Last month, the Employment Appeal Tribunal (EAT) handed down its decision in the combined appeals in Bear Scotland Ltd v Fulton and Baxter; Hertel (UK) Ltd v Wood and others; and Amec Group Ltd v Law and others.  All three cases looked at the issue of whether overtime earnings should be taken into account when calculating workers’ holiday pay in order to comply with the Working Time Directive (the Directive).  

As with any decision relating to the calculation of “pay”, the decision has potential implications in the field of pensions.  Fortunately for employers, the EAT’s decision means it is unlikely that many historic pension calculations will need to be revisited, even if adjustments are needed to pension contributions and entitlements in respect of holiday pay paid in future.

The background

The Court of Justice of the European Union (CJEU) has previously determined (in the case of Williams) that pay during annual leave under the Directive should reflect “normal remuneration”.     

However, the Working Time Regulations (WTR) and the Employment Rights Act 1996 (ERA) expressly exclude overtime for holiday pay calculation purposes if the worker has “normal working hours”, unless that overtime is compulsory and guaranteed.  So on the face of the legislation, non-guaranteed overtime (ie, overtime which the worker must work if offered, but which the employer does not have to offer) should not be taken into account when calculating holiday pay if there are normal working hours.

The EAT’s decision

Following the principles laid down by the CJEU in Williams, the EAT held in Bear / HertelAmec that holiday pay for a worker’s annual leave entitlement of 20 days under the Directive should be calculated on typical average pay, including non-guaranteed overtime.  To avoid the conclusion that the UK legislation was incompatible with the Directive in this respect, the EAT applied a purposive interpretation to the WTR and ERA provisions.

Therefore, employers will need to calculate holiday pay to include non-guaranteed overtime, at least for the 20 days’ leave provided by the Directive (which the EAT distinguished from the 8 days’ additional leave provided by the WTR and any contractual leave entitlement).

Many employers may decide to calculate all future holiday pay in the same way, in the interests of simplicity.  However, for employers who wish only to make adjustments in respect of the 20 days’ leave under the Directive, the EAT also indicated that those 20 days would be the first to be agreed upon during the course of a leave year.

The Bear case related specifically to non-guaranteed overtime, and did not decide the position on voluntary overtime (ie, overtime which the worker can refuse to perform).  Nevertheless, the reasoning in Bear seems broad enough to cover regular voluntary overtime, as well as any other payments (such as bonuses and allowances) where these can be viewed as part of the worker’s “normal remuneration”.  The CJEU has already confirmed in Lock v British Gas that commission must be included in holiday pay for the purposes of the Directive.

What does this mean for pension rights?

The effect of the Bear decision on pension rights will depend on the provisions of the pension plan concerned, and in particular, the way in which “pensionable pay” or similar terms are defined in the governing documentation. 

Pensionable pay is “contractual salary”

For example, if the definition of “pensionable pay” is based on the employee’s headline contractual salary as stated in his/her terms and conditions of employment (with the result that pension entitlements are not related to the pay actually received from the employer over the year), there should be no impact, either in respect of past or future payments.  The EAT’s decision on holiday pay does not alter the amount of the employee’s contractual salary: it merely confirms that under the WTR provisions, the employer is required to pay more than the contractual amount of pay in relation to the 20 days’ period of leave under the Directive.

Pensionable pay is “earnings received”

On the other hand, if the definition of “pensionable pay” is based on the employee’s actual earnings received, the fact that holiday pay will be higher in future is likely to feed through into calculations of pension contributions and benefits, because the employee will be paid more.  

However, past payments (whether of contributions or benefits) should not automatically need to be revisited, since these will have been calculated based on what the employee was actually paid by way of holiday pay (and the fact that he or she should as a matter of law have been paid more does not alter that factual position).  If any back-pay is paid across, adjustments may be needed at that stage, but for the reasons explained in the next section, employers’ exposure to back-pay claims is potentially very limited.

Pensionable pay is “basic pay”

The more difficult area is where the “pensionable pay” definition refers to “basic pay” received by the employee (either with or without an express exclusion of other forms of remuneration such as overtime).  Although there is no conclusive case law on the point, it seems strongly arguable that any element of holiday pay which is calculated by reference to remuneration other than basic pay (such as overtime, commission or bonuses) should not be considered to be pensionable under such a definition.    

