So, where does this leave us now?
Since the Working Time Regulations 1998 were introduced, employers have been calculating the meaning of a weeks pay for the purpose of making holiday pay payments within the definition set out by the Employment Rights Act 1996. This method has been backed by the courts in various cases, but changes are afoot.
The current state of play
Basic salary as opposed to voluntary overtime, commission payments, or other supplementary bonuses has typically been the basis for calculating a weeks pay for most employees. In a series of cases, starting with a class action of British Airways pilots in the case of Williams v British Airways, the European Court of Justice (ECJ) has disagreed with this approach.
The ECJ has indicated that payments intrinsically linked to an employees performance on their contract of employment are payable as a portion of holiday pay. Consequently, the approach is that holiday pay should be reflective of an employees normal remuneration. The rationale behind this is that failing to make such payments reduces an employees earnings while on annual leave. This acts as a disincentive to take holiday.
Penalties are costly
As a result of this inadvertent underpayment of holiday pay, employers face huge financial penalties. The issue is compounded by the fact that, for claims brought in front of an Employment Tribunal, employees can plead that the last deduction from holiday pay was one in a series of deductions, going back several years. This makes this type of litigation a huge financial headache for businesses.
Already, claims management companies and no win, no fee law firms have launched advertising campaigns specifically targeting backdated holiday pay claims. This is particularly prevalent in sectors where a high percentage of staff earn part of their income on the basis of commission, shift allowances and regular overtime, or other bonus-type payments relating to an employee carrying out their contract of employment.
Grappling with the issue
Employers simply cannot afford to take their eye off the ball on this. There are a number of approaches they should consider as they grapple with this issue:
1. Audit, audit, audit
Work with your legal team, or payroll provider, to conduct a full audit of the scope of your holiday pay underpayments. This will help identify the risk to your business, and ensure you make fully informed, strategic decisions moving forward.
2. Settle backdated holiday pay claims straight away
Taking the bull by the horns, in the approach infamously undertaken by the John Lewis Partnership, has several potential benefits. Though initially costly, this approach removes ongoing liability and avoids future litigation costs, both in terms of time and legal fees. It is also likely to have a significantly positive impact on staff morale.
3. Solve the problem before holiday pay litigation becomes wide spread
With time limits so tight in the Employment Tribunal, a change now could cut the chain of liability offering a huge cost saving for employers. This will do little to cut the chain in respect of County Court claims, but far fewer claimant legal services providers will be offering litigation in the County Court as an avenue to their clients.
4. Adopt a new payment method for holiday pay that circumvents the need to increase payments going forward
One suggested method here involves a pro-rata reduction in overtime, commission and benefits. Another is the rolling up of such earnings and then deferring payment until after annual leave is taken. But keep in mind: the jury is still out on whether any of these methods will actually achieve their aims.
These approaches come with differing pros and cons. But, the message is clear. Be proactive. Do not wait. At the very least, businesses must ensure they are informed of the scale of the financial risks.
Emma Renke is an experienced employment law litigator who heads up MidlandHR’s employment law consultancy team.