Under the European Working Time Directive (the “Directive”), full-time workers are entitled to 4 weeks’ (20 days) paid holiday a year. When the UK implemented the Directive under the Working Time Regulations 1998 (“WTR”) full-time workers were granted a total of 5.6 weeks’ (28 days) paid leave each year. The WTR therefore grant additional entitlements to workers over and above that provided for by the Directive.
Whilst the intention was that workers would get a week’s pay for a week’s leave, what this payment includes has not proved that simple in practice.
The Directive requires workers to receive their “normal remuneration” during periods of annual leave. However, under the WTR, the method of calculating a week’s pay means that some elements of pay could effectively be excluded, such as commission and non-guaranteed overtime (i.e. overtime that an employer is not obliged to offer but the worker is obliged to work if it is offered). The European Court of Justice (“ECJ”) determined that this could result in a significant reduction in pay for some workers when taking their holiday and, as a result, could act as a disincentive to workers taking holiday, which undermines the health and safety principles underpinning the Directive.
What should be included in holiday pay?
There has been a line of cases from the ECJ which have held that under the Directive holiday pay is based on pay that is normally received and must include payments intrinsically linked to the performance of the worker’s contractual duties. The ECJ decisions relate to the 4-week entitlement under the Directive only.
The Employment Appeal Tribunal (“EAT”) in the two widely publicised cases of Bear Scotland Ltd and others v Fulton and others UKEAT/0047/13 and Lock v British Gas UKEAT/0189/15 has confirmed that the WTR must be interpreted as including other elements of pay when calculating holiday pay. Whilst Bear Scotland relates to non-guaranteed overtime and travel time payments and Lock relates to results-based commission, similar issues arise in relation to productivity, attendance, performance and possibly other allowances (such as “acting up”), standby or call-out payments and potentially even to discretionary bonuses.
Voluntary overtime was not directly dealt with in the Bear Scotland judgment but case law shows a steady movement towards including all elements of pay that are regularly made and “intrinsic” to the job. It is therefore likely that future tribunals will interpret voluntary overtime as forming part of normal remuneration if a settled pattern has developed over a sufficient period of time to justify the label “normal”. In fact the Court of Appeal in Northern Ireland has given its view (which is not binding) that, in principle, voluntary overtime should be included. In February 2016, the EAT dismissed the employer’s appeal in Lock, in which British Gas sought to argue that the WTR could not be interpreted in keeping with the Directive. However, the EAT is understood to have given permission to appeal to the Court of Appeal. If an appeal is submitted, these issues will be reviewed again but it is unlikely that any appeal will be heard before 2017.
What is clear from these cases is that money paid regularly enough to be labelled as “normal” should be included in holiday pay.
What is the correct reference period?
Payments need to be made for a sufficient period of time to constitute “normal”. The reference period for calculating holiday pay is currently 12 weeks prior to the date that holiday is taken. However, no comment has been made by the EAT as to whether this is in fact an appropriate period and employers are eagerly awaiting guidance on this. Will it remain 12 weeks or will it be amended to a longer period of time, such as 12 months, to account for seasonal fluctuations that might otherwise result in a significant cash windfall if holiday is taken at a certain time of the year? The Advocate General in Lock suggested that 12 months might be more appropriate but the ECJ did not specifically endorse this, saying that the appropriate reference period should be determined by member states.
Until the reference period is clarified specifically by the tribunals or amendments to the legislation, many employers are postponing amendments to their payroll calculations and holiday policies in case such amendments are incorrect. This is understandable; however, it is worth remembering that holiday pay claims could continue to accrue during that time.
Holiday pay claims
There was concern following the decision in Bear Scotland that workers could potentially make claims for unpaid holiday pay as part of a series of deductions from wages going right back to the introduction of the WTR. However, in response, the government introduced new regulations limiting back pay claims to 2 years, which took effect for claims made on or after 1 July 2015.
Whether an individual can successfully claim backdated holiday pay for the full two-year period will depend on whether there is a gap of 3 months or more between periods of annual leave taken. The EAT in Bear Scotland held that a gap of more than 3 months will break the chain of deductions and the individual’s claim will be time-barred from looking back prior to that gap. However, this is also the subject of another appeal to the EAT.
What should employers do now?
Whilst the legal position remains unclear, employers may wish to manage when workers are entitled to take holiday in order to:
- engineer gaps of over 3 months to narrow the remit of claims by refusing or deferring requests for leave; and/or
- prevent them from taking holiday after a period in which significant commission is traditionally earned or overtime is worked, which might increase the normal average remuneration and therefore the costs of meeting this liability.
It is unlikely, given the line of European decisions, that Lock will be overturned by the Court of Appeal. Employers who have not been including other elements apart from basic salary in holiday pay may wish to review their position at this stage. By including all elements of pay for the purposes of calculating holiday pay going forward, employers can attempt to extinguish the potential liability of many backdated pay claims and to manage the risk, rather than wait for their hand to be forced. There is the risk that ultimately this approach might be wrong but it may be worth taking. Much will depend on the employer’s particular circumstances, including their potential liability, the types and amounts of payments involved and the number of workers this affects.
Broadly speaking, employers currently have the following options:
- wait and see what happens with further appeals and decisions;
- accrue against the risk of claims with a view to meeting those claims or seeking to negotiate a settlement if and when necessary;
- actively change policies in keeping with the legal position as it currently stands to avoid future claims and break the chain in any alleged series of deductions. However, with this option there is a risk that payments could be miscalculated and workers could be overpaid.
It is unlikely that issues regarding the interpretation of the WTR and the reference period will be resolved in the short-term, therefore employers should consider taking legal advice to determine how best to approach this issue and manage its associated risks.