TUPE Law: Insolvency, TUPE and managing employment risks

This ThinkHouse TUPE Club Q&A deals with our Top 10 questions on:

• the key employment issues in Administrations and Liquidations; and
• how TUPE applies when there is an insolvency situation.

Q1. What is the effect of insolvency on contracts of employment?

There are various types of insolvency proceedings and these are designed to achieve various different end results. The different types of insolvency also have different consequences for the entity and employees.

Administration

There is no immediate effect on the employees. The Administrator is an agent of the company, so the identity of the employer has not changed and the contracts of employment just continue. They are not automatically terminated.

Where the Administrator retains the employees, after 14 days the Administrator will be deemed to have automatically "adopted" their contracts of employment on their existing terms and conditions (unless the contracts are re-negotiated and this is not a sham).

If the contracts are "adopted" by the Administrator, the contract of employment simply continues with the company but 'adoption' is important because it determines how employees' claims are ranked against other debts of the insolvent company.

Once an Administrator adopts the employment contracts, certain "qualifying liabilities" incurred after the adoption of the contract have "super priority". Super priority means that certain qualifying liabilities will be paid in priority to:

• outstanding claims for the Administrators' fees and expenses; and
• floating charges and unsecured creditors.

The "qualifying liabilities" are restricted to payments of debts or liabilities arising out of the employment contract and are limited to wages and salary (for the period after appointment) and include holiday pay, sick pay, pay in lieu of holiday and pension contributions. However, not all payments count as qualifying liabilities, for example, a statutory redundancy payment, payment in lieu of notice, a protective award and damages for wrongful dismissal.

Compulsory Liquidation

The employees' contracts of employment automatically terminate on the appointment of the liquidator/court receiver because the identity of the employer is deemed to have changed.

However, eligible employees are entitled to eight weeks' pay and pay in lieu of untaken holiday, a statutory redundancy payment and potentially a protective award for failure to collectively inform and consult for redundancy.

Q2. What protection do employees have?

The majority of debts owed to employees are unsecured and rank second to last in the order of priority set out in the Insolvency Act on a realisation of assets.

Employees whose unsecured claims are accepted by the insolvency practitioner will be entitled to a share of the funds available to the insolvent company's creditors that is proportionate to the amount of their claim. In practice, unsecured creditors are only likely to recover a few pence in every pound that the company owes them.

However, there are two limited protections for employees in an insolvency situation. These protections are not extensive and are more akin to a safety net rather than covering all of the losses and claims an employee may have.

The NIF guarantees a minimum base payment of specified debts (some arrears of pay, a statutory notice payment, a statutory redundancy payment, some pensions payments and some holiday payments, a basic award for unfair dismissal in some circumstances) owed to employees provided certain conditions are met (including that the employee must be entitled to the relevant debt on the appropriate date).

1. The first protection is for "preferential debts".
   
   Employees are entitled to a limited amount of "remuneration" as a preferential debt. Preferential debts must be paid in full in priority to all other debts after debts owed to secured creditors and the expenses of the winding up.
   
   "Remuneration" is a defined term and capped at specified amounts. It can fall into two categories:
   • Remuneration owed in respect of the whole or part of the four months prior to the relevant date (capped at a maximum of £800 per employee per claim).
   • Amounts owed by way of accrued holiday pay before the relevant date (unlimited).
   Remuneration would include contractual commission, contractual overtime and contractual bonuses, but it would not include other claims such as a statutory redundancy payment or unfair dismissal awards.
2. The second protection is the National Insurance Fund ("NIF").
   
   This guarantee applies regardless of the types of insolvency procedure or whether the debt is preferential or unsecured.

Q3. How do redundant employees of an insolvent business get a redundancy payment?

An employee with two years' continuous service who is made redundant will be entitled to a redundancy payment. Where an employer is insolvent and does not pay the statutory redundancy payment to the employee, the employee can claim it from the NIF.

However, the employee must have made a written claim to the employer or make a claim to the Employment Tribunal within six months of dismissal. The conditions for payment are that the employee must be eligible to claim a redundancy payment, the company must be liable to pay it and the employee must take all reasonable steps (but not necessarily legal proceedings) to obtain payment from the employer.

Q4. What about the unprotected amounts owed to employees?

Any claims in excess of the limits for the NIF must be claimed from the insolvent employer in the usual way and will be unsecured debts.

These could be claims for notice pay above the statutory minimum or the compensatory award for unfair dismissal.

All creditors, including employees, share any remaining amount, in accordance with the proportion of their claims.

If there is a transfer under the Transfer of Undertakings (Protection of Employment) Regulations 2006, where the insolvency proceedings are classed as "non terminal" (see Q8 below), liability for unpaid sums in excess of the protected amounts will transfer to the transferee.

Employees usually make claims against the Insolvency Service, the insolvent employer and any potential transferee to maximise the chance of recouping some of the debt owed to them.

