Overtime to be paid during the minimum period of statutory leave

On 4 November 2014 in Bear Scotland and others v Fulton and others the Employment Appeal Tribunal (EAT) ruled that employers must now include most types of overtime when calculating holiday pay under the Working Time Regulations (WTR) for salaried workers. 

The judgment, which covers a number of different claimants working for two separate employers, also deals with some other variable payments and the rights of workers to bring claims for historic underpayments of holiday pay. 

As it changes our previous understanding of the law, this decision has serious ramifications for employers engaging workers whose pay incudes variable components to supplement basic salary, particularly those in retail, food and beverage, construction and manufacturing.

What is this about?

The WTR was introduced in 1998 by the UK government to give effect to the Working Time Directive. The Working Time Directive required all member states in the EU to introduce a minimum entitlement to four weeks’ paid leave (minimum statutory leave or “MSL”). 

The WTR incorporate complicated provisions from the Employment Rights Act 1996 in order to calculate the amount of holiday pay. For workers with normal working hours, these provisions have been interpreted for many years to exclude variable payments like commission, and also overtime earnings unless the overtime is guaranteed by the employer. 

In 2007 all workers in the UK were granted an additional 1.6 weeks’ paid leave over and above the minimum entitlement (additional statutory leave or “ASL”), taking the total amount of paid leave a worker is entitled to under the WTR to 5.6 weeks each year. This latest decision does not apply to the rate an employer pays either ASL or contractual leave in excess of a worker’s right to holiday under the WTR. 

Following two references to the European Court of Justice (ECJ), it has been clear that the method specified under WTR for calculating the rate at which holiday is paid during the MSL is inconsistent with the Working Time Directive.

The first reference, BA v Williams, was a case brought against BA by its pilots. The pilots relied on a very similarly worded Aviation Directive to claim their flying hour supplement should be included in their holiday pay. Previously holiday pay had been based on basic pay alone. In a ruling given in 2011, the ECJ held that holiday pay under the Aviation Directive should include all of the elements of remuneration which are “intrinsic” to the performance of the job.

Earlier in 2014 the ECJ held that the principle applied to the way an employer calculated a worker’s right to paid leave under the Working Time Directive. In this particular decision, Lock v British Gas, the ECJ went further and made clear that holiday pay during the minimum period of statutory leave must reflect a worker’s typical earnings. In that case, it held this should include commission as well as basic pay.

The latest development

In a conjoined appeal the EAT has now held that the rate of holiday pay during the minimum period of statutory leave should include payments to reflect:

  • "compulsory" overtime (where the overtime is not guaranteed but the worker must work overtime if required to do so by the employer);
  • “semi-voluntary” overtime (overtime that the worker could refuse on reasonable grounds);
  • supplements for working anti-social hours or being available to work at short notice. 

It has also held that it was possible to interpret the WTR to give effect to this principle. This has two knock-on consequences:

  • to calculate the amount of overtime to be included in holiday pay you would average the overtime paid during the twelve working weeks preceding the holiday; and
  • workers may be able to bring claims for historic underpayments of holiday pay, although the EAT decision has the effect of limiting the circumstances in which this will be possible

However, given the importance of these issues to so many employers, it is likely that there will be further appeals.

Not all of this decision is new. Employers should already be including contractually guaranteed overtime in the way they calculate all holiday pay under the WTR. Moreover, workers without normal working hours, such as zero hours workers, should already receive holiday pay based on an average of all earnings paid in the last twelve weeks of work prior to their holiday.

How far back can claims for underpaid holiday go?

Following the EAT’s judgment, workers can bring claims for underpaid holiday pay during MSL as an unlawful deduction from pay. However, the decision limits the circumstances in which this will be possible. 

The decision applies only to payments of MSL. That means, at least according to the EAT, that in most cases workers will not be able to establish a continuous series of deductions, since they will normally have been paid ASL at the “correct” rate at some point during the previous holiday year. That in turn means many claims for historic underpayments are likely to be out of time, since they must be brought within three months of the underpayment or the last underpayment in a continuous series of deductions.

What is still unclear?

The way in which UK employers calculate holiday pay is likely to continue to be the subject of litigation for many years ahead. Not only is the EAT’s Judgement likely to be appealed on both sides (indeed leave has already been granted for appeals to be brought) but there are a number issues which have yet to be finally resolved, the key ones being:

  • We know that non-guaranteed overtime and linked variable payments should be included in the way an employer calculates holiday pay during MSL. However this decision does not address commission, which is subject to separate litigation. It is possible that different rules will apply to calculating the element of holiday pay attributable to commission.
  • It is not completely clear from the decision whether purely voluntary overtime should be included for workers who otherwise have normal working hours, though there is no reason in principle why this should be treated differently.
  • The WTR uses a reference period of the last twelve working weeks to calculate holiday pay where a worker has no normal hours of work or where he/she has normal hours but their pay varies according to the amount of work done or the time of work. It is now clear that the sum included in holiday pay for any overtime component should be assessed in the same way. If the reference period remains twelve weeks and the variable pay component fluctuates widely throughout the year, this will result in significant variances in holiday pay. Workers will wish to take MSL after periods where, for example, high levels of overtime was earned in order to benefit from a higher rate of holiday pay.
  • When all types of holiday were paid at the same rate, it did not make a difference whether the period of holiday was part of a worker’s MSL, ASL or contractual holiday in excess of that. If, following the EAT’s Judgement, an employer chooses to maintain different practices for calculating the rate of holiday pay (see below), employers will need to know when a worker is taking their MSL. Some employers have provisions in their employment contracts which specify that leave under the WTR is deemed to be taken first. However, many do not and will need to agree when a worker is deemed to be taking MSL. 

What should employers do?

The two important questions for all employers are:

  • whether to change the way holiday pay during MSL is calculated or to wait for the outcome of any further appeals;
  • if a decision to change is made, whether this should apply only in respect of MSL or ASL or indeed any contractual holiday in excess of statutory leave.

To reach this decision employers should undertake a cost/risk benefit analysis by taking the following steps:

  • identify those categories of workers whose holiday pay could change (those with normal working hours whose pay varies as opposed to those paid a fixed monthly salary with no overtime entitlement);
  • identify whether each variable pay component could be deemed “intrinsic” and therefore should be included in the calculation of holiday pay during MSL;
  • taking a sample of each category of worker whose holiday pay could change and looking at all “intrinsic” pay elements averaged over a period of 12 weeks in the current year, calculate the extent to which holiday pay during MSL would be higher if it was calculated as per the EAT’s Judgement;
  • assess the administrative burden of calculating holiday pay differently depending on whether this is MSL, ASL or contractual leave in excess of statutory leave;
  • consider your industrial relations and the prospect of claims; and
  • consider the prospect of adverse publicity.

Employers who have been paying holiday pay incorrectly and who choose not to change their practices would be well advised to allocate monies to a budget to meet any later claims.  For any employer affected by the changes in holiday pay, it will be important to consider this factor in determining the extent of future salary increases to avoid an unwelcome impact once the law has been finally settled. The extent to which it impacts any decisions will need to be given appropriate weight alongside other factors such as staff morale, employee retention and industrial relations.