Holiday pay must be calculated to include payments for non-guaranteed compulsory overtime
Under Article 7 of the European Working Time Directive (Directive), all employees have the right to receive a minimum of 4 weeks' paid annual leave, although the Directive is silent as to how payments for annual leave are to be calculated. This is a fundamental entitlement from which there can be no derogation.
In the UK, the Directive is implemented by the Working Time Regulations 1998 (Regulations). The Regulations go further to provide that employees will be entitled to a total of 5.6 weeks' paid annual leave at the rate of a "week's pay" for each week of leave, which is to be calculated in accordance with a formula set out at ss. 221-224 of the Employment Rights Act 1996 (ERA). A distinction is made between employees with "normal working hours" and those with "no normal working hours". Where an employee has normal working hours they will be paid holiday pay based on the basic salary they receive for working those hours. Where an employee does not have normal working hours they will be paid holiday pay based on their average weekly remuneration calculated over a 12-week reference period.
Where an employee is entitled to overtime pay when working for "more than a fixed number of hours in a week or other period", the employee is treated as having normal working hours equivalent to the fixed number (section 234, ERA). In other words, non-contractual hours are ignored. Further, section 223(3), which concerns the calculation of an employee's average rate of remuneration, provides that overtime premia are to be ignored (the Overtime Provisions).
In 2004 the Court of Appeal in Bamsey v Albon Engineering & Manufacturing plc (2004)(Bamsey) considered a complaint by an employee who had worked an average of 60 hours per week in the 12-week period before he took his holiday. He was paid on the basis of his 39 contractual hours as his overtime was not guaranteed. The Court held that overtime would form part of an employee's "normal working hours" only where it was both compulsory and guaranteed. This meant that payments for compulsory and guaranteed overtime would be included in the calculation of holiday pay, but payments for other types of overtime would not. At that time, the Court of Appeal took the view that Article 7 of the Directive left the question of how to calculate weekly pay at the discretion of the Member States.
The CJEU decisions
Despite the Directive's silence as to how to payments for annual leave should be calculated, the Court of Justice of the European Union (CJEU) has determined a number of important principles in respect of the calculation of holiday pay:
Employees must continue to receive their "normal remuneration" during their annual leave (Robinson-Steele v RD Retail Service Limited (2006) and Stringer v Revenue and Customs Commissioners (2006)).
Normal remuneration means all components of pay which are “intrinsically linked” to the employee's contractual duties (Williams v British Airways (2011) (Williams).
Commission payments could amount to normal remuneration where there is an intrinsic link between the payments and the contractual duties. Where this is the case, such payments should be included in the calculation of holiday pay (Lock v British Gas Trading Ltd (2014)) (Lock).
The domestic overtime cases
The CJEU's decision in Williams suggested that the Regulations (including the definition of "a week's pay" in the ERA) did not comply with the Directive. Consequently, a number of Employment Tribunal (ET) claims were launched in which employees sought to argue that overtime payments formed part of their "normal remuneration" and should be included in their holiday pay.
In Elms v Balfour Beatty Utilities Solutions (2012), an ET held that overtime payments, standby payments and bonus payments did not need to be taken into account when calculating holiday pay. In the ET's view, it was not possible to interpret the Regulations to give effect to the CJEU's decision in Williams. If there was a defect in the Regulations, the ET took the view that this would need to be rectified by Parliament, rather than the courts or tribunals.
However, this view was not shared by the ET in the case of Neal v Freightliner (2012) (Neal). In Neal the Claimant was, throughout his overtime periods, performing tasks that he was required to do under his contract. The ET found that the fact that he might have volunteered to perform those tasks outside his contracted hours did not mean that his overtime pay was not "intrinsically linked" to the tasks for the purposes of the Williams test. Accordingly, the ET found that his overtime hours, pay and premia should have been included in his calculation of holiday pay in respect of the minimum 4 weeks' statutory annual leave required by the Directive. The ET achieved this by disapplying the Overtime Provisions in the Regulations.
Similarly, in Fulton and another v Bear Scotland Ltd (2012) (Bear), the ET decided that a worker who regularly worked overtime (but was entitled to refuse it on reasonable grounds) was entitled to see payments for overtime reflected in his holiday pay. Standby and emergency call out duties also had to be taken into account. The ET took the view that all of these payments were "intrinsically linked" to the performance of tasks required to be carried out under the contract.
Finally, in the cases of Woods and others v Hertel (UK) Ltd (2012) (Hertel) and Law and others v AMEC Group Ltd (2012) (Amec) the ET held that compulsory but not guaranteed overtime must be included in the calculation of holiday pay.
