Insolvency of employer

Summary

9.711

• Most, but not all, forms of insolvency will operate to terminate contracts of employment. Employees will be dismissed for reason of redundancy. (See 9.713 Consequences of insolvency)
• There are a number of different insolvency processes. They will each have slightly different employment implications. Expert advice must always be taken. (See 9.714 Meaning of insolvency)
• If an employer becomes bankrupt (individual or partnership) or goes into liquidation (company), employees will become preferential creditors to some extent in relation to any unpaid wages. (See 9.715 Rights of employees to outstanding wages from an insolvent employer)
• The Government operates a National Insurance Fund. This will meet the claims of employees who have not been paid outstanding wages by insolvent employers. (See 9.716 Claims against the National Insurance Fund)

Future developments

9.712 There are no future developments.

Consequences of insolvency

9.713 Most forms of insolvency will operate to terminate contracts of employment. The employees will be dismissed for redundancy. However, this will not necessarily be the case. An employer should seek expert advice from a solicitor or insolvency practitioner at the earliest opportunity to clarify the effect that the particular insolvency procedure will have upon employment contracts and to seek advice on what steps to take.

When insolvency involves the dismissal of employees within the insolvent business an insolvent employer may not necessarily be absolved of the necessity to consult before dismissal notices are sent out (see 9.401 to 9.414 Redundancy rights). Failure to consult may render the dismissal unfair (see 9.205 to 9.216 Unfair dismissal: rights on termination). If an employer is uncertain whether to or how to consult, expert advice should be taken.

A detailed analysis of the law of insolvency and how it affects employers is beyond the scope of this publication.

Meaning of insolvency

9.714 The meaning of "insolvency" is set out in s.183 of the Employment Rights Act 1996.

Company insolvencies: A company is insolvent if one of the following has happened.

• It has gone into liquidation (also referred to as winding up). Compulsory liquidation proceedings are brought in the court and a liquidator is appointed to realise the assets of the company and then to distribute these to the creditors. This will terminate the contracts of employment and ultimately the existence of the company. The company will eventually be struck off the register of companies maintained by the Registrar of Companies at Companies House.
• It is the subject of an administration order. A court will make such an order with a view to rescuing a company which is in financial difficulties but has a chance of survival. An administrator will be appointed with extensive powers to run the business for a period of time. The company will be protected from its creditors for the period of the administration order.
• A resolution for its voluntary winding-up has been passed.
• It has made a voluntary arrangement approved by a court of law under the Insolvency Act 1986.
• In prescribed circumstances, a receiver or manager has been appointed.
• Possession of the company's property has been taken under a debenture.

Individual and partnership insolvencies: In England or Wales, an individual employer or partnership is insolvent if:

• the individual or all of the partners are bankrupt or have made a composition with their creditors; or
• the individual has died and his or her estate fails to be administered in accordance with an order made under s.421 of the Insolvency Act 1986.

In Scotland, an individual employer or partnership is insolvent if:

• the estate of the individual or partnership has been sequestered;
• the individual or each of the partners has executed a trust deed for his or her creditors or has entered into a composition contract; or
• the individual has died and a judicial factor appointed under s.11A of the Judicial Factors (Scotland) Act 1889 is required by that section to divide his or her insolvent estate among his or her creditors.

In accordance with s.183 of the Employment Rights Act 1996, there is no insolvency if an employer simply stops trading without having made any formal insolvency arrangements.

Rights of employees to outstanding wages from an insolvent employer

9.715 It is self-evident that when an employer becomes insolvent it is unlikely that there will be sufficient funds to pay all debts due, including the wages of employees.

The Insolvency Act 1986, Schedule 6 provides that employees are 'preferential creditors' in respect of remuneration payable to them in the four-month period immediately preceding the insolvency of the employer. To the extent that there are funds available to meet their claims they will be paid in preference to unsecured creditors but they will rank behind secured creditors.

Remuneration for these purposes will include:

• wages or salary including commission;
• accrued holiday pay;
• sick pay
• payment on medical or maternity suspension;
• unpaid contributions to an occupational pension scheme;
• a guarantee payment;
• payment for time off to look for work or arrange training (under s.53 of the Employment Rights Act 1996); time off for antenatal care (under s.56 of that Act); or time off to carry out trade union duties etc (under s.169 of the Trade Union and Labour Relations (Consolidation) Act 1992); and
• a protective award.

The maximum amount of the preferential debt is currently £800 (Insolvency Proceedings (Monetary Limits) Order 1986). If the employer's assets are insufficient to meet all claims in full, each employee will be paid in the same proportion to all other employees. Unpaid remuneration may be claimed from the National Insurance Fund via the Secretary of State (see below).

An employee may also have other contractual claims against his or her employer. These will not be given preferential status and must be proved in the normal way in the insolvency process.

