Furlough and insolvency – High Court ruling on Carluccio’s

What’s been happening at Carluccio’s?

Since Carluccio’s went into administration, the administrators have been pursuing a two-pronged strategy involving “mothballing” the business while, at the same time, seeking to find a buyer. As part of this approach, they wanted to furlough the employees and take advantage of grants payable under the Coronavirus Job Retention Scheme. By doing so, they would not only have better prospects of achieving a sale but would also hope to avoid otherwise inevitable redundancies.

Carluccio’s had no money to pay wages. The administrators therefore wrote to the employees, asking them to agree revised employment terms under which pay would be reduced to whatever was recoverable from the furlough scheme – with Carluccio’s having no obligation to make any payment until cash was received from HM Revenue & Customs (HMRC). Of the nearly 1,800 employees, over 95% agreed to the arrangement. Four rejected the change, saying they wanted to be made redundant. The others did not respond and are being chased for a decision. 

Under the furlough scheme, money received from HMRC must go to the specific employees who are furloughed - it can’t be spent on other things. This caused a potential problem for the administrators, as there are strict rules in an insolvency situation about the order in which debts are paid off. The danger was that those rules would trump the requirement to use furlough money only for those who had been furloughed, meaning the administrators had to use it to meet other claims.

“Adoption” of employment contracts

The only realistic solution was for the administrators to “adopt” the contracts of employment of the staff concerned. If contracts are adopted, wages paid under them have a “super priority” and are payable even before an administrator’s own fees. As administrators generally expect to be paid for what they do, adoption of employment contracts is practically equivalent to a guarantee. It ensures that, where administrators are seeking to rescue a business, employees will receive pay for the work they do during the course of the administration. 

Adoption requires some positive action by the administrators, which typically would involve giving employees work or paying wages. The problem in Carluccio’s case was that employees would be furloughed, doing no work and - at least until the HMRC grant came through - receiving no wages. 

High Court’s decision

The administrators wanted a direction from the High Court as to whether they could treat the contracts of those on revised terms as adopted and, if so, when that adoption would occur. The judge made a declaration that those contracts would be adopted when the Administrators made an application for a payment under the furlough scheme, or when the employees concerned were paid under the revised terms (if earlier).

As the HMRC online claims portal for the Coronavirus Jobs Retention Scheme is expected to go live by the end of April, the employees’ contracts are likely to be adopted in the next couple of weeks.  Clearly this is good news for the employees concerned - and, so long as a buyer is found, also for those of us hankering after a bowl of pasta and a glass of Valpolicella…

Postscript

A few days after the High Court’s judgment, on 15 April 2020, the Treasury published its formal direction setting out the rules that HMRC must follow in operating the Coronavirus Job Retention Scheme (covered in our FAQs on the scheme). This appears to create some problems for Carluccio’s and its administrators.

The Treasury Direction document sets out in some detail which payments qualify for the scheme grant. It uses a concept of “regular salary or wages” and says that this cannot include salary or wages which are “conditional on any matter”. Payment under Carluccio’s arrangements is conditional on receipt of the cash from HMRC. Will there be a further application to the court?

In the matter of Carluccio’s Ltd (in administration) [2020] EWHC 886 (Ch) – judgment available here