The employers in Bear, Hertel and Amec all appealed to the EAT. Although an appeal in Neal was commenced, it settled shortly before the hearing. All three outstanding appeals were heard together in July 2014. We report below on the EAT's decision, which was handed down earlier today.
Three key issues were addressed in the appeals:
Key issue 1: does the Directive require non-guaranteed overtime payments to be included in the calculation of holiday pay?
The EAT's view was that it was obliged to treat the decisions of the CJEU in Williams and Lock as of the highest authority. Provided there was an intrinsic link between the payment in question and the employee's contractual duties, this should be included in the calculation of holiday pay.
The EAT concluded that:
Normal pay is that which is normally received.
Payment has to be made for a sufficient period of time to justify that label.
In Hertel and Amec the overtime was compulsory and, although not guaranteed, it was required regularly enough for payments made in respect of it to be normal remuneration.
Accordingly, the Directive requires, and required, non-guaranteed overtime to be paid during annual leave. There was no scope for any uncertainty which would necessitate a reference to the CJEU on this issue.
Key issue 2: if so, can the Regulations be interpreted to give effect to such a requirement?
Looking through a "modern lens" the EAT held that it was obliged to interpret the Regulations in light of the wording and purpose of the Directive. This was achieved in the same way as in Neal (which concerned whether voluntary overtime payments should be included) by disapplying the Overtime Provisions. This reflects a trend of robust judicial decision making where the UK Courts seem increasingly willing to "rewrite" UK legislation.
Although the EAT did not expressly address the issue of whether purely voluntary overtime would be included in holiday pay, the route by which the EAT interpreted the Regulations to give effect to the Directive suggests that it would also be included, provided the payment in respect of that voluntary overtime formed normal pay and was paid sufficiently regularly over a period of time.
Key issue 3: if so, do historic underpayments constitute a series of deductions which would give the right to commence unlawful deductions from wages claims?
The Claimants had asserted that the sums due to them in respect of holiday pay had been unlawfully deducted from their wages. A claim that there has been a "series" of deductions from wages must generally be brought in the ET within 3 months of the last deduction in the series.
The EAT held that a series of deductions must have a sufficient factual and temporal link. This meant that there must be a sufficient similarity of subject matter, but also that there must be a sufficient frequency of repetition. In the EAT's view, this meant that there could not be a gap of more than 3 months in order for the deductions to form part of the same series. This part of the decision will be welcomed by employers since it severely limits the ability of employees to bring claims for historical underpayments.
The EAT flagged that its decision on overtime only applies to the 4 weeks' leave derived from the Directive. It indicated that in any holiday year employees will normally be deemed to take their Directive holiday entitlement first and the additional 1.6 weeks' leave last. This may mean it is easier to show a gap of more than 3 months in a holiday year. For example, a full-time employee has 28 days' holiday in a calendar year and uses their 20 days' Directive leave by 31 August and then uses the remaining 8 days' additional leave between September and December of that year. Those 8 days are not covered by this ruling and so there would no be no underpayment in respect of overtime. By the time the employee takes further Directive leave (perhaps in the January of the following year) a period in excess of 3 months will have passed. This would mean the employee could not bring a claim alleging a "series" of deductions in respect of both periods of Directive leave.
However, the EAT gave leave to appeal this aspect of the decision to the Court of Appeal.
This decision means that, going forwards, employers will need to reflect non-guaranteed but compulsory overtime payments in holiday pay in respect of the 4 weeks' Directive leave. Employers will need to decide whether it will make such payments in respect of the additional 1.6 weeks' leave. Although this is not a strict requirement, not doing so will be complicated from an administrative point of view.
Some employers may choose to adopt a "wait and see" approach given the possibility of further appeals and the number of unresolved questions on holiday pay including:
Is purely voluntary overtime included? The mechanism by which the Regulations have been read to comply with the Directive suggests that this is possible. Employers should consider what liabilities they have in this respect.
What is the correct reference period for calculating holiday pay? The Regulations refer to a 12-week reference period. Should this be used or another period? If so, what?
On 18 December 2014 the Government announced that it would introduce regulations to limit the scope of historic holiday pay claims to a maximum of 2 years. The rationale for this change is to: "protect UK business from the potentially damaging impact of large backdated claims". This limitation will apply in respect of claims brought on or after 1 July 2015. Claims brought prior to that date will be able to stretch back further (provided there is a series of deductions not punctuated by more than a 3 month gap).