What does insolvency mean for your employees?

Directors’ duties

A company’s directors owe duties to shareholders, which entail monitoring the company’s financial position closely and actively raising concerns about its finances at board meetings. They fail in this duty if they sweep mounting concerns about financial stability under the carpet and could be exposed to claims for damages against them personally.

Continuing to trade when a director knows or ought to have concluded that there was no reasonable prospect of the company avoiding liquidation or insolvency amounts to wrongful trading and will be a breach of directors’ duties to the company, its employees and its creditors, leaving directors liable to disqualification and even criminal prosecution.

Wrongful trading rules were suspended temporarily as a response to the Covid crisis but are now back in place.
Directors therefore need to take active steps to take professional advice from accountants, lawyers and insolvency practitioners about their liabilities and recovery options as soon as it becomes clear that a business is in difficulties that could lead to insolvency.

What happens to employment contracts?

If a company is compulsorily wound up or liquidated, this will automatically terminate employment contracts with immediate effect when the winding-up order is published or when a receiver is appointed.

In a voluntary winding up or liquidation, employers should check the employment contract to see if any provision provides for automatic termination when a resolution to wind up the company is passed.

If there is no such provision, then the contract will terminate when the liquidator decides to stop trading but will continue until that point. Some businesses may want to set up a new company to employ former employees, however that change of employer won’t break continuity of employment so the new business will acquire employees with existing length of service, and therefore rights to redundancy payments and to claim unfair dismissal (both of which require two years’ employment) will remain intact.

In an administration or where an administrative receiver is appointed, the administrator or receiver will effectively take the place of the employer and the employment contract will continue as normal with the employer, but with day-to-day management of employees effectively done under the administrator’s direction.

In some cases the insolvency practitioner may decide to carry on the insolvent business and therefore to keep some employees. They have a 14-day window from appointment to decide if any employment contracts will be adopted. This gives the insolvency practitioner a chance to carry out due diligence on the business so that decisions can be made about who to retain, but also to dismiss employees in the first two weeks after their appointment without creating a liability to continue to pay wages to retained staff.

What about employees’ salaries?

Employers will be liable for debts owed to their employees. This means the company remains liable to pay unpaid wages, notice pay, any money owed under contract such as unaccrued holiday or bonus (where the employee has been employed for more than two years) a statutory redundancy payment, and protective awards for failing to inform and consult employees before making them redundant (see below).

Certain debts owed to employees up to a fixed amount are regarded as “preferential debts” which rank third after the company pays out its secured creditors and expenses of the insolvent estate.

Preferential debts include renumeration owed for the four months prior to insolvency proceedings (up to a limit of £800 per employee), accrued holiday and certain pension contributions. Otherwise any sums owed to employees fall to be settled alongside other unsecured creditors and that is likely to mean that a small amount, if any, of the total sum owed will be paid.

It may be possible for employees who lose their jobs when a business becomes insolvent to claim payment for unpaid arrears of pay and notice monies and for statutory redundancy pay from the National Insurance Fund if these cannot be covered by the employer. The insolvency practitioner should provide affected staff with details of how to claim.

How should employers carry out redundancies?

A redundancy situation will arise where there is a business closure, a workplace closure, or a reduced need for employees to carry out work of a particular kind. In addition to any contractual redundancy policy, employers and insolvency practitioners must follow the correct process to avoid possible liability for unfair dismissal and protective awards of up to 90 days’ full pay per employee. These are ranked as preferential debts only if they relate to redundancies that took place before an insolvency practitioner has been appointed.

If 20 or more employees are to be made redundant collective consultation needs to be carried out. This involves electing employee representatives, providing certain information to them about the redundancy proposals and consulting with them about options for avoiding or reducing the number of redundancies.

An exception to the need to conduct collective consultation arises where there are “special circumstances” but it has been established by the courts that insolvency is not regarded as such.

Challenging as it may seem, the default is that there must be collective consultation if the numbers necessitate this, although it’s possible that protective awards made for failing to inform and consult would be reduced from 90 days to reflect the fact of an imminent insolvency.

Employers must also carry out individual consultation with those selected for redundancy (whether as part of a collective exercise or not) to ensure that the dismissal is regarded as fair.

Many travel businesses will have employees located abroad and working from home, which makes consultation a challenge, but given that consultation meetings can take place via telephone or virtually over videoconferencing, a scattered workforce is not a legitimate excuse for not doing it properly.

Where more than 20 employees are being made redundant, employers or the insolvency practitioner must notify the Department for Business, Energy and Industrial Strategy on a prescribed form. The employer and its officers will commit a criminal offence if they fail to notify.