge stated that where there is a gap of more than three months in any series, the chain is broken and an employee cannot bring a claim.  He said that “any series punctuated from the next succeeding series by a gap of more than three months is one in respect of which the passage of time has extinguished the jurisdiction to consider a complaint that it was unpaid”.  In other words, he argued that if three months was the appropriate time limit to bring a single claim it could not have been Parliament’s intention to link deductions as a “series” where there was more than three months between them.  

3. Will the case be appealed?

The Judge gave leave for the employers to appeal against his decision in relation to all of the points on which they lost.  However, he said that he did not think that an appeal on the first two points had any reasonable prospect of success.  He recognised that an appeal in relation to the third point was “arguable” and of “public importance”.  We await confirmation as to whether any appeal will be lodged.

4. What does this mean for employers?

With approximately five million staff in the UK currently receiving overtime payments, this case has been described as a “time bomb” by the Institute of Directors.  The EEF has said that more than 90% of its members can expect their payroll costs to “spiral” as a result of the ruling.  Two thirds of its members estimate that the change will result in a 3% increase to their pay roll costs whilst two out of five anticipate a 5% increase.

In the meantime, the Secretary of State for Business Innovation and Skills has announced a taskforce to review the judgment in detail as a matter of urgency and to assist employers with understanding the financial exposure they may face.

5. What should employers be doing now to protect themselves from the implications of this case?

Employers need to review their holiday pay arrangements as a matter of urgency to determine whether payments are being made in accordance with the principles set out in this new ruling.  They also need to consider how to go about quantifying (and limiting) any historic and ongoing liabilities as a result of failing to make these payments properly.

However, this will not be an easy task as there remain many grey areas unresolved by this judgment for example:

  • What is the status of truly “voluntary” overtime?
  • How should employers be calculating holiday pay entitlements where overtime arrangements fluctuate, for example to meet seasonal demand?
  • What about other types of allowances/benefits: which should be included when calculating holiday pay and which should not?
  • Should employers be distinguishing between different “types” of annual leave?

For a fixed fee, we can provide you with a review of your current holiday pay arrangements, identify any legal risks and make recommendations about what action to take as a result of this case.

For further information, please contact any member of the Employment team:

Gareth Roberts, Partner, Head of Department - 0161 833 8402/
Laura Darnley, Associate - 0161 833 8461/
Jennifer Platt, Associate - 0161 833 8425/
Chloe Leyland, Solicitor - 0161 833 8423/