How holiday pay is calculated has attracted much press coverage recently. What we now know is that the overtime pay must be included when calculating holiday pay. In a well publicised case in the UK Employment Appeal Tribunal, “non- guaranteed” overtime – that is, overtime which the employer is not contractually obliged to offer but which the worker must work if required to do so – must now be included in the calculation of holiday pay. The logic underpinning the decision is that if overtime pay is “intrinsically linked” to a worker’s duties it has to be paid in respect of holiday. So what are the key implications of the decision.

Which holiday does it apply to?

It only applies to the 4 weeks’ holiday, not the additional 1.6 weeks holiday entitlement in UK law. However, the practical concern is that treating the two elements of statutory holiday separately could cause considerable administrative complexity.

Time limits for claims

Time limits for claims have attracted significant attention and commentary. A shortfall in holiday pay counts as a deduction from wages – these types of claims must usually be brought within three months of the deduction.  However, if there has been a series of deductions over time, all underpayments in the series can be recovered provided the claim is brought within three months of the last underpayment in the series. Therefore, it would be possible for claims to stretch back for the entirety of a workers employment with a long stop date of October 1998. But if there is a gap of more than three months in any series of deductions, a Tribunal will not have jurisdiction to hear the claim. In practice this means that claims for underpayment of holiday pay will be out of time if there has been a break of more than three months between successive underpayments.

In December 2014, the Government announced that it will impose a cap of 2 years on claims for back pay.  This seems to be a direct response to concerns of the potentially damaging impact on businesses of large backdated claims.  The cap will take effect for claims submitted on or after  1 July 2015. It will not affect claims submitted before then so those could potentially still stretch back to October 1998.

Implications for mergers and acquisitions

In the context of M&A, buyers of UK businesses face uncertainty regarding the potential liabilities of the target business for backdated claims for underpayment of holiday pay. Clearly, it will be important to use due diligence to gain an understanding of the potential size of the problem and for the buyer to negotiate appropriate warranty and indemnity protection in the sale and purchase agreement. The imposition of a 2 year cap will be helpful in identifying a quantifiable liability and should make drafting appropriate indemnities more straightforward.

The calculation of holiday pay is likely to take another twist in February 2015 when a case about the inclusion of commission in the calculation of holiday pay is decided. It is likely that the decision will follow the decision about overtime pay. If this is an issue on current transactions (say in businesses that have a  large sales function), buyers should consider negotiating appropriate warranty and indemnity protection in the share and purchase agreement as it is likely that the potential size of such liability will be significant.