Claims against the Secretary of State

9.716 Any employee whose employer is insolvent may apply to the Secretary of State - in practice, the nearest Redundancy Payments Office of BIS - for payment of any debt outstanding on the termination of his or her employment. Once satisfied that: the employee's former employer has become insolvent, the employee's employment has terminated and he or she was entitled to be paid the whole or part of the debt on the "appropriate date" the Secretary of State must pay the employee out of the National Insurance Fund the amount to which the employee is entitled in respect of that debt (s.182).

Section 185 of the Employment Rights Act 1996 states that the appropriate date in relation to:

• unpaid wages or salary and holiday pay is the date on which the employer became insolvent;
• a basic award of compensation for unfair dismissal or a protective award is the latest of the date on which the employer became insolvent, the date on which the employee's employment terminated and the date on which the award was made;
• any other debt to which part XII of the Employment Rights Act 1996 applies is the later of the date on which the employer became insolvent and the date on which the employee's employment terminated.

However, there are limits on the amounts payable by the Secretary of State and the debts to which they relate. Under s.184 of the Employment Rights Act 1996, the Secretary of State's liability extends to:

• unpaid wages or salary (including overtime, commission and guarantee payments) subject to a limit of £430 per week for a maximum of eight weeks;
• up to six weeks' holiday pay (again subject to a limit of £430 per week) for unused holiday and for holiday taken but not paid to which the employee became entitled during the 12 months ending with the date on which the employer became insolvent;
• any basic award of compensation for unfair dismissal;
• any protective award ordered to be paid by an employment tribunal (should the employer have failed to inform or consult trade union and/or employee-elected representatives about a collective redundancy);
• any statutory payments in respect of a period of time off work or suspension on medical or maternity grounds;
• the amount of any statutory redundancy payment (subject to certain conditions);
• any reasonable sum by way of reimbursement of the whole or part of any fee or premium paid by an apprentice or articled clerk; and
• money in lieu of statutory (but not contractual) notice (up to a maximum of £430 per week and subject to the deduction of tax and national insurance contributions, monies earned from other employment during the notice period, and any state benefits paid or payable during that period).

Under s.186 of the Employment Rights Act 1996, the upper limit of £430 on the amount of a week's pay is the figure for 2012/13 (previously £400).

Employees may also claim against the Secretary of State where an employer is insolvent and has failed to pay a statutory redundancy payment in full (see 9.401 to 9.414 Redundancy rights).

Under s.189 of the Employment Rights Act 1996, once payment has been made, the Secretary of State assumes the role of preferred and ordinary creditor and will take appropriate steps to recover at least part of that money from the employer's remaining assets. Any monies recovered by the Secretary of State will be repaid into the National Insurance Fund.

Regulations 9A and 9B of the Statutory Sick Pay (General) Regulations 1982 (SI 1982/892), and regs.7 and 30 of the Statutory Maternity Pay (General) Regulations 1986 (SI 1986/1960) state that, in certain circumstances, HM Revenue and Customs will assume responsibility for the payment of any statutory maternity pay or statutory sick pay owed to an employee at the time his or her employer became insolvent.

Claims can be made only by employees and not by self-employed persons. In Neufeld v (1) A&N Communications in Print Ltd (in liquidation) (2) Secretary of State for Trade and Industry EAT/0177/07, a controlling shareholder argued successfully that he was an employee for the purposes of the insolvency provisions of the Employment Rights Act 1996.

Procedure for claiming debt from an insolvent employer: To lay claim to any debt owed by an insolvent employer, the dismissed employee must complete form RP1 supplied by the employer's representative and either return the form to the representative (if directed to do so) or send it to the nearest Redundancy Payments Office of BIS. An employee dismissed without the benefit of the notice to which he or she was entitled under s.86 of the Employment Rights Act 1996 may apply for a compensatory notice payment by completing form RP2 and returning it to the Redundancy Payments Office.

In accordance with s.187(1) of the Employment Rights Act 1996, where a "relevant officer" has been (or is required to be) appointed in connection with an employer's insolvency the Secretary of State shall not pay monies from the National Insurance Fund in respect of any amount allegedly owed to an employee by an insolvent employer, until the relevant officer sends a statement confirming in writing that the employee in question is entitled to that amount.

If a statement is not forthcoming, the Secretary of State may decide to pay the employee out of the National Insurance Fund if satisfied that such a statement is not required to determine the sum owing to the employee, or to confirm that the sum remains outstanding (s.187(2)).

Under s.187(4) of the Employment Rights Act 1996, a "relevant officer" is a person appointed in connection with the employer's insolvency, ie a trustee in bankruptcy, or a permanent or interim trustee (within the meaning of the Bankruptcy (Scotland) Act 1985); a liquidator, administrator, receiver or manager; a trustee under a composition or arrangement between the employer and its creditors; or a trustee under a trust deed for his or her creditors executed by the employer. The term "trustee" includes the supervisor of a voluntary arrangement proposed for the purposes of, and approved under, part I or VIII of the Insolvency Act 1986.

