WHENEVER a business goes into administration investors, creditors and employees are at risk of losing out financially.
How to distribute the assets of an insolvent business is governed by the Insolvency Act 1986. However, the order of priorities as set out in the Act, it has been argued, is unfair on employees, the self-employed and small suppliers.
The recent collapse of City Link (which went into administration on 24 December 2014) has only highlighted this further. This conclusion has also been reached in a joint report published by Parliament’s Scottish Affairs and Business Innovation and Skills Committees on 23 March 2015 which concluded that the current system is weighted too heavily in favour of investors and does not give enough protection to suppliers, workers and contractors.
The authors of the report are calling for a change in legislation which will redress the imbalance.
The Order of Priorities
When a business goes into administration or becomes insolvent its creditors are paid out in a specific order as set out in the Insolvency Act 1986 which is as follows:
– Fixed charge holders
– Liquidators fees and expenses
– Preferred creditors
– Floating charge holders
– Unsecured creditors
– Interest incurred on unsecured debts post liquidation
Some payments due to employees are preferred (so third in order of priority) and these include:
– Remuneration due for the four month period before the start of insolvency proceedings, subject to a maximum payment of £800. This includes wages, sick pay, statutory maternity pay, guaranteed payments, overtime and the protective award for failure to properly consult about redundancy
– Accrued holiday pay (which is outside of the £800 cap)
– Certain pension contributions
All other sums due to employees such as pay in lieu of notice, redundancy pay, unfair dismissal pay and unpaid expenses rank as unsecured debts. In the majority of cases these debts will not be paid to the employee.
The National Insurance Fund
Where the employer is insolvent employees can also claim up to eight weeks pay from the National Insurance Fund. This includes salary and some other payments including remuneration under a protective award. This is funded by the tax payer so in effect the tax payer is in the case of a protective award paying for the employer’s failure to comply with employment legislation.
This is only open to employees and therefore self-employed and other contractors, as well as small businesses, will still lose out.
An insolvency situation will in many circumstances mean that the employees of the business are redundant. Employers who are dismissing more than 20 employees within a 90 day period are required to follow a statutory redundancy process which involves consultation with employees or appointed representatives. A failure to do so will result in employees having a claim for a protective award.
What has been highlighted by the City Link case is that it is actually in the business’ best interest not to go through the consultation process, the purpose of which is to ensure that employees are forewarned about any pending redundancy and give them time to find alternative employment. This means that deliberately withholding information about the financial situation of a company to the detriment of employees is a decision that many insolvent businesses will take. This results in the employees having a claim for the protective award which the National Insurance Fund is liable to pay but which is actually being funded by the tax payer.
Given the conflict between modern employment legislation and the Insolvency Act 1986, the committee has made a number of recommendations which call for substantial changes to the insolvency legislation which it hopes will protect employees, contractors, workers and the self-employed.
The committee has made the following recommendations:
– Development of best practice guidance on the sharing of information with employees and trade unions where an administration order is likely.
– A procedure for sharing information when a company goes into administration to ensure that those effected have time and the opportunity to take advice.
– Clarification of employers and insolvency practitioners’ obligations to consult on redundancy during administration.
– A crack down on bogus self-employed status.
– An update to the order of payments as set out in the Insolvency Act 1986 to give preferred status to all company workers whether or not they are directly employed and also to consider how to deal with the employees of small companies caught up in a large organisations administration.
What is clear is that it is the small business, employees and the self-employed that always lose out when a large organisation becomes insolvent. These reforms, if they do take place, will help to redress the balance and protect those that often suffer the most in what is a very difficult situation for all concerned.
Tracy Lacey-Smith is the joint head of commercial litigation & dispute resolution at SA Law
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