Employers in the UK will have to look carefully at how they calculate holiday pay in light of the decision of the European Court in Lock, a case referred from the UK employment tribunal, and a forthcoming decision in the EAT dealing with holiday pay and overtime.

The claimant in Lock was a gas sales consultant whose pay was made up of basic salary plus commission calculated on the basis of completed sales.  The commission was generally paid some weeks after the conclusion of the sale, but typically represented over 60% of his normal monthly earnings.

During holiday periods the claimant was paid in the same way as when he was at work: his basic salary plus any commission due from sales completed previously.  He took three weeks' annual leave over a Christmas and New Year period; during this time he received past commission but did not earn any commission as he was not making any sales and, as a result, his salary in the months following was reduced.  He then decided to ask for, in effect, a "top-up" to reflect losses of commission payments in the future, in the form of a claim for unpaid holiday pay and, because the UK's Working Time regulations do not make it clear precisely what must be included in holiday pay, the employment tribunal referred the claim to the European Court.

The European Court – traditionally fiercely protective of annual leave as a health and safety requirement – found that the approach taken by the employer was not in line with the European Working Time Directive.  Workers must retain their normal remuneration during a period of holiday; if they are at a financial disadvantage as a result of taking holiday, they might be deterred from taking it, particularly where (as in this case) commission represented a substantial proportion of earnings.

The European Court went on to explain that this principle applies to any payments "linked intrinsically to the performance of the tasks which the worker is required to carry out under his contract of employment".  In addition to commission, the Court said that allowances for seniority, length of service and professional qualifications should also be maintained, but other components "intended exclusively to cover occasional or ancillary costs" do not have to be taken into account.

The case is now returning to the employment tribunal to assess how the commission element of holiday pay should be calculated; the view of the Advocate General in the preliminary European Court Opinion was that the employee should get holiday pay which includes basic pay, commission actually payable during that period and a proportion of commission (averaged over a period of, say, 12 months) to reflect what he would have earned had he been working rather than on leave.

The case creates considerable uncertainty as to how to calculate the holiday pay entitlement of employees rewarded on any sort of performance basis.  The principle in Lock clearly applies to commission and almost certainly overtime (the subject of cases currently in the Employment Appeal Tribunal in the UK), performance bonuses and standby/call-out payments.  Even allowances might be caught if they are a form of bonus rather than for travel or subsistence.  A particular concern is the possibility of back-dated claims, going back as far as 1998 when the Working Time Regulations were introduced in the UK.

Other knock-on problems include:

  • Over what period of time does holiday pay that includes additional earnings have to be calculated?  The decision in Lockapplies only to the 20 days' leave stipulated in the Working Time Directive, not the full 28 days provided for by the Working Time Regulations.  But the difficulty of assessing which 20 days to apply it to may mean that it is logistically easier to apply it to the whole 28 days.
  • On a business sale, liability for holiday pay claims will pass under the TUPE regulations to the transferee.  Transferees will want to consider how best to deal with that potential liability.
  • Employers who run flexible employee benefits schemes which enable employees to buy and sell part of their leave allocation might need to think about changing the way the price for buying extra leave is calculated.

Following the EAT decision that is expected in October there may be more clarity about how the Working Time Regulations can be reconciled with the underlying Directive in terms of calculating holiday pay.  Employers will want to consider changes to their holiday pay calculations relatively quickly, given that the three month time limit for bringing a claim for unauthorised deductions from wages in the UK tribunals will not start to run until the last payment not calculated in accordance with the Lock decision is made.