Happy holidays? Trouble brewing for employers on the pay front

Ian Watson, a veteran employment law trainer and consultant, examines the latest decision that commission should be included for employees heading off on annual leave.

With the holiday season fast approaching, there is one thorny issue that can cause major headaches: holiday pay. For many years calculating the amount to be paid to employees taking their statutory holiday has been straightforward. However recent court decisions in both UK and Europe have begun to shake what many thought were immutable principles for making such calculations. And the potential increased costs for some employers could be considerable.

In particular, these decisions have suggested that employees, whose pattern of working hours is irregular, supplemented by regular overtime, where they regularly work more than their ‘contractual basic’ hours or whose ‘normal’ pay is supplemented by commission or allowances, should be entitled to have their holiday pay calculated to maintain their normal earnings.

The latest development is the finding of the European Court of Justice (ECJ) in Lock v British Gas Trading Ltd and others. The ECJ ruled that an employee who was paid commission each month should be credited with a notional amount of commission in respect of weeks when he took annual leave. The court found this a necessary step in order that the employee’s future wages would not suffer.

The ECJ is involved because the right to paid annual leave under the Working Time Regulations 1998 is derived from the Working Time Directive and must be interpreted in line with its provisions. However, the directive contains no definition of ‘paid leave’ and the UK Regulations simply adopt the long-standing definition of a ‘week’s pay’ set out in the Employment Rights Act 1996 (ERA) ss.220 to 229.

Future reliance on this definition of a week’s pay for holiday pay calculation purposes could, in the light of Lock and of other recent cases, be a problem for many employers and their legal advisers.

Let’s look at some situations and examine the potential consequences for employers, following the recent case law.

For those employees who earnings are calculated by reference to a basic salary supplemented by commission payments, in respect of successful sales resulting from their personal efforts, the decision of the ECJ in Lock makes it clear that what we thought was established UK law on holiday pay needs to be revisited.

The UK Court of Appeal previously ruled in Evans v Malley Organisation Ltd t/a First Business Support that, where commission was paid based on the success of the employee’s efforts – rather than the amount of work the employee had actually done, holiday pay should be calculated on the basis of the basic pay for working a normal week without the inclusion of any element of commission.

The ECJ has effectively overturned the approach in Evans. The European Court regarded it as definitive that normal pay must be maintained during an employee’s period of annual leave and found that it was a breach of that requirement for an employee to lose out on the commission that he or she would have earned during the leave period. This was the position even though the payment in respect of the ‘lost’ commission may be deferred until some weeks, or even months, after their return.

The ECJ’s decision suggests that the holiday pay calculations relating to employees on commission need to be revisited by their employers to ensure that the employee should not be financially worse off when taking (statutory) annual leave. Some sort of averaging arrangement, taking periods of annual leave into consideration, may have to be devised in order to reduce the risk of future legal challenge.

While it is difficult to generalise about pay arrangements for certain employees who are entitled to various contractual pay supplements or allowances, another ECJ decision suggests that these payments should be taken into account when calculating a week’s entitlement to holiday pay.

In Williams and others v British Airways plc, the ECJ held that pilots were entitled to have various allowances included in their holiday pay. So we can see from these cases that a clear principle emerges: paid annual leave is regarded by the ECJ as a key social right and employees must not be deterred, by their employers’ method of calculating holiday pay, from taking their full entitlement.

Employers who pay such contractual allowances may therefore wish to take specific advice from their legal advisors about the need to revisit the way that their statutory holiday pay schemes operate, in the light of the British Airways case.

The holiday pay calculation issue is not just a subject of discussion in the European Court. Two recent UK cases, currently on appeal to the Employment Appeal Tribunal (EAT), have highlighted the problem of deciding a week’s pay in respect of those who work regular overtime.

The Employment Rights Act approach to these workers is that a week’s pay excludes overtime unless it is a minimum requirement of the contract of employment to work a set number of overtime hours every week. But in both Neal v Freightliner Ltd and Fulton v Bear Scotland Ltd, the employer is appealing to the EAT against a tribunal finding that overtime payments had to be included in the calculation of holiday pay. In both these cases, the ET was persuaded that the ‘European’ approach to ensuring that employees receive a ‘normal’ week’s pay should apply – including the worked overtime hours in the calculation.

We await the EAT’s decisions in these cases with interest and naturally suggest that no action be taken by employers before they have been issued and the implications considered with your legal advisors.

Contractual Hours vs Actual Hours
A substantial number of employers (for example in the retail, hotel and catering and care sector) employ staff on so-called ‘basic’ hours contracts but, in order to deploy their staff flexibly to cope with fluctuating business demands, they then require staff to work substantially greater weekly hours – often on a long term basis. It is common in these situations for employees going on annual leave to find their holiday pay calculated on ‘contractual’ (i.e. ‘basic’) hours, rather than calculating the holiday pay on an average of hours worked by the employee in the period before the leave is taken.

If the EAT in Neal and Fulton follow the ‘European approach’ to holiday pay calculation then it must be questionable whether employees who regularly work ‘excess’ hours can be denied their holiday payment at some sort of ‘average’ rate. This will inevitably be financially challenging for employers who have hitherto followed the ‘basic’ holiday pay calculation system, in order to keep staff costs down.

Once again we suggest that, if you are an effected employer (or employee), you seek advice from your legal advisors on how to deal with the consequences of these court decisions.

Legal risk: Good News and Bad News
So what might be the cost of legal challenges on holiday pay calculation following these cases? What principles should be followed?

It may be that, following these cases, the Government will need to revisit the definition of a week’s holiday pay for calculation purposes. The ECJ case law is now sufficiently clear to allow for a new definition of a week’s pay to be drafted into the Working Time Regulations, making it clear that an employee is entitled to be paid the same amount in respect of holiday that he or she would have received for a normal week’s work. Where that varies – for any reason – holiday pay should be averaged over a representative reference period.

Bear in mind that the decisions of the ECJ and UK courts following them, based as they are on the EU Working Time Directive, affect calculation of holiday pay only in respect of the first 20 days’ holiday in any leave year. This is because the additional statutory holiday entitlement of a further 8 days a year is a UK-only supplement to the 20 days provided for in the EU Directive. That’s the good news for employers.

The bad news is that, if an employee makes a claim for an unlawful deduction from wages in respect of ‘underpaid’ holiday pay, employers may face backdated holiday pay claims in respect of previous periods of annual leave.

Where there is a series of unlawful deductions, the employee can claim in respect of all the deductions in the series, provided that he or she brings a claim within three months of the last one. A persistent failure, over several leave years, to pay the correct amount of holiday pay would arguably be a series of unlawful deductions.

So there is a clear risk that employees who bring a claim within three months of receiving an inadequate payment will be able to bring claims stretching as far back as the implementation of the Working Time Regulations in 1998. That alone might justify them risking the cost of paying the Tribunal fees in respect of their claim. Good news for employees. Bad news for employers.