Holiday pay calculation and back payments

Author: Darren Newman

Darren Newman

Consultant editor Darren Newman looks at the latest rulings in a long line of holiday pay cases, including one with significant back-pay implications for Northern Ireland employers. He also explains why the issue of lengthy back-pay periods may not yet be completely resolved for employers in the rest of the UK.

I cannot think of any area of employment law that has taken longer to sort out than the right to paid annual leave. It seems that every year we ask a slightly different version of the same question - what is included in the calculation of a week's pay for holiday pay purposes?

The problem stems from what was probably thought to be a convenient shortcut in the drafting of the Working Time Regulations 1998 (SI 1998/1833). When it came to the right to paid annual leave, it was the existing definition of a week's pay from the Employment Rights Act 1996 that was used. This is the latest version of a definition going back to the Contracts of Employment Act 1963. The problem is that it is a highly technical and somewhat limited definition of a week's pay that has not kept pace with the case law - and there has been plenty - of the European Court of Justice (ECJ).

The clear principle that has emerged from the ECJ is that workers who take annual leave should not lose out in terms of pay. They should continue to be paid as normal and should suffer no disadvantage as a result of taking leave - otherwise there would be an incentive for them not to take their full holiday entitlement and that would undermine the protection of the Working Time Directive (2003/88/EC).

Once you accept this, the position is relatively simple. Workers should continue to receive their normal pay when they take annual leave. In relation to any type of payment - commission, allowances, overtime and bonuses - you need to decide whether or not it forms a normal part of their pay. If it does, it should be included in the holiday pay calculation.

The latest case to make this point is East of England Ambulance Service NHS Trust v Flowers and others [2019] IRLR 798 CA, where the issue was whether or not voluntary overtime had to be included. We knew from Bear Scotland Ltd and others v Fulton and others; Hertel (UK) Ltd v Woods and others; Amec Group Ltd v Law and others [2015] IRLR 15 EAT that compulsory overtime had to be included in the calculation, and in Dudley Metropolitan Borough Council v Willetts [2017] IRLR 870 EAT the Employment Appeal Tribunal (EAT) held that the same applied in the case of voluntary overtime. However, the employer in Flowers argued that this conclusion could not stand in light of a comment made by the ECJ in Hein v Albert Holzkamm GmbH C-385/17 ECJ. This suggested that overtime did not count towards holiday pay at all because of its exceptional and unforeseeable nature.

The Court of Appeal rejected this argument and was surely right not to take an isolated comment from the ECJ too literally. What mattered was whether the overtime was indeed exceptional and unforeseeable or (as in Flowers) broadly regular and predictable. The Court concluded that voluntary overtime that was sufficiently regular should be included in the calculation.

The piecemeal manner in which the proper way to calculate holiday pay has been revealed through case law - Flowers being the latest example - means that many employers will have been underpaying holiday pay for years, possibly going back as far as 1998. When Bear Scotland was pending there was a worry that employees would be able to bring claims for the full amount of their arrears on the basis that each underpayment was one in a series of unlawful deductions from wages. The time limit for such claims starts to run from the final deduction in the series. If you could regard each underpayment in respect of annual leave as one deduction in a single series of deductions, the impact on employers would be massive.

It was this worry that prompted the Government to intervene. In the Deductions from Wages (Limitation) Regulations 2014 (SI 2014/3322) it provided that a series of deductions could not stretch back for more than two years. As it happened, it seemed this reform was not needed. The EAT in Bear Scotland held that a series of deductions was broken if more than three months passed between any two deductions. This meant that it would be difficult for deductions based on annual leave to form a series of deductions stretching back for any extended length of time.

The EAT's ruling surprised many because it seemed to have no basis in the legislation itself. Normally one would have expected the issue to be the subject of an appeal, but both sides in the case felt that they took something away from the decision and no appeal was brought.

In Chief Constable of the Police Service of Northern Ireland and another v Agnew and others [2019] IRLR 782 NICA, the Northern Ireland Court of Appeal has now ruled that the EAT was wrong to introduce a three-month rule in deciding whether or not two deductions are part of a single series. Technically the decision applies in Northern Ireland only and is not binding in the rest of the UK, but the Court's view is a highly persuasive authority - and has the additional benefit of appearing to be right.

The case has a particular impact in Northern Ireland because the two-year limitation introduced by the 2014 Regulations applies in Great Britain only. The case therefore opens up the Police Service of Northern Ireland to potentially huge claims for unpaid holiday pay.

However, even in the rest of the UK, the two-year limit is not guaranteed. The ECJ decision in The Sash Window Workshop Ltd and another v King [2018] IRLR 142 ECJ established that an employee who was denied paid holiday for the entire duration of his contract could claim compensation for the whole period. The Working Time Regulations will therefore have to be interpreted in such a way as to allow this. Whether or not the same principle applies in a case when paid annual leave is granted, but not paid at the correct rate, will probably be the next big issue for the courts to decide.

Brexit itself does not change this. Under the European Union (Withdrawal) Act 2018, our courts will continue to interpret the Working Time Regulations in a way that complies with EU law. Whether or not that remains the position under a new Prime Minister and with the prospect of a no-deal exit in October we will soon discover.