Administration expenses do not include employees´ payments in lieu of notice and protective awards

The High Court has recently had a number of opportunities to consider the issue of whether certain liabilities to employees are payable as first priority administration expenses and therefore in priority to the administrator’s remuneration, the preferential creditors, amounts secured by floating charge and unsecured creditors.

Following conflicting decisions at first instance, the Court of Appeal held, on 9 August 2005, that liability for protective awards are not payable as an administration expense and (with one exception) neither are payments in lieu of notice.

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The High Court has recently had a number of opportunities to consider the issue of whether certain liabilities to employees are payable as first priority administration expenses and therefore in priority to the administrator's remuneration, the preferential creditors, amounts secured by floating charge and unsecured creditors.

Following conflicting decisions at first instance, the Court of Appeal held, on 9 August 2005, that liability for protective awards are not payable as an administration expense and (with one exception) neither are payments in lieu of notice.

Paragraph 99(4), 99(5) and 99(6) of Schedule B1 to the Insolvency Act 1986 provides for which liabilities, arising out of contracts of employment adopted by the administrators can be considered as "wages and salary" and are therefore payable in priority to other administrations expenses and remuneration.

In July 2005, the administrator of Huddersfield Fine Worsteds Limited and Globe Worsted Company Limited made an application to Court for directions in respect of prospective claims made by the employees of those companies (the case known as "Krasner"). Specifically, the Administrator sought a declaration that any liability for protective awards in respect of redundancy consultation under section 189 of the Trade Union Labour Relations (Consolidation) Act 1992, and any sums payable in lieu of a notice period, should be treated as unsecured claims in the administration of the companies rather than administration expenses. Mr Justice Peter Smith, however, refused to make the declaration sought and held that the two categories of liabilities fell within the definition of "wages and salary" and should be paid as administration expenses with "super-priority".

This decision caused serious concerns among administrators as it increased the types of liabilities payable as administration expenses. This could prove to be disadvantageous for future administrations and the rescue culture as a whole.

Meanwhile, the administrators of Ferrotech Limited ("Ferrotech") and Granville Technology Group Limited ("Granville") sought a similar declaration before Mr Justice Etherton. Mr Justice Etherton refused to follow the earlier decision in Krasner and granted the declaration sought.

The appeals of all of these matters were held together the same afternoon as Mr Justice Etherton's decision. It was recognised that the position needed to be settled quickly in order to allow the administrators of Granville to make a decision concerning the future employment of 150 members of staff. The 14-day period (after which the administrators may have been deemed to adopt the relevant contracts of employment) was due to expire the following morning and the employees' fate rested on the appeal.

The Court of Appeal held that liability for a payment in lieu of notice is not an administration expense, except for any payment due when an employer has given proper notice, but tells the employee not to work and gives him the wages attributable to the notice period as a lump sum. Only this specific category of claim for payment in lieu of notice (which is really a type of 'garden leave') would be entitled to priority expense status. Therefore liability for normal types of payments in lieu of notice on summary termination or immediate termination on receipt of a payment in lieu do not qualify as an administration expense.

The Court of Appeal held that liability for a protective award is not payable as a priority administration expense.

Counsel for the employee representative failed to persuade the court that a liability for a protective award is "a liability arising under a contract of employment" and that it fell within the ambit of the definition of "wages and salary".

It was considered that a protective award could not be said to "arise under a contract of employment". Even though it no doubt arises because of the existence of a contract, it cannot be said to "arise under the contract" because it is created by statute. It was also held that it was unlikely that a protective payment award would fall within the scope of "wages and salary". It was recognised that the drafting of the relevant provision was "thoroughly unsatisfactory" and that it was not surprising given its ambiguity that Mr Justice Smith in Krasner and Mr Justice Etherton in Ferrotech had such a "sharp difference of opinion".

Following the Court of Appeal's decision, the position is that liability for protective awards and practically all payments in lieu of notice do not have priority under paragraph 99(4) of Schedule B1 to the Act. Only one type of payment in lieu of notice will benefit from such priority.

The Appeal Judges agreed with Mr Justice Etherton's comment that it would "seriously undermine the 'rescue culture' which underlies the administration regime….if protective awards and payments in lieu are treated as having priority".

This decision has ironed out the drafting anomalies introduced to this issue by the Enterprise Act reforms. Administrators can now breathe a sign of relief and get on with the job of trying to rescue companies and businesses.

Re Huddersfield Fine Worsteds Limited and Globe Worsted Company Limited; Krasner (the Administrator of Globe Worsted Company Limited & Huddersfield Fine Worsteds Limited) v Mr McMath (Representing the employees of the companies);

Re Ferrotech Limited: Duggins & Kelly (Joint Administrators of Ferrotech Limited) v Tipper (Representing the employees of the company); and

Re Granville Technology Group Limited: Ellis, Hosking & Ross (Joint Administrators of Granville Technology Group Limited) v Harris (Representing the employees of the company)

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 19/08/2005.