Insolvency Proceedings

May 1998

76.27 When is a contract of employment terminated

The state of insolvency has no effect on contracts of employment, in the absence of a stipulation in the contract to the contrary. If the insolvency results in a breach of contract, e.g. non-payment of wages for services rendered, that is likely to constitute a repudiatory breach of contract, entitling the employee to treat the contract as at an end. The employee’s claim would then be one of constructive dismissal. The employee has the choice either to accept the breach and bring the contract to an end or to waive the breach and call for performance of the contract. Any subsequent insolvency proceedings will not in themselves release the employer from the consequences of the breach of contract but claims may be unsecured and/or subject to a range of statutory guarantees and preferential status. During a voluntary liquidation, the company retains its property and the liquidator is an officer of the company rather than the court. So the general rule is that the appointment of a voluntary liquidator does not, of itself, terminate contracts of employment, there being no purported change of employer. (For details relating to the effect of a winding up order see paragraph 76.30). If the effect of a winding up is an immediate cessation of business, there will be a breach of contract and employment will cease. If the liquidator carries on the business, then employment may continue until the business ceases.

Notes:  [s95 ERA 1996]

76.28EA Effect of insolvency proceedings

Under the insolvency provisions of the Employment Rights Act 1996, if an employer becomes insolvent certain debts owing to employees may be paid by the Secretary of State from the National Insurance Fund. The most common of these debts are arrears of pay, holiday pay and pay in lieu of notice. The provisions apply only when an employer has become formally insolvent, as defined in section 183 of the Employment Rights Act 1996. An employer who stops trading but against whom no legal insolvency action is taken is not deemed insolvent neither is a company which is dissolved (struck off the Register).

The following situations constitute insolvency:

a) where the employer is an individual:

  1. he has been adjudged bankrupt or has made a composition or arrangement with his creditors, or

  2. he has made a proposal for an individual voluntary arrangement which has been approved by his creditors, or

  3. he has died and his estate falls to be administered in accordance with an order under section 421 of the Insolvency Act 1986 (ie under The Administration of Insolvent Estates of Deceased Persons Order 1986).

b) where the employer is a company :

  1. a winding up order has been made, or a resolution for voluntary winding up has been passed with respect to the company,

  2. if the company is in administration for the purposes of the IA86,

  3. if a receiver or (in England or Wales only) a manager of the company’s undertaking has been duly appointed or possession has been taken by or on behalf of the holders of any debentures secured by a floating charge of any property of the company comprised in or subject to the charge, or

  4. if a voluntary arrangement proposed has been approved under Part 1 of the Insolvency Act.

The following situations do not constitute insolvency:

  1. receivership under a fixed charge,

  2. winding up under the provisions of the Insolvent Partnerships Order 1994 (where no bankruptcy orders have been made against the partners),

  3. receivership under the Law of Property Act 1925,

  4. appointment of an interim receiver, or

  5. receivership under the Agricultural Credits Act 1928.

Also, the appointment of a provisional liquidator prior to the winding up order does not create a state of formal insolvency.

Notes: [s183 ERA 1996 as amended by EA2002 schedule 17 paragraph 49]

76.29 Employer’s state responsibility (European Law)

Article 3 of Council Directive 80/987/EEC requires Member States to take measures necessary to ensure that guarantee institutions guarantee payment of employees’ outstanding claims resulting from contracts of employment or employment relationships on the insolvency of the employee. As a result of a decision of the European Court of Justice, (Case C -117/96) if an insolvent employer has employees who live in a Member State other than the United Kingdom, the insolvency provisions of the Employment Rights Act 1996 will normally apply to the employment debts (as described in the previous paragraph) owed to them.

