When an employee takes annual leave, how much should he be paid? You might think that this should be a straightforward question, but it is proving to be one of the biggest and potentially most costly employment issues of 2014-15 and one that has generated widespread publicity following the recent decisions on overtime in the cases of Wood and others v Hertel and and Fulton and Bear Scotland Limited that was delivered on 4 November 2014.

The EU Working Time Directive (from which our Working Time Regulations derive) does not specify which elements of pay should be included when calculating holiday pay. The UK opted to utilise the method of calculating a “week’s pay” included in the Employment Rights Act 1996 which was not originally designed to be used in the context of holiday pay.

It provides that where a worker has “normal working hours” and is on a fixed salary, that weekly pay will form the basis of the assessment. However, if the amount the worker receives varies depending on the amount of work he does, or when he does it, a week’s pay is averaged over the previous 12 weeks. Guaranteed contractual overtime payments and commission payments have always been included if they fall within the 12 week period.

Difficulties arise where the worker’s salary varies because it is dependent on simple sales bonus payments, non-contractual or non-guaranteed overtime and other payments not necessarily related to the amount of work done such as attendance and travel allowances.

What should be included in holiday pay?

Although a number of cases are still going through the appeal courts, and leave to appeal has been given in the overtime cases, some trends are emerging which provide guidance rather than definitive advice.

The basic position is that payments that are intrinsically linked to the work or tasks the worker is required to do, should be included in the calculation of holiday pay. In other words, holiday pay should reflect a worker’s “normal” pay.

To understand the reason for this, it is necessary to consider the reasons underpinning the Working Time Directive. The requirement to provide workers with paid holiday is a health and safety initiative – implemented to ensure that workers take a break from the demands and stresses of work. It is regarded as a particularly important principle of social law, from which there can be no derogations.

Workers must not be discouraged from taking leave. Therefore the pay they receive whilst absent, must generally correspond to what they would have received had they been at work.

We examine the current legal position in relation to the following payments.

Overtime

1 Non-guaranteed overtime

The EAT in Wood and others v Hertel held that non-guaranteed overtime (which the worker was contractually obliged to accept if offered) must be included. In that case, the overtime was worked ‘week in week out’ and this formed part of the worker’s ‘normal remuneration’ and there was no requirement to average it out.

If a worker can establish that he has a regular, pattern of overtime which he is obliged to accept (such as working a set number of hours each week or each month), this will constitute his normal pay and must now be counted.

However, this is subject to an important limitation. The requirement to include non-guaranteed overtime only applied to the 4 weeks’ leave required under the Directive “Directive leave” and not to the additional 1.6 weeks provided for under the WTR’s (“additional leave”), or to any contractual leave in excess of 5.6 weeks.

The EAT accepted that this will cause practical problems for employers and indicated that the Government may have to consider adjusting payments for the additional leave (presumably to bring these in line with the calculation of the Directive leave). That is probably unlikely given the Government’s reaction to the decision which was to set up a taskforce to look at limiting the impact of this decision.

2 Non-guaranteed intermittent overtime

To the extent that overtime is intermittent (ie; there is no regular pattern), but if offered must be accepted, the EAT said that such payments could be averaged over a reference period to be determined by Member States.

In the UK, this period is 12 weeks. No indication was given as to whether a 12 week period is compatible with the Directive and there are likely to be future cases which seek to argue that representative periods may need to be different.
For example, if overtime fluctuates widely over the year, or reflects seasonal spikes in demand (such as in the build up to Christmas for example), a 12 week reference period may not be representative (or fair).

The Supreme Court in the aviation industry holiday pay claims (involving British Airways) left the question of the appropriate reference period up to the employer to reasonably determine. Therefore employers who do have seasonal fluctuations may prefer to average pay for the purposes of calculating holiday over a more representative period, such as 12 months albeit it is not clear how this would be viewed by the Courts when tested in this context.

