Holiday pay should include overtime but backdated claims are limited

The EAT judgment has now been given in the much anticipated holiday pay cases of Bear Scotland Ltd v Fulton, Hertel (UK) Ltd v Wood and Amec Group Ltd v Law.

By way of a brief recap, in the case of Williams v British Airways Plc, the European Court of Justice (‘ECJ’) held that payments ‘intrinsically linked’ to the tasks that an employee carries out under his employment contract must be taken into account in calculating the appropriate rate of holiday pay. The ECJ then held in the case of Lock v British Gas Trading Ltd that commission should be included in holiday pay. Subsequently, various UK Tribunals held at first instance that non-guaranteed overtime (i.e. overtime which the employer does not have to offer but the employee must work if offered) should be included in holiday pay. The employers in these cases appealed to the EAT and we now have the appeal decision.

The bad news for employers is that the EAT held that non-guaranteed overtime should be included in holiday pay going forward, leading to higher wage bills in the future. The good news is that the ruling has substantially limited the ability of employees to retrospectively claim for backdated holiday pay. In this respect, the EAT has not opened the floodgates for expensive holiday pay claims going back many years, which was a significant concern for employers.

How should holiday pay be calculated?

The EAT held that employees must be paid their ‘normal remuneration’ during the four weeks of annual leave granted by the European Directive (‘EU leave’). This is employees’ typical average pay not just their basic pay. It therefore includes commission, overtime and other payments which are intrinsically linked to the tasks which the employee is required to carry out and which are ‘normally’ paid to the employee. In the Hertel and Amec cases, it was held that travelling time payments which were allowances for travelling time spent going to sites should be included in holiday pay. The payments exceeded expenses incurred and therefore the excess amounted to additional taxable remuneration to be included in holiday pay.

We have seen that some commentators have suggested that purely voluntary overtime (i.e. overtime which the employee can refuse to carry out) might not be included in this ruling. It is correct that the EAT concentrated on ‘non-guaranteed’ overtime, but this was because this was the type of overtime relevant to the appeal. Our view is that paid overtime is likely to be treated in a similar manner irrespective of how it comes about. This is a potential area of uncertainty for the future.

However, this ruling does not apply to the additional 1.6 weeks of annual leave granted to employees in the UK under the Working Time Regulations 1998 (‘WTRs’) or any additional contractual leave that employees are entitled to (‘additional leave’). It is therefore open to employers to only pay employees basic pay for additional leave over and above the four week minimum under the European Directive. However, the saving employers will achieve by paying less holiday pay for this additional leave may not be worth the administrative burden of operating two different holiday pay rates. This will depend on how regular overtime is and how many overtime hours an employee typically works.

In addition, the EAT gave no guidance as to how holiday pay should be calculated, except that it must correspond to the normal remuneration received by an employee during the appropriate reference period. The Advocate General in Lock suggested averaging pay over a reference period of 12 months in relation to commission payments but this was not confirmed by the ECJ. In many businesses there will be peaks and troughs in the levels of overtime worked by employees and therefore averaging overtime over previous weeks or months (as opposed to a 12 month period for example) could result in an obligation to pay sums in respect of overtime that would never have been received if the employee was at work. Employees may also be incentivised to take holiday after periods of high levels of overtime in order to maximise their holiday pay. The key here is to use a reference period that is representative and therefore puts the employee in a position that they would have been in had they been at work rather than on holiday.

What about backdated holiday pay claims?

Significantly, the scope for employees to claim underpayments of holiday pay has been substantially limited by the EAT’s judgment.

In order for employees to claim unpaid holiday pay going back over a number of years, they need to prove that there has been a ‘series of deductions’ and bring their claim within three months of the last deduction. The EAT held that in order for there to be a ‘series of deductions’, there must not be a significant time gap between the deductions. It therefore held that employees cannot make an unlawful deduction from wages claim where, in any case, a period of more than three months has elapsed between the deductions. Such claims will be out of time, unless it was not reasonably practicable for the claim to be brought in time.