76.30 Effect of winding up order and continuing the business

A winding up order terminates the contracts of employment of all employees of a company. The effect of the order repudiates the contract (Re Oriental Bank Corporation (1886) 32 ChD 336), even if employment continues after the making of the winding up order. This can have serious consequences for long serving employees as it breaks their continuity of employment and reduces the amount of any subsequent redundancy payment. However, if the liquidator continues to pay employees, the Secretary of State appears to take a practical view and treats the redundancy as occurring at the time of the eventual dismissal by the liquidator. Where a liquidator continues trading for a period after an order and then declares redundancies, there is some doubt as to whether redundancy payments due to employees are the liquidator’s personal liability or an expense of the winding up.

In order to avoid such uncertainty, a liquidator will often treat his appointment as dismissing the employees and then re-employ them under a new contract which contains an exclusion of his personal liability. In principle, a winding up order may terminate employment, but whether it actually does so may depend upon the nature of any work done by the employee after the date of the order. If the work is to further the liquidation alone, without any continuation of the business, then employment terminates. If the business continues after the date of the order and the employee continues to work in the business, then his employment may also continue. For further details regarding the continuation of a business see paragraph 76.34 and Chapter 62.

76.31 Debts payable

There are certain limitations to the debts payable by the Secretary of State from the National Insurance Fund (NI Fund) in an insolvency situation:

i) only those claimants whose employer is formally insolvent within the meaning of section 183 of ERA 1996 may qualify for payment,

ii) only those claimants whose contract of employment is terminated may qualify for payment,

iii) only those debts specified in the legislative provisions may be paid, and

iv) the amount payable in respect of any debt is subject to the limits laid down by the legislation provisions (these limits are subject to regular review and are increased as necessary).

The following is a brief list of the debts guaranteed and payable from the NI Fund :

  1. arrears of pay up to a maximum of 8 weeks, which may include guarantee payments, pay for time off work to carry out trade union activities and protective award payments under the Trade Union and Labour Relations (Consolidation) Act 1992,
  2. notice payment in compensation for the employer's failure to give correct period of statutory notice,
  3. holiday pay up to a maximum of 6 weeks during the last 12 months preceding the relevant date,
  4. any basic award of compensation for unfair dismissal,
  5. reimbursement of a fee or premium paid by an apprentice or articled clerk, and
  6. occupational/personal pension scheme contributions -additional voluntary contributions may be included.

Item (d) may be reclaimed in full but the other payments are subject to a maximum of £210 per week. The limit is reviewed each year. However, the maximum is subject to reduction if the employee earns from another source or receives unemployment or other state benefits during the period of notice. The Secretary of State may apply the limit before making deductions in respect of income tax and national insurance contributions (Morris v Secretary of State for Employment [1985] IRLR 297). Where an employer has a counter - claim against the employee, for example in respect of a loan, this may be set off (Secretary of State for Employment v Wilson and BCCI [1996] IRLR 209) and the employee's entitlement under the insolvency provisions will be the net amount owed after set off. Income tax and national insurance contributions should be calculated on the gross amount owed under the provisions before set off.

Notes: [s182 ERA1996][s184 ERA 1996][s186 ERA1996]

76.32 Who is entitled to make a claim

For a claimant to establish a basic entitlement to insolvency payments, the following conditions must be satisfied:

  1. the employer must be formally insolvent as defined in section 183 of ERA 1996,
  2. the contract of employment with that employer must have terminated,
  3. the claimant must have been an employee as defined in section 230 of the ERA 1996 (see paragraph 76.2).

Persons who are casual workers may be entitled to make a claim if it is established that they had entered into a binding arrangement which amounted to a contract of employment (see Re Carmichael and Another v National Power plc and paragraph 76.3 (7) ).