3 Overtime that the worker can refuse on reasonable grounds

The position is not yet clear with regard to overtime that the worker can refuse on reasonable grounds. In Fulton v Bear Scotland, the Tribunal said that overtime that the worker could refuse on reasonable grounds should be included. That decision was appealed to the EAT and was heard at the same time as the Hertel case and it seems likely that such payments must be included, although the particular issue was remitted back to the Tribunal to determine following the principles laid down by the EAT.

4 Voluntary overtime

In Neal v Freightliner, the Employment Tribunal found that voluntary overtime (which the employee could, but is not obliged to accept) should be included. That case was appealed, but was settled before a hearing.

The law does not require employers to include these payments in holiday pay at the moment. This is likely to be subject to future challenges and is likely to change in the future.

 

Commission

Earlier this year, the ECJ ruled that a British Gas sales employee, Mr Lock whose salary included significant commission payments should not be financially disadvantaged by the fact that he could not earn commission during his holiday. Accordingly, he was entitled to be paid, as though he had earned commission, on his return to work. To do otherwise would according to the ECJ, discourage him from taking annual leave. The ECJ considered it ‘irrelevant’ that the reduction in Mr Lock’s salary occurred after, rather than during, his holiday.

That case has been remitted back to the Tribunal to determine whether the WTR’s can be read purposively so as to be consistent with European Law, or whether words should be added to the domestic legislation. If this part is successful (as now seems likely), further dates have been set in February 2015 to determine the practical issues about Mr Lock’s commission payments.

 

Allowances

The extent to which “allowances” must be included will depend on whether the payment is intended to cover occasional costs incurred by the worker, such as travel or subsistence expenses, or are linked to productivity or the work in some other way.

In Hertel, the EAT said that radius allowances (payable to employees who travelled to a site more than a set number of miles away) and payments made for travelling time should be included (to the extent that they were taxable) in calculating holiday pay. They were not simply expenses and the taxable elements were directly linked to work.
This suggests that taxable allowances that can be distinguished from payments that purely reimburse expenses should be included in the calculation.

 

Bonuses

It is far from clear whether bonuses do have to be included. There are no decided cases. However, there are likely to be arguments that discretionary bonuses that are linked to performance (as is often the case) should be within the scope of a worker’s ‘normal remuneration’ and therefore included.
If they are included, arguments are likely to be made about the adequacy of the 12 week reference period. It is difficult to see that anything shorter than a 12 month reference period will be sufficiently representative.

 

How far back can workers bring claims?

There was a real concern that workers could make claims against their employers for historically having failed to reflect these elements in their holiday pay.

The worst case scenario is that claims could be brought as a series of unlawful deductions from wages, potentially going back many years. Businesses feared that workers would be able to argue that they are entitled to recover underpaid holiday from the start of their employment, or the implementation of the Working Time Regulations in 1998 if later.

These concerns appear to have been alleviated (at least for the time being).

The EAT in Hertel agreed that although the workers had been underpaid over many years and could bring unlawful deductions claims to recover their holiday pay, they had to do so within 3 months from the date of the last underpayment.

It rejected the workers’ argument that there could be a series of deductions when incidences of underpayment are interspersed with incidents of proper payment of holiday pay.

Essentially, what this appears to mean is that it will not be possible to claim back pay if there has been a gap of more than 3 months between holiday payments where there has been a shortfall. In other words, there cannot be a series of deductions if there has been an “interruption” in the amount paid or the time between payments.

For example, if an individual takes holiday in March (and is underpaid as it does not include overtime) and then does not take a holiday again until December (and is underpaid), there is a more than 3 months’ break in the payments and they would not be able to claim for the shortfall in March (but would be able to do so in respect of December) provided that they then brought the claim within 3 months of that non-payment.

Because the requirement to include non-guaranteed overtime only relates to the Directive holiday, over the course of a worker’s holiday year, it also appears that the series may also be interrupted by payment of holiday for the additional subsequent 1.6 weeks’ leave which can be paid without reference to overtime.

It appears that an employee will not be able to retrospectively determine that the holiday they have already taken relates to the Directive holiday, or the additional 1.6 weeks’ leave in a creative attempt to link the non-payments. Instead, it was suggested that employers can determine this and that the 4 week holiday leave required under the Directive should be taken first.