Unpaid pension fund contributions

9.717 If an insolvent employer has failed to pay employer or employee contributions into an occupational or personal pension scheme, the trustees of that scheme may apply in writing to the BIS Redundancy Payments Service for payments into the scheme from the National Insurance Fund, claiming that the insolvent employer failed to pay pension contributions (either on its own account or on behalf of the employee) into the scheme during the 12 months preceding the date on which it became insolvent.

In accordance with s.124 of the Pension Schemes Act 1993, once satisfied that there are unpaid contributions, the Secretary of State will withdraw the money from the National Insurance Fund and pay it into the occupational pension scheme fund.

As of 6 April 2005, the Pension Protection Fund guarantees payment of a minimum level of pension to members of defined benefit schemes that are under-funded when an employer becomes insolvent.

Complaints to an employment tribunal

9.718 Under s.188(1) of the Employment Rights Act 1996, should the Secretary of State decline or fail to pay any of the amounts referred to above, the affected employee may apply to an employment tribunal for a declaration on the matter.

A complaint must be lodged within three months of the alleged refusal or failure to pay (or within six months, if the employee's complaint relates to an unpaid statutory redundancy payment).

Section 188(2) of the Employment Rights Act 1996 provides that, should such a complaint be upheld, the tribunal will make a declaration to that effect and will declare the amount of any such payment that it finds the Secretary of State ought to make.

Practical example

9.719 P&M Ltd (P&M) is a specialist computer hardware development company. P&M started up five years ago on the back of a substantial bank loan and overdraft facility provided on the basis of a business plan which projected a massive growth in its particular specialist hardware sector. It employs 15 people.

As part of the security for the loan and overdraft the bank took a fixed and floating charge from P&M. The anticipated growth has not occurred. P&M has been unable to make the repayments under the loan and the overdraft has reached its limit. It has not paid its staff for two months and trade creditors are threatening to bring winding-up proceedings if their bills are not paid.

The bank calls in an administrative receiver (AR) under its floating charge. The AR attempts to run the company for one week and continues to employ the employees during that period. The AR concludes that the business is not a viable concern and sells off sufficient assets to repay most of the bank's borrowings. P&M's remaining unsecured creditors then apply to the court to wind the company up in the hope that there may be a small dividend payable by the liquidator to them as unsecured creditors.

The liquidator appointed by the court realises all company assets. These produce enough to pay off part of the monies owing to the employees as preferential creditors, in preference to the unsecured creditors who end up with nothing. There are sufficient funds to pay all employees 40% of the wages due to them for the previous two months.

The employees claim against the National Insurance Fund for the remainder of their unpaid wages.

Action point checklist

9.720

• Take early specialist advice on how any insolvency process will impact on the employment relationship.
• Consider what employees' entitlements as preferential creditors might be.

Key references

9.721

Legislation

Insolvency Act 1986
Pension Schemes Act 1993
Pensions Act 2004
Insolvency Proceedings (Monetary Limits) Order 1986
Employment Rights (Increase of Limits) Order 2007 (SI 2007/3570)

Questions and answers

9.722

Q483: If an employer goes out of business, what are its duties towards employees?

Although most forms of insolvency will terminate contracts of employment, with the automatic effect of dismissing employees by reason of redundancy, this is not always the case. Employers should always seek expert advice from a solicitor or insolvency practitioner to check the effect that their particular insolvency may have on existing employment contracts. The same goes for consultation before dismissal, as an insolvent employer may not be absolved of the necessity to consult.

Q484: How can an employee secure his or her wages if the employer becomes insolvent?

In the event that an employer becomes insolvent and does not have sufficient funds to pay outstanding wages due to employees, the Insolvency Act 1986 provides that employees become 'preferential creditors' in respect of remuneration payable for the four-month period immediately preceding the insolvency of the employer. Remuneration in these circumstances will include: wages or salary, including commission, guarantee payments, payment due on account of medical or maternity suspension and accrued holiday pay.

Q485: What happens if an employer becomes insolvent and has insufficient funds to meet all its employees' pay claims?

If an employer does not have enough assets to pay all its employees' claims in full, then each employee must be paid in proportion to all other employees. Employees can then claim any unpaid remuneration from the National Insurance Fund. Employees can claim against the fund for: arrears of pay for periods of between one and eight weeks, the statutory minimum notice period and holiday pay for periods not exceeding six weeks. They can also make a claim for a basic award of compensation due to unfair dismissal.

Q486: Does the National Insurance Fund cover unpaid pension fund contributions in an insolvency situation?

Under the Pension Schemes Act 1993, employees of an insolvent employer may make a claim against the National Insurance Fund for certain types of unpaid employer contributions to an occupational pension scheme or personal pension scheme.