Self employed persons or members of a partnership do not qualify but may lodge a claim as an unsecured creditor in respect of monies due to them. Certain categories of employee are excluded from the scope of the legislation e.g. merchant seamen, share fishermen who are paid solely by a share in the catch and those who ordinarily work outside the territory of the European Union (EU). A claim may be made at any time after dismissal unless it is statute barred. In order to qualify for payment, the termination of the contract does not have to be caused by the insolvency or by dismissal but there has to be a relevant insolvency. Any former employee of an insolvent employer can claim debts owed at the relevant date, whatever the reason for the cessation of employment and no matter how long before the insolvency occurred (unless the claim is statute barred). There is one exception in that holiday pay depends upon when the debt accrued, ie it must have become payable in the twelve months before the relevant date. A claim on behalf of someone who has died may be submitted by a personal representative or person legally entitled to act on his or her behalf. The claimant is not required to have worked for the employer for a number of hours per week nor for a minimum period of time, except to qualify for a notice payment. There is no age limit for claimants. Employees of British registered companies who under their contracts of employment ordinarily work in other EU countries are entitled to insolvency payments ,except notice pay and the basic award for unfair dismissal (see paragraph 76.29). Employees of foreign registered companies which are wound up in Great Britain may be entitled to insolvency payments. The Channel Islands and the Isle of Man are Crown Dependencies and as such do not form part of Great Britain; however, the Channel Islands are covered by the EC Insolvency directive and should be treated as EC territory. The Isle of Man is not covered by the Directive and therefore should be treated as a non EC territory.

Notes: [s199 ERA 1996] [S196 ERA 1996][s196ERA 1996]

76.33 Procedures for making a claim

The insolvency practitioner appointed to the case is known as the employer's representative (ER) to the Redundancy Payments Service (RPS). Claims arise on the "relevant date" which is defined as the latest of the following dates:

  1. the date on which the employer becomes insolvent or
  2. the date of termination of the claimant’s employment.

The date on which the employer becomes insolvent should always be the date of the winding up order or the date of the bankruptcy order (the making of which automatically terminates all contracts of employment). In a company, if there have been prior insolvency proceedings, the effective date if that of the first insolvency. If the prior insolvency is a receivership, there are two effective dates and two separate sets of preferential debts, possibly overlapping. If employment ceased prior to the date of the winding up order but the employee was not dismissed, there could be arrears of pay and holiday pay beyond the date the employee last worked. The period may also count towards the employee's statutory notice entitlement, as his period of employment will be longer.

The "relevant date" for a basic award or remuneration under a protective award is the later of the following:

  1. date on which the employer became insolvent,
  2. date of termination of claimant’s employment, or
  3. date on which award was made.

Notes: November 2006

Employees who feel that they have a claim should complete an application form (RP1(T)); the form also includes the option to apply for a claim for compensatory payment for not getting proper notice. This form is available from the Insolvency Service website RPS will process all claims from employees of insolvent businesses. RPS will send a monthly statement to the official receiver in respect of each insolvency being dealt with showing the amount RPS has paid.

It is no longer necessary for the official receiver to complete and submit forms RP14 and RP14A to RPS. If contacted by RPS the official receiver should make the insolvent's wages records available for inspection.

RP14 is included in the preliminary information questionnaires (PIQDP, PIQB and PIQC) and should be referred to by the official receiver if queries are raised.

When RPS has taken a decision to pay or to reject a claim, the claimant has 3 months in which to apply to an Industrial Tribunal for a review of the decision.

76.34 Continuation of employment

Not all insolvencies terminate contracts of employment automatically, e.g. receiverships and voluntary liquidations. However, the employees are often dismissed upon the appointment of the insolvency practitioner. When an insolvency does not terminate contracts, the insolvency practitioner may retain some or all of the employees and keep the business trading. In these circumstances the employees cannot claim pre- insolvency debts until their employment terminates. Wages for the period after the insolvency must be paid out of the company's funds and no claims can be made under the insolvency provisions in respect of such wages. The Insolvency Act 1986, as amended by the Insolvency Act 1994, provides that in respect of contracts of employment adopted by an administrator, administrative receiver and receiver on or after 15 March 1994, the liability of an administrator, administrative receivers and receiver is restricted to "qualifying liabilities" i.e. wages, salary and contributions to a pension scheme (see also Paramount Airways (No 3) [1993] BCC 662).