This is because the overtime (or commission / bonus) would not have been pensionable if actually paid to the employee in return for work done.  It would therefore be somewhat illogical for a court to conclude that a part of the employee’s holiday pay which is calculated by reference to an otherwise non-pensionable element of remuneration should itself be classed as pensionable.

On this analysis, it is only “basic” holiday pay which will be pensionable, rather than the additional amounts payable as a result of the holiday pay litigation.  Therefore, in our view, the Bear decision should not have any impact on past or future pension calculations for pension plans where pensionable pay is defined as “basic pay” only.

However, even if a court disagreed with the above analysis, and concluded that the full amount of an employee’s holiday pay should be treated as “basic pay” and therefore pensionable, any significant impact would again be limited to future payments, since past calculations should already have been based on the pay actually received.

What about settlements?

Unexpectedly, the EAT’s decision in Bear means that it is unlikely that employers will be exposed to significant back-pay claims.  Generally, a claim in respect of a series of deductions from wages must be brought within 3 months of the end of that series.  The EAT decided that any interval longer than 3 months between underpayments in a series of deductions from wages will break the series and therefore prevent claims for back-pay in respect of periods prior to the break, unless the tribunal exercises its discretion to allow the worker to bring a claim out of time.  As a result, the prospect of sizeable claims for arrears of pay dating as far back as 1998 (when the WTR were first enacted) has receded, much to employers’ relief.  

However, although very helpful to employers, the EAT’s decision on back-pay is limited to deductions from wages claims brought in an employment tribunal, and does not provide comfort in relation to a breach of contract claim brought in the civil courts (where the limitation period is 6 years).  As a result, some employers may still want to achieve complete certainty by entering into negotiated settlements with employees (or trade unions) to deal with historic back-pay claims.   

In any case where there is any real doubt regarding the impact of Bear on accrued and future pension rights (which, as explained above, is likely to depend on the terms of the pension plan’s governing documentation), it would be legally possible, and advisable, for the settlement to cover pensions: for example, whether any element of an agreed compensation payment should be treated as damages for pension loss, or whether it should be treated as arrears of pensionable pay.  

Previous case law in the pensions arena, such as the Court of Appeal decision in IMG v German, has confirmed that such settlements of disputed or doubtful pension rights should not fall foul of section 91 of the Pensions Act 1995 (which prohibits members of occupational pension schemes from surrendering their accrued pension rights).  Similarly, there are a number of cases confirming that pension plan trustees should give  effect to terms which have been contractually agreed between employer and employee as regards pensionable pay.

Is there an impact as regards auto-enrolment?

The auto-enrolment legislation focuses on “earnings” actually paid to a worker, rather than on what should have been paid.  Again, therefore, employers should not be in breach of their auto-enrolment duties simply as a result of having previously underpaid holiday pay.  

However, higher amounts of future holiday pay could result in affected workers who currently fall below the auto-enrolment earnings threshold tipping into the “eligible jobholder” category, and payroll departments need to be alert to this possibility.  

In addition, the “tier 1” or “tier 2” alternative quality requirements both require pensionable earnings, as described in the scheme’s provisions, to be at least equal to “basic pay” (which under the auto-enrolment legislation specifically excludes “any commission, bonuses, overtime or similar payments”).  Employers who have self-certified their schemes as “qualifying schemes” by reference to tier 1 or tier 2 may want to document that they have considered the implications of the Bear and other holiday pay litigation for that certification, and to record whether (in line with the reasoning described above) they consider “basic pay” to exclude any element of holiday pay which is calculated by reference to any of the excluded payments.

Comment

It is likely to be some while before the full ramifications of Bear and other holiday pay cases are worked through.  From the employer’s perspective, there remain unresolved questions in particular about the fine detail of the holiday pay calculation, which it is hoped may be answered in the Lock v British Gas litigation early next year.  Further, although it appears that the claimants have opted not to appeal to the Court of Appeal regarding the issue of whether a 3-month break in a series of deductions will bar claims for back-pay, the point is one of general application to deductions from wages claim, rather than a specific issue relating to holiday pay.  As such, it seems likely that this particular aspect of the decision will be subjected to further judicial scrutiny at some stage in the future.

Nevertheless, employers looking to assess the implications of the decision for their overall employee cost-base need to be alert to the pensions aspects of the matter if they are to get the full picture.  Fortunately, this is one area which is not affected by the outstanding points of principle in the holiday pay litigation, and as such employers should be in a position to start working through the issues immediately.