In the Hertel and Amec cases at first instance, the Judge held that it is for the employee to choose which type of leave they are taking at any time (i.e. EU leave or additional leave). However, the EAT disagreed. It stated that the employer is entitled (within reasonable bounds following the procedure set out in the WTRs) to direct when holiday is taken and the employer therefore has the power to direct when, within the holiday year, EU leave should be taken. In addition, the WTRs describe the additional 1.6 weeks’ leave granted to UK employees as ‘additional leave’ which, the EAT held, suggests that such leave should be the last taken during the holiday year.

It is therefore to be assumed that in each holiday year, an employee will take their four weeks of EU leave first and then later in the holiday year they will take any additional leave to which they are entitled. It now accepted that EU leave should be paid at a higher rate (including commission, overtime payments etc.) It follows that in the past employers would have made a series of deductions (where the higher rate of holiday pay was not paid) followed by a series of correct holiday payments (i.e. for additional leave where the basic rate was, and still is, appropriate). This period in which holiday pay was paid at the appropriate rate breaks the series of deductions, if it is for a period of more than three months. In practice, this means that it is likely that there will have been a substantial gap at the end of any given holiday year when no unlawful deductions from wages were made, breaking the ‘series’. Many historic holiday pay claims may therefore be limited to the most recent holiday year.

Practically speaking, if there is a period of more than three months since the employee last took holiday then there is unlikely to be any liability for the employer. If the employee has taken holiday in the last three months then it will be necessary to assess whether this holiday can be categorised as additional leave rather than EU leave. This will be easier to prove if the employer is nearing the end of its holiday year.

What should employers do now?

The EAT judgment is binding on Employment Tribunals and is a statement of correct law as of today.

The EAT gave permission for the parties to appeal to the Court of Appeal so we have not heard the end of this matter yet. An appeal is unlikely to be heard until late next year so what should employers do in the meantime?

• The EAT has made it clear that overtime payments should now be included in holiday pay and, in our opinion, this is unlikely to be overturned on appeal.
• Employees will want to know what their employer is going to do. We advise caution in terms of any contractual changes. Employers need to give themselves a ‘get out clause’. If employers include additional payments in holiday pay going forward, as a precaution it is advisable to state to employees that the company will pay holiday pay in accordance with the law in force from time to time. This will enable the employer to change its policy if the decision is reversed on appeal.
• Some commentators are suggesting that employers could wait to see what happens, and make an accrual in the meantime. We would be concerned that, in the real world, employees will want to know how their pay packets will be affected now. Also, an employer who delays might face a number of Employment Tribunal claims.
• The issue of backdated holiday pay claims and the requirement for a gap of less than three months between deductions is more likely to be challenged on appeal. In dealing with employee queries or claims at this stage, if the employee has not taken any holiday in the last three months then they are likely to be out of time for bringing a claim. If the employee has taken holiday in the last three months, the employer may be able to rely on categorising holiday taken later in the holiday year as additional leave rather than EU leave to establish the required gap of three months. It is our view that the Court of Appeal is unlikely to support employers being able to simply pick and choose which holiday is EU leave and which is additional leave in order to artificially create a three month gap and deprive employees of a claim.
• Paying overtime as part of holiday pay now may well assist an employer in the future if the time limit issue is changed on appeal. We cannot offer any guarantee in this regard but it may mean that a series of deductions is broken now, when it is looked back on in a few years’ time.

This decision has far reaching effects for the future. Many employers may look to reduce the availability of overtime where feasible or may take on agency staff to cover periods of increased demand rather than offer overtime to their permanent employees. In the meantime, the Government has announced that it is setting up a new taskforce (including representatives from seven employer organisations) to assess the possible impact of the judgment and discuss how the impact on businesses can be limited.

If you require any legal advice on specific factual situations in your organisation then please contact Jane Biddlecombe or any member of the employment team. We are also running a seminar on this topic on Tuesday 18 November 2014 at 4.00pm. Please email any member of the team if you would like further details.