Holiday pay – a practical guide to the law

Why has holiday pay suddenly become a topic for board level concern at a number of manufacturing companies asks Akshay Choudhry – an associate at leading UK law firm, Burges Salmon.

Overtime, shift allowances and productivity bonuses are all long established remuneration practices in the manufacturing sector, helping employers to incentivise and organise their workforce.

Akshay Choudhry, associate, Burges Salmon LLP.
Akshay Choudhry, associate, Burges Salmon LLP.

Unfortunately, the prevalence of these pay practices is now creating a headache for those who have relied upon them.

What is the issue?

All workers are entitled to paid holiday, which employers have generally paid at basic rate of pay (guaranteed, compulsory overtime and shift premia – which form part of the employee’s normal contractual working hours – have also been included).

However, a series of recent court decisions have decided this is inadequate.

Instead, workers should be paid their ‘normal remuneration’ for their four weeks’ annual leave guaranteed by the European Working Time Directive.

Applying the core principles distilled from recent decisions, normal remuneration should arguably include all of the following, in addition to basic pay:

  • regular non-guaranteed, but compulsory, overtime (i.e. overtime that the employer is not required to provide but which the worker is required to work if offered);
  • bonuses based on individual performance (an annual bonus may not be a regular enough payment to count as normal remuneration);
  • on-call or standby payments;
  • commission payments based on individual performance; and
  • any other allowances or payments that are intrinsically linked to a worker’s employment and/or relate to their personal or professional status, provided they are made with sufficient regularity.

What is the impact on employers?

There are a number of likely consequences:

  • Workers who have been underpaid holiday pay may be able to bring claims for historic underpayments (though, since 1 July 2015, a cap of two years applies to historic holiday pay claims).
  • If businesses need to pay additional holiday pay going forwards, this may significantly increase the wage bill. The EEF estimates that 93% of manufacturers will see increased wage costs. This could present a challenge where profit margins are tight – businesses may try to pass the cost onto customers through price increases or to cut costs elsewhere.
  • When businesses grow through acquisition or when services (such as logistics) are outsourced, the parties normally enter into indemnities regarding historic liabilities for employees who transfer. These indemnities can include liability for underpayments of holiday pay. Businesses involved in any such transactions should check their commercial contracts to assess their position.
  • Employers may also have a shortfall in pension contributions if holiday pay is included in pensionable earnings (as defined in the relevant pension scheme rules).
  • Businesses also need to consider their employee relations environment. While trade union influence in manufacturing has declined from its peak, it remains significant; a unionised workforce may require a different approach to one that is not.

Outstanding issues

Unfortunately there remain a number of issues yet to be clarified by the Courts.

For example, while the aforementioned payments should arguably be included in holiday pay, question marks remain over others – the most significant of which for many is voluntary overtime.

While the Northern Ireland Court of Appeal recently held that there is no principle preventing the inclusion of voluntary overtime in holiday pay calculations, this decision is not binding on the Courts of England, Scotland or Wales and, furthermore, the Court did not hear full arguments on the key issues.

There are also unsettled arguments in relation to what regularity is required for a payment to be normal remuneration and what reference period should be used to determine an employee’s average pay for holiday pay purposes.

Nonetheless, there is sufficient clarity for employers to assess risk now and develop strategies.

What options do employers have?

There is no universal solution. The best starting point is to carry out an audit of what payments you make to workers and whether these are included in holiday pay.

It can be a good idea to involve your lawyers in the audit so that a confidential, privileged report can be prepared.

Depending on the audit outcome, various non-mutually exclusive options are available.  These include:

  • Do nothing – this may be viable if your audit reveals low risk and/or your workforce is not vociferous. In addition, certain aspects of these recent decisions remain under appeal, so waiting for more certainty will be a viable option for some;
  • Settle historic claims – depending on your bargaining position this may be cost effective, particular now that the two year cap applies to historic claims. A carefully crafted message that increased labour costs could lead to reduced headcount may smooth the path for reasonable negotiations;
  • Include relevant payments in future holiday pay calculations – you would need to carefully consider how and when to do this; and/or
  • Change working practices – you may be able to reduce your holiday pay bill, for example, by reducing overtime or removing allowances and incentives (but be wary of breaching contractual arrangements).

These developments are undesirable for employers and, with potential liabilities in the millions-of-pounds for some businesses, could become a business critical issue.

However, you can manage your risk once you’ve taken steps to understand it. For many manufacturing companies, this should be a business priority.