Q5. Can employees bring tribunal claims against an insolvent business?

Administration

All claims are stayed as there is a moratorium on legal proceedings. No claims can continue or be brought without either the consent of the Administrator or the permission of the court.

However, the Administrator can agree to proceedings continuing and it may be in the interests of the Administration to do so, for example, to avoid the costs of a successful application for a court order by the employee.

Liquidation

There is also a moratorium on legal proceedings in a Liquidation. However, claims cannot be brought or continued without the leave of the court.

Q6. What about collective consultation for redundancy?

Where 20 or more redundancies are proposed at one establishment within a 90 day period, there is an obligation on the employer to inform and consult with appropriate representatives. Failure to do so may result in a protective award and the maximum award is 90 days' gross pay per employee.

There is a "special circumstances" defence for failure to inform and consult for collective redundancy purposes but it is very narrow and difficult to demonstrate, even in an insolvency situation. Insolvency is not, of itself, a special circumstance. In any case, even if there is a special circumstance defence, there is a duty on the employer to take all such steps as are reasonably practicable in the circumstances to comply with the duty.

It is a criminal offence not to submit a HR1 form notifying the Secretary of State of the proposed redundancies at the appropriate time before the dismissals. Recent high profile prosecutions for breach of this duty have highlighted the importance of this requirement. However, criminal liability does not pass under TUPE and would remain with the transferor.

Q7. What incentive is there for an insolvent business to comply with the redundancy collective consultation duties?

If an Insolvency Practitioner breaches the duty to inform and consult in a large scale redundancy situation (20 or more proposed at one establishment within 90 days), this could result in a liability for a protective award for the company.

In practice, there is often insufficient time to carry out a proper information and consultation process with appropriate representatives. If a protective award is made, then employees can claim any unpaid protective award (up to statutory limits) from the NIF.

If there is a sale of the business, there are potential risks for the Buyer as they may pick up liability for the protective award. Therefore, reducing the financial risk of a claim for a protective award may make the business more attractive to the Buyer. A Buyer may be more easily found, at the best possible purchase price, potentially ensuring a better return to creditors.

Compliance, even complying as much as possible given the timescales, could reduce the risk of claims from employees, saving time and cost.

Protective awards can also be preferential debts in certain circumstances.

Q8. Does TUPE apply to an insolvency?

TUPE applies to an insolvency situation but the extent to which it applies depends on whether the insolvency proceedings are 'terminal' or 'non terminal'.

"Terminal" proceedings

Terminal proceedings are defined as bankruptcy proceedings or any analogous insolvency proceedings instituted with a view to the liquidation of the assets under the supervision of an insolvency practitioner.

In terminal proceedings, there is no automatic transfer of employees. This means a Buyer can cherry pick staff without incurring liabilities for those who do not transfer. A Buyer can also employ transferring employees on their own terms and conditions as there is no requirement to maintain existing terms and conditions of employment.

Technically, other provisions of TUPE apply, such as the requirement on the outgoing employer to provide employee liability information and the requirement to inform and consult. In a Compulsory Liquidation, usually most employees are dismissed automatically on the appointment of the liquidator which makes consultation unrealistic in a practical sense.

"Non terminal" proceedings

Non terminal proceedings are relevant insolvency proceedings which have been opened without a view to the liquidation of the assets of the transfer.

Government guidance suggests that this will include a number of different insolvency procedures, including Administration and a 'pre pack' (where there is an immediate sale of the business on appointment of the Administrators).

In non terminal proceedings, TUPE applies, but with some limited changes.

Employees will retain most TUPE protection and there is an automatic transfer of assigned employees. There is a requirement on the transferor to provide employee liability information and the obligations on the transferor and transferee to inform and consult will still apply. There will be a transfer of most pre-existing employee liabilities to the transferee, however, there are a few, limited exceptions.

1. Some outstanding liabilities (those amounts that the employees have a right to claim from the NIF) will not transfer to the transferee and can be claimed by the employee separately from the NIF. Those claims are taken over by the government and the debts remain with the transferor.
2. If certain conditions are satisfied, the transferor or the transferee can agree permitted variations to terms and conditions of employment of assigned employees.

Where TUPE is relaxed to permit some flexibility in changing terms and conditions of employment, the reason for any changes must be to safeguard employment opportunities by ensuring the survival of the business, there has to be consent from appropriate representatives, not individuals, and there are extra requirements if non trade union representatives are used.

These conditions limit the value of this relaxation in practice and employers may remain uncertain as to whether any changes were valid.

Q9. What risks are there for a potential Buyer in an Administration?

