Holiday Pay

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The Problem

So off I go on holiday to the sunny climes of the Mediterranean; an escape from the office for a precious two weeks’ break.  Whilst getting paid by my employer to lie on a sun lounger and sip sangria, a thought flashes through my mind – “can I afford another sangria?”  Put another, more legal way, am I being paid the right amount of money for being on holiday or am I being underpaid?

The Principle

The European courts are increasingly interested in workers taking holidays and receiving the correct holiday pay. Indeed, the cases referred to below run alongside a growing body of cases addressing issues around holiday entitlements and sickness absence.

What does the law currently say?

European Legislation

Article 7 of the European Working Time Directive 2003 (WTD) requires the UK to ensure that workers have the right to at least four weeks’ paid annual leave.  However, it does not specify how pay for this leave should be calculated. This is left to national legislation to determine.

UK Legislation

The WTD is implemented into UK law by the Working Time Regulations 1998 (WTR).  The WTR provide workers with 5.6 weeks’ (i.e. 28 days) annual leave.  Workers are entitled to be paid at the rate of a ‘week’s pay’ for each week of leave.

Sections 221 to 224 of the Employment Rights Act 1996 (ERA) prescribe how to calculate a week’s pay.  The calculation depends on whether a worker’s hours and remuneration vary week to week. If a worker’s hours or pay vary week to week, a week’s pay is calculated by averaging pay over a 12 week reference period.  This sounds straight forward enough but here comes the Sirocco wind to blow sand in the employer’s sandwiches!

Case law

In 2006 the European Court of Justice (ECJ) ruled that workers must continue to receive their “normal remuneration” whilst on holiday (Robinson-Steele v RD Retail Service Ltd).  The ECJ expanded on the concept of “normal remuneration” in Williams and Others v British Airways plc (2011).  In Williams the ECJ ruled that  workers should be no worse off during annual leave than if they were still working.  Thus, a week’s pay should be at the rate of the worker’s normal remuneration which will include any payments “intrinsically linked” to the performance of the worker’s job.  In the Williams case this included flying supplements for pilots (but excluded certain expenses on the basis that these were only in fact incurred if an employee was at work).

A year later in Fulton v Bear Scotland (2012) the Employment Tribunal (ET) decided that normal remuneration should include payments received by an employee over a 12 week reference period including overtime, stand-by payments and call out supplements.  In Neal v Freightliner (2013) the ET then decided that normal remuneration could include non guaranteed overtime payments. Fulton and Neal are first instance decisions and are therefore not binding.  However, both of these cases are also being appealed and are to be heard together at the end of July by the Employment Appeal Tribunal (EAT) (see below).

Building on the above cases comes the most recent case of Lock v British Gas Trading Limited (2014).  In this case the ECJ was tasked with deciding whether a worker’s normal remuneration should be made up of basic salary and commission?  Was the commission element of Mr Lock’s remuneration intrinsically linked to his job?

Mr Lock was employed by British Gas as an Internal Energy Sales Consultant.  His remuneration consisted of a basic salary and (predominantly) commission, both payable monthly.  There was a time lag in paying commission. Commission payments received each month typically related to sales made by Mr Lock in previous months.  This meant that there was a period after Mr Lock’s holiday when he would receive less commission because no commission could be generated whilst Mr Lock was away.

The ECJ concluded that Article 7 of the WTD precludes a national law under which a worker receives statutory holiday pay based only on his basic salary.  The consequence of this is that:

  • normal remuneration should also include commission (even though no commission was being earned whilst away on holiday);
  • a reduction in a worker’s remuneration is liable to deter him from exercising his right to take annual leave; this is contrary to the objective pursued by the WTD.  The fact that the reduction in remuneration might occur sometime after the holiday period is irrelevant;
  • Mr Lock’s commission payments were directly and intrinsically linked to the performance of the job he was required to carry out under his employment contract.  Therefore, commission should form part of a worker’s normal remuneration and must be taken into account when calculating holiday pay.

The Practice

So will my organisation be affected?

Certain sectors or professions will be harder hit by the Lock ruling (and the appeal rulings we anticipate later in the summer) than others.  Workers on fixed salaries are not likely to be affected; it is straightforward to calculate their normal remuneration.  Workers with variable hours and/or variable pay are more likely to be affected.

