How Does the Furlough Scheme Interact With the Insolvency Regime?

The government’s ‘furlough’ scheme is an unprecedented means of saving jobs and viable businesses in the midst of the COVID-19 crisis – but how does it interact with the insolvency regime? The High Court addressed that burning issue in the context of a restaurant chain which went into administration within days of the UK entering lockdown.

The administrators of the chain, which had over 70 branches, planned to sell it as a going concern after the lockdown was lifted, a course which they considered would offer a better outcome both to its creditors and its roughly 2,000 employees. The chain had no money with which to pay ongoing wages so that, unless it were able to take advantage of the furlough scheme, the administrators would be forced to make the workforce redundant.

They had written to most of the employees, offering to apply for furlough grants so that, during their enforced lay-off whilst the pandemic persisted, they would continue to receive 80 per cent of their pay, up to a maximum of £2,500 a month. The letter stated that the chain was not in a position to meet the remaining portion of regular staff wages and that, by agreeing to the terms of the letter, employees would be consenting to their wages being cut by 20 per cent for the period of their furlough leave.

The administrators were, however, in a difficult position because, although the furlough scheme had been explained by the government in broad terms, no precise details had been given as to its legal structure and specifically how it was intended to operate consistently with insolvency legislation. Concerned that they might be accused of having acted inappropriately in dealing with employees and making applications under the scheme, they applied to the Court for guidance.

Ruling on the matter, the Court found that the letter had validly varied the contracts of all those employees – the majority – who had accepted its terms. That meant that the chain would not be liable for any wages in excess of the amount of grants received under the furlough scheme. It would also not be obliged to make payments to employees prior to receipt of the grant funds. In receiving furlough payments, employees would also enjoy super-priority over the chain’s other creditors.

The Court’s decision also opened the way for the administrators to make redundant those employees who had rejected the letter’s terms. Their employment contracts would be terminated. The position of employees who had not responded to the letter posed more difficult issues, however, in that they could not, by their silence, be taken to have accepted its terms.

The Court concluded that employees who had not responded would simply continue to be employed by the chain on the terms of their unvaried contracts unless and until they are terminated. In that they were not attending work, however, their contracts had not been adopted by the administrators. They would thus be treated as unsecured creditors and, in claiming wages due to them under their contracts, they would enjoy no greater priority in the administration than trade and other creditors.

The Court noted the importance of judges working constructively with insolvency practitioners in order to effectively implement the government’s response to the crisis in a similarly innovative manner. Its ruling on the law, whilst not formally binding, would enable the administrators to implement their proposals to furlough most of the chain’s employees without fear of future criticism.

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