Taking a practical approach to the recent EAT holiday pay decision

14 November 2014

Elizabeth Lang, Alison Dixon

Much of Langstaff J's judgment in Bear Scotland v Fulton and Baxter, the recent Employment Appeal Tribunal (EAT) decision on holiday pay, is unhelpful to employers. The blaze of publicity in which it was announced means that many employees who earn overtime or commission payments, or other performance related payments when at work, will be looking at their payslips to see whether their holiday pay is commensurate with their earnings when at work. If it is not, questions are likely to be asked.

The Bad News…..

The part of the Bear Scotland judgment that made the headlines was, unsurprisingly, the finding that compulsory overtime which is not guaranteed by the employer must be taken into account when calculating holiday pay. It is significant because this is the first English appeal court judgment on the issue of holiday pay since the European Court of Justice issued its decision in the case of Lock v British Gas, which held that the European Working Time Directive (the Directive) requires commission to be taken into account when calculating holiday pay. The decision in Lock was based on the premise that holiday pay should equate to the "normal remuneration" received by a worker when at work, including any payments which are linked intrinsically to the performance of his duties. 

Bear Scotland confirms that the UK Working Time Regulations 1998 (the Regulations) can be read so as to comply with the Directive. Therefore, payments which are linked to the performance of a worker's duties, including commission and compulsory overtime, are required under the Regulations to be included in holiday pay. Although not specifically dealt with in the judgment, it is likely that voluntary overtime will also need to be included, as well as other payments linked to the worker's performance of his or her duties, such as individual performance-related bonuses. 

The EAT's decision that the Regulations can be read so as to comply with the Directive means that there is no need for the UK government to change the legislation. Further, it means that employers who pay overtime and other sums which relate to the performance of a worker's duties, such as commission and bonuses for individual performance, on top of basic salary, but who have not reflected these elements in holiday pay to date, face historical liabilities as well as future costs. 

An additional blow for employers is that whereas Lock did not give any guidance on the appropriate reference period over which remuneration must be averaged in order to calculate holiday pay, Bear Scotland suggests that the very complicated provisions of the Employment Rights Act 1996, which require pay to be averaged over a 12 week period leading up to the holiday, will apply. These will place a huge administrative burden on employers and may give rise to very significant peaks and troughs of holiday pay where workers' remuneration varies over the year. For example, employers who pay annual performance-related bonuses could face much greater holiday pay liabilities for annual leave which is taken in the 12 weeks after those bonuses are paid, than at other times of the year. This may lead to workers seeking to take "tactical" holidays at the times when it is most financially advantageous for them to do so. 

The Good News…?

It is not all bad news for employers. Although they must now consider adjusting the way they calculate holiday pay going forward, the judgment does provide some quite large crumbs of comfort in relation to historic liabilities. First, it is now clear that this ruling only applies to the four weeks' paid annual leave which is guaranteed under the Directive and not the additional 1.6 weeks' leave guaranteed under the Regulations (or any further leave provided under a worker's contract). The ruling also states that it is the first four weeks of leave in any holiday year which are the four weeks guaranteed under the Directive. This means that many employers will be able to continue paying basic salary only for those 1.6 or more weeks' leave and will only have to adjust their calculations for the first four weeks of holiday in the holiday year.

In addition, the EAT held that although a worker can claim holiday pay by way of an unlawful deductions claim in the tribunal, and can claim for a series of deductions going back over time as long as he issues his claim within three months of the date of the last deduction in the series, that series will be broken if there is a gap of more than three months between deductions.

These two findings, in combination, significantly limit how far back workers can claim unpaid holiday. This is because:

  • There will be many cases where employees have taken periods of leave which are more than three months apart. For example, an employee may take two weeks' leave in August, followed by two weeks over Christmas. The EAT's ruling on the "series of deductions" point means that even if that employee brings an unlawful deductions claim within three months of the Christmas holiday payment, he will not be able to go back further and claim underpayments for the August leave or any previous holiday, because there is a gap of more than three months between underpayments.
  • If only the first four weeks of leave in the holiday year are weeks for which overtime / commission / bonus etc. must be paid on top of basic salary, then for any holiday taken after those first four weeks there will be no unlawful deduction, even if only basic salary is paid, because that later leave is governed purely by domestic law. This increases the likelihood that there will be a gap of more than three months between unlawful deductions.
What Now? 

