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The working time “bombshell” – how should you calculate holiday pay?

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 states 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 received 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. Contractual overtime payments and commission payments are only 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 overtime and other payments not necessarily related to the amount of work done such as attendance allowances. 

Do these have to be included? 

Although a number of cases are still going through the appeal courts, the answer is yes, probably

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. 

Most recently, the European Court of Justice (“ECJ”) has 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 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.

A number of similar claims are currently also before our appeal courts. The EAT will determine whether non-contractual and irregular overtime payments should be included in the calculation – Neal v Freightliner and in Bear Scotland v Fulton the EAT will examine whether holiday pay for workers without normal hours should be calculated by reference to the average over 12 weeks of basic pay, overtime, standby payments and supplements. 

What should you do now?

The decision in Lock could have a significant impact for many businesses, particularly those whose staff receive commission payments and non-guaranteed overtime. The worry is 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. Workers will 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.

The problem is not limited to your business’s existing workforce either. Former employees have three months from the date of their last deduction in which to bring an unlawful deduction from wages claim in the Employment Tribunal and may also be able to bring breach of contract claims against their old employer for the failure to pay contractual holiday. In the county court, claims must be brought within six years of the breach.

Defending such claims is likely to be complex and time consuming for employers – particularly where the claims go back several years.  It will also involve significant cost, both in lost management time and legal fees. Similarly the claims will not be simple to bring where accurate computation of the shortfall in holiday pay over past years is required.

We recommend that if your workers receive pay for non-guaranteed overtime, or receive commission payments or other enhancements, you focus your immediate attention on piecing together the information needed to calculate your business’s potential liabilities. 

There are a number of options that you can consider to limit the cost to your business, including re-basing holiday pay. Employees have three months from the last deduction in which to bring an unlawful deductions from wages claim. Taking this step will break the chain of causation and may prevent employees from recovering all unpaid holiday.

Unresolved issues

There are a number of unresolved issues which make it difficult for businesses to precisely calculate the extent of their potential liabilities. For example:

  1. It is not clear what reference period should be used to determine the calculation.  Will 12 weeks be sufficient, or is a one year period more representative? Can employers (rather than the Courts) set their own reference period and if so, what factors should be considered?
  2. Can employers differentiate between the 20 days paid holiday required by the Working Time Directive, and the additional 8 days required under UK law, and/or any additional paid holiday provided when calculating holiday pay?
  3. Can private employers argue the Working Time Directive and the case law which interprets it does not bind it directly? UK courts appear to increasingly take the view that it is possible to re-interpret UK provisions to comply with Directives, even where words have to be written in or existing words disregarded. However, there are limits and UK legislation cannot be reinterpreted in such a way that it is contrary to UK legislation
Irwin Mitchell are exploring a number of creative ways to minimise employers potential liabilities for holiday pay. If this issue has significant financial implications for your business, please contact us for advice.

- Glenn Hayes

Key Contact

Glenn Hayes