A Buyer of an insolvent business will usually face increased risk. Initially, the Buyer must assess whether there is a relevant transfer under TUPE and, if so, whether the insolvency procedure is terminal or non terminal. In an Administration (non terminal procedure), it is important to consider that:

1. the process may be very fast paced and confidentiality may be important;
2. it is unlikely that there will be a full due diligence process;
3. TUPE requires the outgoing employer to provide employee liability information, but there is no effective enforcement mechanism in an insolvency situation if this is breached or the information is incomplete or incorrect;
4. if TUPE applies, all assigned employees will transfer to the Buyer (or a new provider of the services). In some cases, the question of who is assigned to the business (or the services) is relevant, yet it is more difficult to assess in light of limited information;
5. amounts that the assigned employees can claim from the NIF will not transfer but other liabilities connected with those employees (and liabilities connected with employees who have been dismissed pre-transfer by reason of the transfer where there is no economic, technical or organisational defence) will transfer to the Buyer including:
   1. any salary arrears /unpaid holiday;
   2. ongoing claims caused by the Seller's acts or omissions pre transfer (e.g. discrimination);
   3. liability for unfair dismissal for pre-transfer dismissals made to make the business more attractive for the Buyer; and
   4. protective awards relating to any collective redundancies pre transfer of employees who would have otherwise transferred;
6. liability for breaches of the duty to inform and consult under TUPE is joint and several and so, in practice, will be a liability for the transferee;
7. the transferee is unlikely to have the warranties and indemnities that it would normally expect from a transferor which would mitigate the impact of the automatic transfer principle under TUPE;
8. the Buyer is usually contractually responsible for these transferring liabilities in the sale agreement (depending on the commercial negotiation);
9. the Seller/Administrator may require an indemnity from the Buyer for any amounts the employees claim from the NIF. As the government takes over the employees' claim and becomes a creditor of the company, the indemnity is to reduce the liability of the insolvent company. This effectively negates the protection offered by TUPE in preventing certain liabilities transferring to the Buyer; and
10. an Administrator will typically seek an indemnity in relation to a failure to provide Employee Liability Information under TUPE in order to minimise the risk that any additional claims will be brought against the company in Administration.

Dismissal issues in Administration

A key issue is often liability for dismissals. Under TUPE, where the principal reason for a pre-transfer dismissal is the transfer then the dismissal is automatically unfair and the liability will pass to the Buyer under TUPE.

If the principal reason for the dismissal is an economic, technical or organisational reason (ETO reason) entailing changes in the workforce, then any liabilities would remain with the Seller.

When a company is in economic difficulty, redundancies may have been made in order to cut costs even before the company enters formal insolvency proceedings. After appointment, an Administrator may make at least some dismissals immediately, and more over time. The key to whether or not the Buyer inherits the liability under TUPE depends on the reason for the dismissal and whose reason it is.

If the reason for dismissal is that the Seller or Administrator aims to slim down the workforce with a view to making the business more attractive for sale then this will be by reason of the transfer itself and the dismissal will be automatically unfair. This is the case even if there is no identifiable transferee on the horizon and a potential buyer has not been identified.

Alternatively, if dismissals are made because the company cannot pay employees' wages, and wants to run the remainder of the business, this will be an ETO reason and the dismissals will not be automatically unfair. The Seller (or Administrator) would still need to follow a fair procedure to avoid unfair dismissal claims but any liability would not transfer under TUPE.

Q10. How can a Buyer mitigate the extra risks of an Administration situation?

The practical steps to mitigate risk and potentially reduce liability will depend on the commercial strength of the negotiating parties and the specifc circumstances of the proposed deal. However, the following can be considered:

1. Do as much due diligence as circumstances permit to identify and mitigate the extra risks of an insolvency situation. Bear in mind that the information will usually be provided by an Administrator who may not have the full information about the business or complete access to records.
2. In a pre-pack there may not be full access to staff or information but it may be possible to gather some information informally through contacts within the company, such as the number of employees, their terms and conditions, whether there have been any dismissals, likely liabilities, and whether the wages have been paid.
3. The Buyer then assesses the potential risk and whether it outweighs the benefits of acquiring the business.
4. Ensure that the employees claim all possible amounts from the NIF.
5. In the absence of any indemnities, risks needs to be taken into consideration in the purchase price or other mechanisms e.g. holding back a retention amount from the purchase price, deferred consideration or an escrow account.
6. The Buyer should resist indemnities requested from the Seller/ Administrator, if possible and limit any given e.g. to a defined list of employees.
7. Securing cooperation from the Insolvency practitioner to inform and consult as required by TUPE may mitigate liability even if it is not possible to fully comply with the obligations. It is important to do as much as possible in the circumstances, even if that is limited to providing the information required under TUPE. The Buyer can draft appropriate letters and manage the process. The Buyer can also reduce the burden of consultation by not envisaging taking any measures after the transfer.
8. Settlement agreements preventing claims against the Buyer may be possible in limited circumstances e.g. for the senior management team.
9. Obtain documents and evidence that would help defend claims of automatic unfair dismissal for pre-transfer dismissals. A Buyer will have difficulty defending claims if it does not have access to the documents recording the reasons and the party who made the dismissals and can persuade them to give evidence.
10. Plan for claims and the management time and additional costs this involves.