Notes: [s19,s44 and s57 IA]

76.35 Preferential status of claim

An employee usually has preferential creditor status in the insolvency of his former employer. The Insolvency Act 1986 provides for the following employee's debts to be treated as preferential:

  1. 4 months arrears of wages , including unpaid commissions) subject to a maximum set by the Secretary of State from time to time by statutory instrument,
  2. arrears of pay for notice worked,
  3. statutory payments including guarantee payments, medical suspension payments, pay for time off and protective award payment (see paragraph 76.21),
  4. all accrued holiday pay ,that is for holidays not yet taken to which the employee became entitled in the 12 months prior to the insolvency,
  5. certain occupational and personal pension scheme contributions, and
  6. apprentices' and articled clerks' fees or premiums.

Any other sums due and owing such as pay in lieu of notice and unpaid expenses may be claimed as unsecured debts. The insolvency provisions enable the Secretary of State, within the prescribed limits, to pay the employees' specified debts in an insolvency, whether the debts are preferential or not. When the payments have been made, the Secretary of State assumes the rights of each employee and becomes a single creditor of the employer. The priority of the Secretary of State's claim depends on the priority of each payment made to the employee. Once payment in full has been received from the NI Fund, the employee has no further rights in the insolvency; however, if a debt has not been paid or only partly paid, the employee retains the right to claim the balance in the insolvency. Under the insolvency provisions of the Employment Rights Act, as much as possible of the payment must be recovered and repaid to the NI Fund first before any further payment is made to the employee.

Notes: [s175, Sch 6, [Category 5, para. 13] [s189 ERA1966]

76.36 Tribunals and Protective awards

In an action for unfair dismissal under the Employment Rights Act 1996, as well as the basic award, a "compensatory award" can be made as compensation having regard to the loss suffered as a result of dismissal. It may include compensation for immediate loss of earnings (i.e. between dismissal and the hearing), future loss of earnings, loss of fringe benefits, expenses in looking for work, loss of pension rights, loss of employment protection and the manner of dismissal if it makes the former employee less acceptable to another employer. In addition to the basic and compensatory award there is also the possibility of a "special award" where the unfair dismissal was on the grounds of trade union membership and of an additional award where there is a failure to comply with a reinstatement order.

A protective award is made by an Industrial Tribunal for employees in whose dismissal the employer failed to comply with the consultation requirements. An administrator must also comply with the consultation requirements and failure to do so may result in the employee applying to an industrial tribunal for a protective reward. The protective award will require the employer to pay the employees covered by the award their normal weeks pay for a specified period. The protected period will begin with the date on which the dismissal takes effect or the date of the tribunal award, whichever comes first. If during the protected period the employer made a normal payment under the terms of the employee’s contract of employment it will be offset against any payment liable to be made to the employee under the protective award. Since a protective award is treated as arrears of wages, it has the same priority as wages claims.

76.37 Tribunal after insolvency order

If the official receiver receives notification of an Industrial Tribunal hearing, he should inform the tribunal of the insolvency of the company (employer) and that the leave of the court is required to commence or continue any action against a company.

If an individual has applied to an Industrial Tribunal which has not been concluded at the date of his bankruptcy order, the action will remain vested in him. Any rights of action relating to bodily or mental suffering of a bankrupt or from injury to his person or reputation will remain vested in him. Similarly, in any actions for discrimination on the grounds of race or sex , the cause of action is not property and cannot be claimed by the trustee, but the proceeds of the action may be claimed. However, the trustee may be able to claim the funds awarded whether compensatory or otherwise, by Industrial Tribunals in respect of unfair dismissal for the estate, except those required for reasonable domestic needs. It is unlikely that a court would find the element of the award which relates to lost earnings (past or future) to be "income" under section 310 of the insolvency Act 1986, because it is compensation for income rather than being itself income, Therefore no income payments order would be required. See Chapter 31.9 Part 3 for further details regarding Rights of Action and paragraph 31.8.3 regarding after acquired property. Advice should be sought from Technical Section in such cases.