Although there may be some workers who might still be able to bring claims over a number of years, in most cases this part of the ruling is likely to severely restrict the ability of workers to bring valuable, retrospective claims for underpaid holiday pay for previous leave years.

The EAT has given leave to appeal this part of the decision and has indicated that it is arguable. It is therefore possible, that the Court of Appeal could reach a different decision and decide that workers can bring historic claims. It is clearly going to be a significant focus for the new Government taskforce.

Can employees bring civil claims to pursue holiday pay?

If the Hertel decision does prevent employees from recovering unpaid holiday over a long period of time, employees may seek to bring claims for breach of contract in the civil courts. Our view is that whilst this is arguable, such claims are unlikely to be successful.

In most cases of non-payment or underpayment of wages, the worker has the choice of bringing an unlawful deductions claim, or if the 3 month time limit has passed, a debt claim in the civil courts. The civil route is available because the worker is claiming sums due under the contract of employment.

Claims for underpayment of statutory holiday pay do not involve a claim for sums due under the contract as such. Instead, workers enforce these via the WTR’s, subject to the 3 month time limit. There is no current rule that implies into the contract a term that contractual holiday must comply with the WTR’s or Directive and the courts are wary of developing common law remedies in parallel with statutory rights where the effect would be to circumvent restrictions Parliament has put into place to enforce those rights (the 3 month time limit).

It is therefore unlikely that any civil claim will be successful unless the contract includes an express term requiring compliance with the WTR’s. Most don’t.

 

What should employers do now?

The EAT gave the parties leave to appeal its decision in Hertel and we expect an appeal to be launched. If it is, then the law will remain in a state of flux.
Employers therefore have a number of options available to them.

  1. Review the contracts of those staff actually undertaking overtime and examine whether any patterns of overtime emerge. Paid non-guaranteed overtime should be included in respect of Directive leave.
  2. Decide whether to limit pay in respect of the Directive leave. If this option is taken, businesses must ensure that their payroll systems have the ability to adjust holiday pay in each holiday year to differentiate between Directive and additional leave.
  3. Review their workforce’s terms and conditions of employment. Contracts and policies could be re-worded to make it clear that Directive holiday will be taken before any additional or contractual holiday.
  4. Business that have seasonable fluctuations in their non-guaranteed overtime arrangements could consider:
    4.1  Specifying when workers can take holiday and, for example, providing a moratorium on holiday being taken within 3 months of a busy period. Although employers do have the right to decline holiday requests under the WTR’s, if staff were required to take all of their Directive holiday at a particular time of the year, they may seek to argue that this disadvantages them in some way (for example, it prevents them from taking time off when their children are on school holidays), or affects their health and is therefore contrary to their Directive rights.
    4.2  Setting a more appropriate reference period to calculate holiday pay, such as twelve months.
  5. Re-structuring the workforce so that the business is not as reliant on overtime. Businesses would need to ensure that they comply with relevant legislation around the need to collectively consult before making any changes.
  6. Refuse to include payments for voluntary overtime (or any other payment where the law is uncertain) until such times as the law determines that these must be included.
  7. Set up a ‘task force’ within the business to deal with any queries about holiday pay and make sure that line managers know to refer complaints or grievances about holiday pay to it.

The publicity generated around the overtime cases is likely to encourage many workers to examine their payslips and begin to think about whether they have been “underpaid”. A number of unions have already publically declared that they are using the decisions to encourage membership.

Businesses do of course have the option of doing nothing yet (in terms of changing holiday pay) until the law is settled. Many are likely to do so, it seems.

If this option is chosen, the business must keep a close eye on developments in this area and start to consider its potential exposure (and perhaps make financial provision for it). Businesses must also decide how they are going to approach any claims and grievances raised about holiday pay should be dealt with in accordance with the ACAS Code of Practice.

Our experience

We have been closely involved in a number of holiday pay claims and have experienced lawyers to deal with these issues and can help you to minimise the impact of these decisions on your business.