Thus, if any of your workers are paid, for example:

  • commission;
  • overtime;
  • work related allowances (e.g. shift or attendance allowances);
  • call out or stand-by payments; and/or
  • certain bonuses linked to individual financial contribution/performance.

then it is likely their pay will be variable and this ruling may impact upon your organisation because it may impact upon what you should pay workers whilst on holiday.

However, it should be stressed that even if workers receive variable pay the ruling may not, ultimately, have any impact.  This is because either you are already paying holiday pay in a way compliant with the ruling or because the specific terms and practice of certain payments made are not actually caught by the ruling.  Discretionary performance related bonus schemes or profit share schemes may not, for example, be caught by the ruling.

To determine where you stand as a business on this issue, you will need to begin by considering your remuneration payments and structures to see if holiday pay has been (and is being) calculated and paid correctly.

How should I calculate holiday pay?

In Lock the ECJ dodged answering this question, noting it was for the UK courts or tribunals to determine on the basis of an average over a reference period, probably of 12 weeks.  The Lock case has been passed back to the ET to determine this point.  But in light of the above cases and the ECJ’s comments in Lock, our current opinion on this is that employers should calculate a week’s pay by calculating what intrinsically linked payments have been paid to a worker in the 12 week working period (prior to the holiday) and dividing this sum by 12.

What if holiday pay has not been paid correctly?

There are two areas of risk if this is the case.

Historic and backdated claims – In order to deal with claims which may already exist (but which have yet to be brought) we suggest you:

  • establish the extent of the potential liability.  The current legal thinking is that holiday pay claims (in the form of unlawful deduction from wages claims) could be made for incorrect holiday pay on 20 days per year going back to the longer of the start of employment or, possibly, the start of the WTR  on 1 October 1998.  There may also be a pensions issue if contributions to pension funds have been based on pensionable salary excluding, for example, commission payments and establishing what may amount to “pensionable pay” under your pension scheme is an important early consideration;
  • establish the risks of those claims landing – are workers (or their unions) raising these claims now?  If you look to address future claims (see below) what will need to be done in respect of the potential for historic claims?;
  • make budget allowances.  The value of any allowances to be made will be determined by the potential value of the holiday pay liability – see above;
  • establish an approach to dealing with such issues based on your findings to the above points.  For example, will you be proactive or reactive?  Being proactive may mean looking to correct any short fall in holiday pay by paying lump sums (as John Lewis did some time ago), perhaps through settlement agreements or offsetting the anticipated costs of such claims by not making discretionary bonus payments.  Being reactive may mean remaining on your sun lounger until the legal position is clarified, either through the conclusion of the current cases or the government amending the WTR.  Either way, we anticipate that any holiday pay claims made now will be adjourned pending the conclusions of the current cases.  This means claims could rumble on for some time.

Future claims – The danger of being proactive and taking any action to address future claims is that it may alert workers to historic claims.  However, taking action may also crystallise the value of future claims.  Therefore, in order to limit claims, which may otherwise exist in the future, you could consider:

  • reviewing and revising contractual terms such as overtime (as well as any terms which may be created by custom and practice) to clarify what normal remuneration is.  Reviewing terms will obviously require careful planning and workers giving consent to the changes which may in turn increase the potential for historic claims;
  • adjusting holiday pay to account for commission and other ‘intrinsically linked’ payments made to workers – this may help break the chain of historic claims if such claims are not lodged in the tribunal within three months of the revised payments being made.

What’s next?

The best way to understand the current direction of travel on holiday pay issues is to understand the EU’s position that holidays are sacrosanct; “thou shall do nothing to dissuade or prevent workers from taking holidays.”

This means that we expect the two cases going through the EAT in July (Neal and Fulton) to ultimately go the same way as Lock – i.e. found in favour of the employee (even if the cases first get referred to the ECJ).  Therefore, we would expect the courts to confirm that, in addition to commission payments, holiday pay must be calculated by reference to a 12 week reference period and include, for example, non guaranteed overtime, standby payments and call out supplements.

The fact that a general election is on the horizon and UKIP has won support in recent months adds an intriguing political angle to this issue.  It is clear that the CBI and other employer representative groups are lobbying the Government hard on this subject.  The Government has also, for the first time, been given the ability to play a part.  We understand that it will be represented at the Neal and Fulton hearing later this month.  However, leaving this intrigue for novels read by the pool, employers need to be alerted to the issue and we recommend that, at the very least, they carry out an impact assessment and prepare appropriately for what may bring a bad case of the post-holiday blues.

For more information help or advice on this issue please contact Tim Davies on 0191 211 7927 or email [email protected].