Notes: [s130]

76.38 Pensions

The Secretary of State can pay into the funds of a pension scheme certain unpaid employer's and/or employees' contributions, within limits, owed to the scheme when an employer becomes insolvent. An application for the payment of contributions may be made by "persons competent to act" i.e. the trustees, the scheme administrators or the employer's representative. The right to unpaid employer's pension contributions extends to :

  1. arrears accrued over 12 months prior to insolvency,
  2. arrears certified to be necessary to pay employees’ benefits on dissolution of the scheme, or
  3. 10 per cent of the last 12 months' payroll for the employees covered by the scheme.

The maximum payable is the lowest of these figures, any unpaid contributions owed to the pension scheme above these limits cannot be paid by the Secretary of State. The Secretary of State will defer payment until an insolvency practitioner is appointed. Where an employee receives arrears of pay under the insolvency provisions, the employer's representative should deduct pension scheme contributions from the payments and pay them to the pension scheme. In the event of a dispute the matter may be referred to an Employment Tribunal. For details regarding Pensions generally, see Chapter 61.

76.39 Redundancy payments

The insolvency of an employer will frequently lead to redundancies and the employee retains the three basic rights as set out in paragraph 76.26. The main condition for receipt of a redundancy payment is that the person must have worked for at least 2 years for the insolvent employer since the age of 18. An employer proposing to dismiss as redundant an employee whose job is recognised by an independent trade union must consult trade union representatives about the dismissal. If an employer fails to consult with a trade union, a complaint may be presented to an Industrial Tribunal unless it can be shown that there were special circumstances which made it impracticable to comply with the requirement. "Special circumstances" are not defined in the Trade Union and Labour Relations (Consolidation) Act 1992 but it has been held that insolvency alone is not a special circumstance (Clarks of Hove v Bakers Union [1979] 1 AllER 152). This is supported by the decision in GMB v Rankin and Harrison [1992] IRLR 514 that there is nothing intrinsically special about an insolvent employer or a receiver. In addition, the making of an administration order has been held not, in itself, to be a special circumstance (Re Hartlebury Printers [1993] 1 AllER 470). The amount of the lump sum payment depends upon how long the person has worked for the employer, how the years of service relate to particular age bands and the weekly wage but it does not constitute compensation for loss of earnings. An employee may claim a redundancy payment direct from the National Insurance Fund where he is entitled to such a payment in the usual way. Any claims for redundancy payment should be made on form RP21 which can be obtained from one of the Redundancy Payments Offices. Payment is sent direct to the person entitled.

76.40 Redundancy payment due after Bankruptcy order

A redundancy payment represents compensation for loss of an established job and is not intended to compensate the beneficiary for loss of future income (Wilson v National Coal Board [1981] SLT 67). If a bankrupt has not received the redundancy payment at the date of the bankruptcy order, he should be reminded that he has an obligation to inform his trustee of all property received after the making of the bankruptcy order and that this includes the receipt of any redundancy payment. A redundancy payment should not be treated as income but may be claimed as after acquired property. However, the official receiver must be satisfied that the amount claimed as after acquired property does not include any amount payable in respect of wages which should be regarded as income. See paragraphs 31.5.13, 31.5.14 and 31.8.3 for further details.

Notes: [s333]

76.41 Maternity payments

There are similar provisions for a claim from the Maternity Fund except that the employer need not be insolvent (Statutory Maternity Pay (General) Regulations 1986 (SI 1986 No 1960), Regs 7 and 30). An employee is entitled to her maternity pay even though the employer is placed into liquidation in the course of her absence (Secretary of State for Employment v Cox [1984] IRLR 437).

76.42 Procedure when an insolvency practitioner is appointed

The procedure as detailed in paragraph 76.33 should be followed to the point of despatching the necessary claim forms to the former employees. After the first meetings, if a liquidator or trustee other than the official receiver has been appointed, the RPS should be notified of the name and address of the insolvency practitioner. The employees should also be notified of the appointment of the liquidator or trustee.


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