Whilst the Bear Scotland judgment may be appealed, and therefore may not be the last word on the subject, it is now very clear that many employers will need to adjust their holiday pay practices going forward in order to minimise the risk of claims. Historic liabilities may also be significantly mitigated by taking steps to correct the basis on which holiday pay is calculated in future, as the longer it has been since a non-compliant holiday payment was made, the shorter the worker's window to file a claim. It is important for historic liabilities to be carefully assessed by businesses, as these may need to be reported / recorded in their accounts. 

Many questions remain unanswered about how businesses should go about calculating holiday pay. These include:

  • Whether genuinely voluntary overtime (i.e. overtime which a worker is not obliged to do even if offered) must be included in holiday pay. As indicated above, it seems likely that it must.
  • What the appropriate reference period is for the calculation of the amount of "variable" holiday pay to be paid. As mentioned above, comments made by Langstaff J in Bear Scotland suggest that the correct reference period is the 12 week period set out in the Employment Rights Act 1996, endorsing the very technical calculation set out in that legislation.
  • Whether payments in lieu of accrued untaken annual leave on termination of employment must be calculated in the same way as pay for holiday actually taken. It seems likely that the answer will be yes, but this is not specifically dealt with in Bear Scotland.
What Can Businesses Do?

There are a number of practical steps businesses might be able to take to try and manage the administrative burden and legal exposure. Here are some suggestions:

  • Start paying Bear Scotland compliant holiday pay. Depending on the holiday year and other business or strategic considerations, this may be advisable to do straight away, or from the start of the next holiday year.
  • Assess the extent of potential historic liabilities and consider whether or not to make payments to compensate staff for underpaid holiday where they have potential claims which are not time-barred, or alternatively to take a "wait and see if someone complains" approach.
  • Consider whether to pay Bear Scotland compliant holiday for all annual leave or just the first four weeks as required by the current law – there may be administrative benefits in taking the former approach, which outweigh the cost.
  • Review contracts of employment and policies on holiday to ensure that they are consistent with the current law.
  • Consider regulating the taking of leave, for example by limiting the taking of single days or requiring or prohibiting leave from being taken at particular times.
  • Review bonus and commission schemes – and consider whether "on target" earnings / maximum bonus levels can or should be adjusted downwards to take into account the additional liability.
  • Consider adjusting the timing of payment of bonuses – rather than paying them in a lump sum, could they be paid in smaller instalments to avoid large "windfall" holiday payments after the payment of bonuses?
  • Review overtime arrangements and consider placing limits on the amount of overtime that can be worked (if not already in place).
  • Consider whether to stick to the letter of the law and use a 12 week reference period for calculating holiday pay, or to come up with another sensible period which provides staff with broadly equivalent levels of holiday pay but imposes less of an administrative burden on employers.
  • Consider whether the employer's right under Regulation 15 of the Regulations (to require holiday granted under the Regulations to be taken or not taken on particular dates) can be used to its advantage (e.g. to prevent leave from being taken immediately after a large bonus or commission payout).

Clearly, all of the above will require careful thought and will involve employment law considerations outside the narrow scope of holiday pay and the Regulations (for example, contractual and policy amendments are likely to require consultation and consent). There will also be commercial considerations, and issues of employee relations, which will vary significantly from employer to employer. Unionised workforces are likely to require very different handling to those without collective bargaining machinery in place.  

The International Dimension

Although the law in the rest of the EU is also governed by the Directive, some businesses with international operations may find that they have not been complying with the requirement to pay holiday pay in the way the European case law says they should. It is worth international employers checking what their actual practices are for staff working in other EU countries and assessing whether there are any adjustments to be made going forward, and/or any historic liabilities. The attention that this issue is receiving in the UK may trigger closer scrutiny of payment of holiday pay in other countries in Europe.

The Future….

The Bear Scotland judgment may be appealed to the Court of Appeal and possibly higher, so the issue of holiday pay may not be fully resolved for some time. However, Langstaff J indicated that he felt an appeal against his findings that the Regulations can be read so as to comply with the Directive, and that holiday pay must include sums which are intrinsically linked to the performance of a worker's duties, is unlikely to succeed, so employers holding out for a more favourable decision from the Court of Appeal on these points are likely to be disappointed.  

Langstaff J also expressed the view that the question of how far back holiday pay claims can go is the one on which he felt the workers have the best chance of success on appeal. This means that whilst the prospect of employers facing significant historic liabilities for underpaid holiday over a number of years has gone away for now, it has not gone for good.